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Summary for
the busy executive
The check-kiting scheme between the U.S.
Treasury and the Fed, that has been going on quite openly
for some 35 years, may have now been supplemented with another, this
time between the Fed and the Bank of Japan, conducted in high secrecy. It
involves the conspiratorial exchange of non-interest-bearing yen balances for
interest-bearing Treasury debt in ever greater volume, over and above
the need to finance the American trade deficit with Japan, huge as the latter
may already be. The purpose of the conspiracy is to forestall a run on the
dollar by other central banks and foreign exchange speculators. If my
assumption about the existence of this conspiracy is correct, then the
end-game of the regime of irredeemable currencies will be stretched out by
another decade or so. However, that decade will not be one of inflation most
observers expect. It will be one of deflation and world-wide depression which
hardly anybody expects. Speculators shorting dollar-bonds will be massacred,
and people in debt hoping to find relief in inflation will be squeezed out of
their possessions. Reports on the demise of the bond bull have been Grossly (sic)
exaggerated. Bill Gross, the self-styled Bond King, now talks about tsunami
in the bond market with several more waves to come.
Aristotle's axiom and the history
of money
The history of money can be compressed into
one line: man's efforts to defeat Aristotle's axiom asserting that it is not
possible for any substance to be simultaneously present at two different
places. Clearly, Aristotle meant physical substances. Intellectual substances
such as a promise to transfer ownership of chattel, or title to real
property, can be simultaneously present in two different balance sheets. This
is why governments are so enamored with paper
money, another intellectual substance very different from gold money, which
is a physical substance subject to Aristotle's axiom.
Stories about inspectors visiting rural banks
in Scotland abound. The inspector's carriage was preceded by another, drawn
by the fastest horses available in the country, loaded with gold coins to be
shown to the inspector when he arrives, then to be moved post-haste to the
next bank on the inspector's itinerary. In fact, companies existed to provide
this important service to the banks. A worthy topic for research in economics
could be the question to what extent the breeding of racehorses in England
was financed by the desire of banks to defeat Aristotle's axiom. If we still
had a gold standard, we would probably read about bank inspectors flying with
the speed of Mach 1, preceded by another airplane carrying gold with the
speed of Mach 2. By the time inspectors caught up with progress and could
also fly with the speed of Mach 2, there would be supersonic aircrafts, the
development of which was financed by the banks, to fly gold ahead of bank
inspectors with the speed of Mach 3.
Invention of check-kiting
Luckily for the banks this was not necessary.
Irredeemable currency made flying gold back-and-forth pointless. The banks
soon found a less expensive way to defeat Aristotle's axiom. They invented
check-kiting which, if necessary, could be operated with the speed of light.
This is how it goes. Two banks, A and B, conspire. Bank A
issues an unbacked check payable to Bank B.
Then Bank B issues a second unbacked check
of similar amount payable to A that can be shown when the first check
is presented for payment. Then A issues a third unbacked
check of similar amount payable to B that can be shown when the second
check is presented for payment. And so on and so forth. The game the two
banks play can be continued indefinitely with the result that they have
appropriated, quite fraudulently, the amount of the first check, the wages of
conspiracy.
"Float" is the name of the sum total
of checks in the process of clearing. It is obvious that banks A and B
have tapped into the float to enrich themselves. In actual practice
check-kiting is more complicated in that the two conspiring banks do not act
under their own name but employ proxies in order to make detection more
difficult. Naturally, the criminal code prescribes stiff penalties for this
crime, a form of embezzlement. However, it is important to understand that
detection is extremely difficult as the embezzled sum is extracted from a
large number of accounts, and the loss suffered by any individual account
holder is relatively small. Victims don't notice their loss and no complaint is lodged.
To recapitulate: check-kiting consists in
issuing an unbacked check that the conspiring banks
"back" with an endless string of further unbacked
checks. These unbacked checks don't bounce. At the
clearing house each is offset by the next. Under a gold standard check-kiting
is not possible because of the existence of an ultimate means of payment, the
gold coin. Individuals can protect themselves against fraud by presenting
checks for payment in specie. The essence of the regime of irredeemable
currency is that there is no ultimate means of payment, so the individual is
deprived of protection against the crime of check-kiting.
Check-kiting made legal
Before 1968 there was a legal requirement that
Federal Reserve notes be backed by gold for no less than 25 percent of their
face value. To that extent the public was protected against check-kiting, as
an audit could be held at any time to ascertain that the gold was there. In
1968 Congress in its wisdom repealed the legal requirement to back Federal
Reserve notes by gold. After F. D. Roosevelt had made the possession of gold
coins a crime by executive proclamation in 1933, the individual could no
longer test checks against kiting. Nonetheless, legal requirement for gold
backing provided a modicum of protection of the public against large-scale
fraud.
The repeal of gold backing was said to be
justified by the need that Treasury gold should not be tied up for domestic
purposes but be available to pay foreign creditors of the United States in
order to bolster the international value of the dollar. This was deemed
sufficient protection to domestic holders of dollar balances as well. If it
was, this protection was soon taken away, too. President Nixon defaulted on
the foreign-held debt of the United States three years later in 1971, and the
dollar lost more than 90 percent of its purchasing power in less than 10
years.
