[R-G] [BillTottenWeblog] The Retreat of the Shadow Lenders

[Bill Totten]

Why Deflation, Not Inflation, is the Order of the Day

by Ellen Brown

www.webofdebt.com (June 18th 2009)


While contrarians are screaming "hyperinflation!", the money supply is
actually shrinking. This is because most money today comes into existence
as bank loans, and lending has shrunk substantially. That means the Fed
needs to "monetize" debt just to fill the breach.

On June 3 2009, Federal Reserve Chairman Ben Bernanke assured Congress,
"The Federal Reserve will not monetize the debt". Bill Bonner, writing in
The Daily Reckoning, said it had a ring to it, like President Nixon's "I
am not a crook" and President Clinton's "I did not have sex with that
woman". Monetizing the debt is precisely what the Fed will do, says
Bonner, because it has no other choice. The Chinese are growing reluctant
to lend, the taxpayers are tapped out, and the deficit is at unprecedented
levels. "Even good people do bad things when they get in a jam. The Feds
are already in pretty deep ... and they're going a lot deeper."

But Mr Bernanke denied it. "Either cuts in spending or increases in taxes
will be necessary to stabilize the fiscal situation", he said.

Both alternatives will be vigorously opposed, leaving Congress in the same
deadlock California has been in for the last year. That makes the
monetization option at least worth a look. What is wrong with it? Bill
Bonner calls it "larceny on the grandest scale. Rather than honestly
repaying what it has borrowed, a government merely prints up extra
currency and uses it to pay its loans. The debt is 'monetized' ...
transformed into an increase in the money supply, thereby lowering the
purchasing power of everybody's savings".

So say the pundits, but in the past year the Fed has "monetized" over a
trillion dollars worth of debt, yet the money supply is not expanding. As
investment adviser Mark Sunshine observed in a June 12 blog:

"[W]hile media talking heads were ranting about how the Fed was running
their printing presses overtime to push up money supply, the facts were
very different. M1 has actually declined since the middle of December
2008. During the same six month period M2 has only risen by a little less
than three percent."

The Fed is no longer reporting M3, the largest measure of the money
supply, but according to Sunshine:

"[W]e know that broader measures of money supply, like M3, haven't
materially risen in 2009.

"M3 followers can get a very rough idea of what M3 would have been, if it
were published, by looking at the Federal Reserve quarterly Flow of Funds
Accounts of the United States which was distributed yesterday. As it turns
out, total net borrowing of the United States (private and public) dropped
approximately $255 billion in the first quarter and other indicators of M3
fell or are about flat (on a net basis) ... [T]his data supports [the]
theory that the fall in private borrowing is more than offsetting the rise
in government borrowing and therefore, at least for the time being,
financing the deficit isn't a problem."


All of this flap about the Fed driving the economy into hyperinflation
because it is creating money on its books reflects a fundamental
misconception about how our money and banking system actually works. In
monetizing the government's debt, the Fed is just doing what banks do
every day. All money is created by banks on their books, as many
authorities have attested. The Fed is just stepping in where the
commercial banking system has failed. Except for coins, which are issued
by the government and compose only about one ten-thousandth of the money
supply (M3), our money today is nothing but bank credit (or debt); and
we're now laboring under a credit freeze, which means banks aren't
creating nearly as many loans as they used to. In February, the Bank for
International Settlements published research showing that European banks
could not settle their debts because of a $2 trillion shortage of US
dollars. Proposals for alternative reserve currencies followed. And in
March, Blackstone Group CEO Stephen Schwarzman reported that up to 45% of
the world's wealth has been destroyed by the credit crisis. The missing
"wealth" cannot be restored without putting the missing "money" back into
the system, and that means getting the credit engine going again.

Congress, the Treasury and the Federal Reserve have therefore been
throwing money at the banks, trying to build up the banks' capital so they
can make enough loans to refuel the economy. At a capital requirement of
eight percent, $8 in capital can be leveraged into $100 in loans. But
lending remains far below earlier levels, and it's not because the banks
are refusing to lend. The banks insist that they are making as many loans
as they're allowed to make with their existing deposit and capital bases.
The real bottleneck is with the "shadow lenders" - those investors who,
until late 2007, bought massive amounts of bank loans bundled up as
"securities", taking those loans off the banks' books, making room for yet
more loans to be originated out of the banks' capital and deposit bases.
In a Washington Times article titled "Banks Still Standing Amid Credit
Rubble", Patrice Hill wrote:

"Before last fall's financial crisis, banks provided only $8 trillion of
the roughly $25 trillion in loans outstanding in the United States, while
traditional bond markets provided another $7 trillion, according to the
Federal Reserve. The largest share of the borrowed funds - $10 trillion -
came from securitized loan markets that barely existed two decades ago ...

