Even as the Fed has printed trillions of new dollars, they have kept the dollar's value from plummeting by manipulating the futures market. Using dollars to keep the value of the dollar up would seem to violate basic economic principles. It does, and it is like a chain letter or pyramid scheme that cannot continue forever.

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Repealing the Law of Supply and Demand

When you flood the market with widgets, it drives the price of widgets down.  That's Econ 101, the Law of Supply and Demand.  The same principle says that when you try to borrow a ton of money all at once, you run out of people to borrow from, and have to pay a higher interest rate to get others to lend to you.  Borrowing drives the interest rate up.  It's basic economics.

Imagine if it worked the other way.   Suppose you could keep making widgets until the cows come home, and use those widgets (somehow) to keep the price of widgets up.  That would be quite an operation - a sure-fire ticket to riches.  You would keep making more and more widgets, and the value of each widget would keep getting higher and higher.  

Imagine if you could borrow money, and use some of the proceeds to buy yourself a lower interest rate for the next round of borrowing.

It's too bad economics doesn't work that way.  You can't change the Law of Supply and Demand...or can you?

The Federal Reserve has printed more money in the last decade than for the entire previous 200 years put together.  Yes, more money was created between 2003 and the present than for all time from 1776 until 2003.  (The new name for this policy of printing money is "quantitative easing".)  And yet, the value of the dollar is still high.  The dollar has kept its value against gold, against the Euro and the Yen.  Gold, in fact, is at a 5-year low price this spring.  I got to wondering how the Federal Reserve has managed to keep the value of the dollar up, while printing more  money than in all previous history.  

In addition to the money being just printed, the Federal Government is also borrowing new money faster than at any time since World War II.

Econ 101 says that borrowing on this scale should push the interest rate up.  In fact, when Nixon borrowed in the 1970s to pay for the war in Vietnam, interest rates began to rise, with short-term rates peaking at 16% in 1981.  Last month, the rate on 1-year T-Bills fell to one eighth of one percent per year.  That's 0.12%, the lowest it's been since before World War II.  

What's happening?  

The rest of this article is conjecture.  Blame no one but me - this is my guess as to how this has come about.  (I've bounced the guess off the most prominent economists who will answer my emails, and they sorta confirm that this is what they think as well.)

Detour: Derivatives

The Securities Market consists of stocks and bonds - shares of corporations and promises to pay money in the future.  The Derivatives Market exists on the side, as a way for people to make bets on the future behavior of stocks and bonds, and a lot of other things as well, including the price of gold and the exchange rates among various world currencies.  In the good old days, trading in the derivatives markets was overseen and regulated by the SEC. The price of the side-bets in the derivative markets followed the prices of stocks and bonds in the securities market.  The securities markets were the dog and the derivative markets were the tail.  

Beginning in the Reagan era and continuing through to the present in D and R administrations alike, a policy of deregulation has been pursued.  The SEC no longer asserts effective control over the derivative markets.  At the same time, the size of the derivative markets has mushroomed.

The result is that now the tail is wagging the dog.  Instead of the primary markets leading the price of the derivatives, the derivative markets are pushing the primary markets around.

A widget called the US Dollar

Let's go back to our fantasy of creating more and more widgets and using the widgets to keep the price of the widgets high.  For the widget called "US dollar", this is precisely what the Federal Reserve has managed to do.  The game is to use some of that boatload of newly-printed dollars to bet in the futures market.  Bets are placed, for example, on the price of gold.  The bets are made "on margin", which means they are highly leveraged.  For each $1 that you have on deposit, you may be able to bet on the price of $50 worth of gold.  

The Fed, acting probably through Goldman Sachs and other private agents, places heavy bets that the price of gold will go down.  Of course, the people on the other side of those trades are betting that the price of gold will go up.  They are not so sure of themselves, nor do they have the unlimited backing that the Fed has.  So the people on the other side of the bets do what prudent betters do everywhere: they hedge their bet that the price of gold will go up by selling real, tangible gold in the primary marketplace.  This practice of bet-hedging is called "arbitrage", and it can be a way to lock in a sure profit.  (As long as the price of gold in the derivatives market is lower than the price of gold in the primary market, the arbitrager can buy "paper gold" and sell "physical gold" and pocket the difference in price.)

So the price of physical gold is pushed down by the price of the bets in the derivatives market.  The tail is wagging the dog.  The strange thing is that this is in exact opposition to the law of supply and demand.  The Fed is able to create new dollars at unprecedent speed, and use those dollars to bet that the dollar's value will go up.  Since those huge bets are made in a leveraged derivatives market, they become a self-fulfilling prophesy; the value of the dollar floats upward and the price of gold goes down.  In order to do this, no actual gold is needed.  But new "paper gold" must be continually "manufactured".  The amount of paper gold in the world goes up and up and up, while the amount of real gold stays the same, or increases much more slowly via old-fashioned mining operations.

