WHO’S BAILIING OUT WHOM?

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As with the second quarter newsletter, this edition comes to us at the tail end of the 3rd quarter. As this goes to press, the Senate and House have passed the “Emergency Economic Stabilization Act of 2008”. This act epitomizes the pinnacle of legalized theft. When the bill left the House on first rejection, it contained slightly over 100 pages. As I slog through the final version, it has ballooned to 451 pages bursting with pork to encourage votes from reluctant lawmakers.

To be sure, it includes toys for both men and boys: EXEMPTION FROM EXCISE TAX FOR CERTAIN WOODEN ARROWS USED BY CHILDREN (Sec 503) and SEVEN-YEAR COST RECOVERY PERIOD FOR MOTORSPORTS RACING TRACK FACILITY (Sec 317). However, buried within these extra pages there are a few troubling extracts that we will attempt to dissect in these pages. First and foremost the INCREASE IN STATUTORY LIMIT ON THE PUBLIC DEBT (Sec 122). Title 31, United States Code, is amended by striking out the dollar limitation, inserting $11,315,000,000,000. In case your eyes are bugging out, that’s $11 trillion and some change. By now we should just stop complaining and stem the bloodletting. Banks are selling the family jewels to raise dollars while others are collapsing or being consumed by the ravenous Citi and JPMorgan.

Lest we forget, credit default swaps were invented by JP Morgan. Citigroup invented Structured Investment Vehicles and was the biggest manager of the funds. Citigroup, Hong Kong Shanghai Bank Corp (HSBC), Bank of America and Wachovia started this entire fiasco with an aid and assist from Goldman Sachs, by sponsoring more than half a trillion dollars worth of “off-balance-sheet” affiliates (Hedge Funds) to engage in highly speculative financial deals with money borrowed from America’s commercial system. That is where the money went. As every loss in this world of money has a corresponding gain, a lot of somebodies made a lot of gains. The deposits of the nation fell prey to a pile of fraudulent debt. Who knows what these so-called investments are worth because there is massive selling across the board along with moves to recapitalize the banks.

Up until this point, The Federal Reserve Bank of New York has been more or less quietly trading liquid Treasury securities to banks and corporations within air because it cannot create Banking Reserves without collateral. The banking system currently does not contain enough money in circulation to repay outstanding loans and like a blood transfusion, you can not squeeze it all in at once. This is the Public Debt on 09/30: $10,024,724,896,912 Notice the $300 billion increase from 9-08 (above) to 09-30-08. This is the result of a new facility, the Supplementary Financing Program, that has shown up in the FRBNY balance sheet. The essence of this new device is that the Treasury Department sells Treasury Notes and Bonds at auction and deposits the proceeds with the NY Fed as “cash for use in the Federal Reserve initiatives”. Unlike currency swaps and previous credit facilities, this liquidity injection does not have an offsetting component, it is not a shift in columns, moving from one part of the balance sheet to another. It is accretive and it represents a massive increase in Reserve Balances. This total will multiply many times over as it filters through the money supply. Moreover, there has been an increase in balances kept by the Treasury at the NYFED.

Here are the “Reserve Balances with Federal Reserve Banks” year over year: According to the FEDERAL RESERVE statistical release H.4.1: Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks (in millions) September 26, 2007 NYFed Reserve Funds: $911,442 September 4, 2008 NYFed Reserve Funds: $945,890 September 25, 2008 NYFed Reserve Funds: $1,186,957 Notice the increase in the last year in the Monetary Base of $275 billion. 85% of that came in the last two weeks.

A $275 billion increase in the Monetary Base means, thanks to the multiplier effect, an increase of about $2.75 trillion in the money supply at M2 level, or roughly a 30% increase. Such a dramatic change in the Monetary Base is probably the most reliable indicator of both monetary and price inflation. This is base money. It is the raw material of the money system. Reserve Balances represent the claims of the banking system and the U.S. Treasury Department on the cash held in the vaults of the 12 Federal Reserve Banks. This is the capital in the system. If we increase this base, then the banking system as a whole can create more credit money against this base. Destruction of the monetary base occurs as the loans are paid back.

In fractional reserve economies, the monetary base is not where money comes from; most of it is created through lending. An explanation of how it works from the FRBNY “Reserve Requirements and Money C reation”: “Reserve requirements affect the potential of the banking system to create transaction deposits. Example: a bank that receives a $100 deposit may lend out $90 of that deposit. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money.” This was all done before the $700 billion Congress gifted. Incredibly we can not calculate the massive increase in the money supply that has resulted. Neither can we calculate the ensuing inflation that follows.

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