"Many legislators in Congress complain that banks aren't lending, and cite
that as an excuse to vote against further bank bailout funds ... But Mr
Regalia [chief economist at the US Chamber of Commerce] said these critics
are wrong. 'Banks are lending more, but seventy percent of the system
isn't there anymore', he said".

Seventy percent of the system isn't there anymore because the traditional
bond markets and securitized loan markets have dried up. Writes Hill:

"Congress' demand that banks fill in for collapsed securities markets
poses a dilemma for the banks, not only because most do not have the
capacity to ramp up to such large-scale lending quickly. The securitized
loan markets provided an essential part of the machinery that enabled
banks to lend in the first place. By selling most of their portfolios of
mortgages, business and consumer loans to investors, banks in the past
freed up money to make new loans ...

"The market for pooled subprime loans, known as collateralized debt
obligations (CDOs), collapsed at the end of 2007 and, by most accounts,
will never come back. Because of the surging defaults on subprime and
other exotic mortgages, investors have shied away from buying the loans,
forcing banks and Wall Street firms to hold them on their books and take
the losses."


The retreat of the shadow lenders has created a credit freeze globally;
and when credit shrinks, the money supply shrinks with it. That means
there is insufficient money to buy goods, so workers get laid off and
factories get shut down, perpetuating a vicious spiral of economic
collapse and depression. To reverse that cycle, credit needs to be
restored; and when the banks can't do it, the Fed needs to step in and
start "monetizing" debt.

So why don't Fed officials just say that is what they are up to and put
our minds at ease? Probably because they can't without exposing the whole
banking game. The curtain would be thrown back and we the people would
know that our money system is sleight of hand. The banks never had all
that money they supposedly lent to us. We've been paying interest for
something they created out of thin air! Indeed, their credit money is less
substantial than air, which at least has some molecules bouncing around in
it. Bank credit exists only in cyberspace.

Ben Bernanke's predecessor Alan Greenspan was sometimes compared to the
Wizard of Oz, the little man who hid behind a curtain pulling levers and
twisting dials, maintaining the smoke and mirrors illusion that an
all-powerful force was keeping things under control. Early in his term,
Chairman Bernanke was criticized for revealing too much. "If you're going
to play the Wizard", said one TV commentator, "you have to stay behind the
curtain". The Chairman has evidently learned his lesson and is now playing
the role, wrapping his moves in that veil of mystery expected of the man
considered the world's most powerful banker, the Wizard who moves markets
with his words.

The problem with the Wizard playing his cards close to the chest is that
investors don't know how to play theirs. The Chinese have grown so
concerned about the soundness of their dollar investments that the head of
China's second-largest bank recently said the US government should start
issuing bonds in China's currency, the yuan. What do we want with yuan? We
need dollars; and we would be better off getting them from our own central
bank than borrowing them from foreign rivals. We could then spend them on
projects aimed at internal domestic development - as the Chinese
themselves have been doing - and get the wheels of production turning
again.

If Ben Bernanke stands by his word and refuses to monetize the federal
debt, Congress should consider issuing the money itself, as the US
Constitution provides. The "full faith and credit of the United States" is
an asset of the United States, and it should properly be issued and lent
by the United States rather than by unaccountable private banks and shadow
lenders.  The true path to economic recovery - the path from an economy
strangled in debt to one blooming in prosperity - is to reclaim money and
credit as public resources, transforming money from private master to
public servant.


_____

Ellen Brown developed her research skills as an attorney practicing civil
litigation in Los Angeles. In Web of Debt (2007), her latest book, she
turns those skills to an analysis of the Federal Reserve and "the money
trust". She shows how this private cartel has usurped the power to create
money from the people themselves, and how we the people can get it back.
Her earlier books focused on the pharmaceutical cartel that gets its power
from "the money trust." Her eleven books include Forbidden Medicine
(1998), Nature's Pharmacy (1998), co-authored with Dr Lynne Walker, and
The Key to Ultimate Health (2000), co-authored with Dr Richard Hansen. Her
websites are www.webofdebt.com and www.ellenbrown.com.

(c) Copyright 2007 Ellen Brown.

http://www.webofdebt.com/articles/quantitative_easing.php

http://webofdebt.wordpress.com/2009/06/18/the-retreat-of-the-shadow-lenders-why-deflation-not-inflation-is-the-order-of-the-day/


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