In a game of poker, the man with the largest stack of chips has a distinct advantage.  Even without the luck of a good hand, he can raise the bid higher than other players can afford to match, forcing them to abandon the position they've got on the table and withdraw from the hand, essentially by sheer bluster.  In the derivative markets, a similar manipulation is possible.  If the Fed sells a lot of gold futures rapidly, that creates paper losses for people who have speculated in gold on the upside.  When these losses exceed the amount they have on deposit, brokers will call them up and demand more money to stay in the game.  Brokerage policies even allow them to sell the position automatically if there is any question that the available cash can cover the loss.  When this happens, it adds to the imbalance of selling over buying, dragging the price down yet faster.

This is an old and well-known tactic for market manipulation.  In the US, there are laws against it, and there was a time when the SEC would investigate and prosecute market manipulation.  That time is not now.

What about inflation?

By the old rules, printing so much money would cause inflation.  In fact, there seems to be some indication in the real economy that prices are rising - especially prices for food, raw materials, and basic necessities.  But statistics are being doctored to make it look as though the inflation rate is modest.  (John Williams over at ShadowStats.com  documents the difference between government-published inflation rates and his measure of inflation, calculated according to historic standards.)

It helps that the American economy is sputtering along so slowly that ordinary people don't have the money to pay for the basics; otherwise prices would be pushed up much faster.

Interest rates are suppressed in the same way

Just the same game can be played with interest rates.  There are derivatives for interest rates as well as for commodity prices.  The Fed borrows money, and uses the money to bet in the derivatives market that the interest rate will go down.  The bets are huge.  The bets themselves motivate arbitragers to buy up T-bills, pocketing the marginal difference in price between the derivative price and the price in the primary market.  Using leveraged bets in the derivatives market, the Fed is creating real-world demand for its own T-bills.  In addition, the Fed has also become the largest direct purchaser of T-bills, far outstripping the Chinese in recent years.

How do I know this is happening?

I don't, really.  I'm guessing, based on a few hints.  The price gap between paper gold and physical gold keeps growing, suggesting there's something unreal about the price of gold.  The low interest rate doesn't mean that banks are eager to lend money to peons like you and me.  (I managed to get a 3.5% mortgage this spring, but the application process was a nightmare.)  And Paul Craig Roberts pointed out in an article this Spring that the timing of large gold sales has been just the opposite of what you would expect if someone had a lot of gold to sell and wanted to maximize the price it could fetch in the marketplace.  

How long can this last?

I'm not going to try to guess.  Suffice it to say I have had a terrible record in the past, forecasting disasters decades before they occur.

How will it end?

As Yogi Berra said, it's hard to make predictions, especially about the future.  But here are some facts that might help us imagine where we are headed:

• The total value of the derivative market is now estimated to be one and a half quadrillion dollars.    To put that number in perspective, it's 11 times the net worth of everyone in the world put together..  It's twenty years worth of the world's GDP.  It's a hundred times bigger than it was just fifteen years ago.

• In theory, paper gold is exchangeable for the real thing.  (Of course - that's what gives it value.)  But the amount of paper gold far exceeds the physical gold in the world, and at some point, the people who hold paper gold will turn in their chips faster than sources of physical gold can keep pace.  At the first hint of default, everyone who holds paper gold will rush for the door at once.  The price of gold could rise precipitously.  The same thing could happen with the value of world currencies that are backed more firmly than the dollar.

• Since 1982, the US has been importing more than we export, and borrowing to make up an ever-growing gap between the two. The BRICs are the largest countries that are still exporting more than they import - Brazil, Russia, India and China.  They have been happy to accept dollars for their wares, but now that the dollar has been debased and propped up by the derivatives market, they may decide to demand payment in some currency not controlled by the Federal Reserve.  Just this spring, the BRICs met in South Africa and issued a call for a new global currency.  

• The US is still a net exporter of food, but virtually all our manufactured small consumer goods are imported.  Clothing, furniture, and electronics are imported.  Some percentage of large appliances and automobiles purchased by Americans are still manufactured here, and about half our oil comes from American wells. So if there is a collapse in the gold market or the dollar goes south, it is small manufactured goods that will most quickly become dear.  The price tags at WalMart could begin to make you think of Neiman Marcus.  People who invested early in energy conservation and alternative energy will be lionized as if they had some kind of ESP.

• I feel confident in predicting that this implosion of the world's economic system will precipitate a crisis for democracy.  Whether it leads to a populist uprising or a tightening into a full-fledged police state depends on us.  Don't count on the courage of our political leaders.

  
  
  
  Authors Bio:
  
  
  
  

  Josh Mitteldorf, de-platformed senior editor at OpEdNews, blogs on aging at http://JoshMitteldorf.ScienceBlog.com. Read how to stay young at http://AgingAdvice.org.
  
  Educated to be an astrophysicist, he has branched out from there to mathematical modeling in a variety of areas, including evolutionary ecology and economics. He has taught mathematics, statistics, and physics at several universities. He is an avid amateur pianist, and father of two adopted Chinese girls, now grown. He travels to Beijing each year to work with a lab studying the biology of aging. His book on the subject is "Cracking the Aging Code", http://tinyurl.com/y7yovp87.