Share on Google Plus Share on Twitter Share on Facebook 2 Share on LinkedIn Share on PInterest Share on Fark! Share on Reddit 1 Share on StumbleUpon Tell A Friend (3 Shares)  
Printer Friendly Page Save As Favorite View Favorites View Stats   3 comments

OpEdNews Op Eds

How to Reverse a Deflation: Helicopter Ben Needs to Drop Some Money on Main Street

By (about the author)     Permalink       (Page 1 of 2 pages)
Related Topic(s): ; ; ; ; ; ; ; ; , Add Tags Add to My Group(s)

Must Read 4   Well Said 1   Supported 1  
View Ratings | Rate It

opednews.com Headlined to H2 9/9/10

Become a Fan
  (173 fans)

In 2002, in a speech that earned him the nickname "Helicopter Ben," then-Fed Governor Bernanke famously said that the government could easily reverse a deflation, just by printing money and dropping it from helicopters. "The U.S. government has a technology, called a printing press (or, today, its electronic equivalent)," he said, "that allows it to produce as many U.S. dollars as it wishes at essentially no cost." Later in the speech he discussed "a money-financed tax cut," which he said was "essentially equivalent to Milton Friedman's famous "helicopter drop' of money." You could cure a deflation, said Professor Friedman, simply by dropping money from helicopters.

It seems logical enough. If there is insufficient money in the money supply (deflation), the solution is to put more money into it. But if deflation is so easy to fix, then why has the Fed's massive attempts to date failed to do the job? At the Federal Reserve's Jackson Hole summit on August 27, Chairman Bernanke said he would fight deflation with his whole arsenal, including "quantitative easing" (QE) purchasing longterm securities with money created on a computer. Yet since 2008, the Fed has added more than $1.2 trillion to "base money" doing just that, and the economy is still in a serious deflationary spiral. In the first quarter of this year, the money supply actually shrank at a record annual rate of 9.6%.

Cullen Roche at The Pragmatic Capitalist has an answer to that puzzle. He says that as currently practiced, quantitative easing (QE) is not really a money drop. It is just an asset swap:

"[T]he Fed doesn't actually "print' anything when it initiates its QE policy. The Fed simply electronically swaps an asset with the private sector. In most cases it swaps deposits with an interest bearing asset."

The Fed just swaps Federal Reserve Notes (dollar bills) for other assets (promissory notes or debt) that can quickly be turned into money. The Fed is merely trading one form of liquidity for another, without raising the overall water level in the pool.

The mechanics of how QE works were revealed in a remarkable segment on National Public Radio on August 26, describing how a team of Fed employees bought $1.25 trillion in mortgage bonds beginning in late 2008. According to NPR:

"The Fed was able to spend so much money so quickly because it has a unique power: It can create money out of thin air, whenever it decides to do so. So . . . the mortgage team would decide to buy a bond, they'd push a button on the computer "and voila, money is created.'

"The thing about bonds, of course, is that people pay them back. So that $1.25 trillion in mortgage bonds will shrink over time, as they get repaid. Earlier this month, the Fed announced that it will use the proceeds from the mortgage bonds to buy Treasury bonds essentially keeping all that newly created money in circulation. The decision was a sign that the Fed thinks the economy still needs to be propped up with extraordinary measures."

"Extraordinary measures" was a reference to Section 13(3) of the Federal Reserve Act, which allows the Fed in "unusual and exigent circumstances" to buy "notes, drafts and bills of exchange" (debt instruments) from "any individual, partnership or corporation" satisfying its requirements. The Fed was supposedly engaging in these extraordinary measures to "reflate" the money supply and get credit flowing again. Yet the money supply continued to shrink. The problem, as Roche explains, is that the dollars were merely being swapped for other highly liquid assets on bank balance sheets. That this sort of asset swap will not pump up a collapsed money supply has been shown not only by the Fed's failed experiments over the last two years but by two decades of failed QE policy in Japan, an economy which remains in the deflationary doldrums. To reverse deflation, it seems, QE needs to be directed somewhere else besides the balance sheets of private banks. What we need is the sort of helicopter drop described by Bernanke in 2002 one over the towns and cities of the real economy.

There is another interesting lesson suggested by two decades of failed QE: it might actually be possible for the government to "print" its way out of debt, without triggering the dreaded hyperinflation long warned of by pundits. Swapping dollars for debt hasn't inflated the circulating money supply to date because federal debt securities already serve as forms of "money" in the economy.

The Textbook Money Multiplier Model . . .
And Why It Is Obsolete

Beginning with some definitions, "quantitative easing" is explained in Wikipedia like this:

"A central bank . . . first credit[s] its own account with money it has created ex nihilo("out of nothing').It then purchases financial assets, including government bonds, mortgage-backed securities and corporate bonds, from banks and other financial institutionsin a process referred to as open market operations. The purchases, by way of account deposits, give banks the excess reserves required for them to create new money, and thus a hopeful stimulation of the economy, by the process of deposit multiplication from increased lending in the fractional reserve banking system."

"Deposit multiplication" is the textbook explanation for how credit expands as it circulates through the economy. In the textbook model, banks must retain "reserves" equal to 10% of outstanding deposits (including deposits created as loans). With a 10% reserve requirement, a $100 deposit can support a $90 loan, which gets deposited in another bank, where it becomes an $81 loan, and so forth, until a $100 deposit becomes $1,000 in credit-money.

The theory is that increasing the banks' reserves will stimulate this process, but both the Federal Reserve and the Bank for International Settlements (BIS) now concede that the process has not been working in the textbook way. (The BIS is "the central bankers' central bank" in Basel, Switzerland.) The futile effort to push more money into bloated bank reserve accounts has been compared to adding more apples to shelves that are already overstocked with apples. Adding more reserves to a banking system that already has more reserves than it can use has no net effect on the money supply.

The failure of QE either to increase bank lending or to inflate the money supply was confirmed in a March 24 paper by Federal Reserve Vice Chairman Donald L. Kohn, who wrote:

"The huge quantity of bank reserves that were created [by quantitative easing] has been seen largely as a byproduct of the purchases [of debt instruments] that would be unlikely to have a significant independent effect on financial markets and the economy. This view is not consistent with the simple models in many textbooks or the monetarist tradition in monetary policy, which emphasizes a line of causation from reserves to the money supply to economic activity and inflation."

Next Page  1  |  2

 

Ellen Brown is an attorney, founder of the Public Banking Institute, and author of twelve books including the best-selling WEB OF DEBT. In THE PUBLIC BANK SOLUTION, her latest book, she explores successful public banking models historically and (more...)
 

Share on Google Plus Submit to Twitter Add this Page to Facebook! Share on LinkedIn Pin It! Add this Page to Fark! Submit to Reddit Submit to Stumble Upon

Go To Commenting
The views expressed in this article are the sole responsibility of the author and do not necessarily reflect those of this website or its editors.

Follow Me on Twitter

Contact Author Contact Editor View Authors' Articles

Most Popular Articles by this Author:     (View All Most Popular Articles by this Author)

It's the Derivatives, Stupid! Why Fannie, Freddie and AIG Had to Be Bailed Out

Mysterious Prison Buses in the Desert

LANDMARK DECISION PROMISES MASSIVE RELIEF FOR HOMEOWNERS AND TROUBLE FOR BANKS

Libya: All About Oil, or All About Central Banking?

Borrowing from Peter to Pay Paul: The Wall Street Ponzi Scheme Called Fractional Reserve Banking

"Oops, We Meant $7 TRILLION!" What Hank and Ben Are Up to and How They Plan to Pay for It All

Comments

The time limit for entering new comments on this article has expired.

This limit can be removed. Our paid membership program is designed to give you many benefits, such as removing this time limit. To learn more, please click here.

Comments: Expand   Shrink   Hide  
3 people are discussing this page, with 3 comments
To view all comments:
Expand Comments
(Or you can set your preferences to show all comments, always)

Here's a comment that came to my email that I thou... by Ellen Brown on Thursday, Sep 9, 2010 at 6:12:37 PM
What we have is an excess of labor, and houses too... by Mike Preston on Friday, Sep 10, 2010 at 2:52:22 PM
group of people who have caused our problem from t... by Samuel Bryan on Monday, Sep 13, 2010 at 12:27:38 AM