The default removed the last obstacle in the
way of the largest check-kiting scam in history. The conspirators were the
U.S. Treasury, issuing obligations in the form of government debt, and the
Federal Reserve, issuing obligations in the form of Federal Reserve notes and
deposits. The former were supposed to be extinguished by paying out the
latter, and the latter were offset in the balance sheet of the Federal
Reserve banks by the former. Technically correct, but rotten to the core. A
most incestuous relationship that is consummated through check-kiting.
As check-kiting between banks A and B
taps into the float and victims are the account holders belonging to the same
clearing house, so check-kiting between the U.S. Treasury and the Federal
Reserve taps into the wealth of the nation and victims are all the producers,
consumers and savers in the country.
There are several problems. First, the value
of Treasury obligations is not fixed but varies inversely with the rate of
interest. It could theoretically go to zero if interest rates rose beyond any
limit, as indeed they threatened to do in the late 1970's. Since Treasury
obligations balance the liabilities of the Federal Reserve banks, the dollar,
too, is staring at the bottomless pit into which its value could fall in
adversity. However, the main problem is that, although check-kiting is done
quite openly, it is done in bad faith nevertheless. The U.S. Treasury and the
Federal Reserve banks have neither the means nor the intention to meet their
obligations value for value. Paying off Treasury debt with Federal Reserve
notes, the backing of which is the same Treasury debt, is a scam to fool and
plunder creditors, domestic and foreign. And among creditors we must count the
poorest of the poor who has to have Federal Reserve notes to buy food for his
children. It was no accident that the Big Bang marking the beginning of
debt-explosion in the world occurred in 1968, the year of the legalization of
check-kiting in the United States.
Federal Reserve notes may be made "legal
tender" by capricious and coercive legislation, but they certainly
cannot be made the "ultimate means of payment". They are the
product of legalized check-kiting.
Exportation of check-kiting
An early consequence was that the foreign
central bank creditors of the United States suffered huge losses as their
dollar-denominated reserves were depreciating both in absolute terms and also
relative to the domestic currency. Since the two most important creditors were
Germany and Japan that had been vanquished in World War II and were
technically still under military occupation, a little bit of arm twisting
brought quick results. Losses on the books of their central banks were offset
through a local version of check-kiting. The Japanese government issued
special obligations to paper over the holes that the dollar default punctured
in the balance sheet of the Bank of Japan. The problem was similarly
"solved" in Germany. Thus the original check-kiting in the United
States begot more check-kiting abroad through damage-control, which was done
without much public fanfare. Financial journalists and academic experts
"forgot" to quiz the Bank of Japan and the Bundesbank
about the miraculous disappearance of losses due to default on the dollar.
Virtually all critics of irredeemable currency
ground their objections in the Quantity Theory of Money arguing that as the
quantity of paper money increases faster than goods and services, prices will
increase and paper money will eventually lose all its value. I have never
accepted this simplistic explanation as it ignores the fact that paper money
can buy other things beside goods and services. In particular, it can buy
bonds. And to the extent it does, it could cause the exact opposite effect to
that predicted by the Quantity Theory. Instead of causing inflation, it could
cause deflation, and worse. Much worse. Of course, blatant increases in the
money supply will alert people and they will be reluctant to buy bonds, no
matter how high a figure the government prints on the interest-coupons.
Still, I can't consider this an adequate protection against deflation because
the loop-hole, check-kiting between central banks, remains and can trump the
Quantity Theory. This is exactly the situation that we are facing right now.
More check-kiting to save the
dollar
This also explains why managers of the
dollar-based international monetary system chose the roundabout way to
monetize government debt in preference to the direct way. They certainly had
the power to inflict pure fiat money on the people of the world, that is, the
dollar could be non-interest-bearing, never-maturing U.S. Treasury debt. This
would bring large savings for the U.S. government that would not have to pay
interest on the national debt to the extent it could be put in circulation.
Arguably, a balanced U.S. budget would boost confidence in the value of the
dollar like nothing else could. From the point of view of the advocates of
irredeemable currency, the regime of pure fiat dollar would be superior to
the present regime with its ghastly and worsening budget deficits due largely
to interest payable on the national debt.
However, the managers are aware more than
anybody else that pure fiat money has a record of 100 percent mortality through
the sudden-death syndrome, the congenital disease of irredeemable currencies.
The managers hope that, through chicanery and fraud, they could save the
dollar from sudden death. They are counting on people being too stupid to see
through the scam of check-kiting.
But, as the accelerating avalanche of debt in
the world shows, theirs is a forlorn hope. The managers must have a
contingency plan to fend off a run on the dollar by central banks and foreign
exchange speculators, thus defying the sudden-death syndrome. This
contingency plan involves highly secret check-kiting between the Federal
Reserve and the Bank of Japan.
You can't cry
"conundrum" too many times
I have no other proof than logic, and so far
events have justified my theory. Bonds are defying gravity, even in the face
of the Fed increasing short-term interest rates. The yield-curve is
flattening as expected, but not because the intermediate and long yields are
going up less than the short. It is flattening because they are going
down in the face of the short which is going up. Bill Gross of
PIMCO, who considers himself the best bond manager in the world, calls this
extremely rare phenomenon bull flattener. He says it is as rare as Ahi tuna that never hits the grill. Of course, there is
an element of self-justification in this observation. Last year Bill Gross,
writing at length in the widely-followed Investment Outlook of PIMCO,
declared the bond bull dead. However, the dead bull, like Mark Twain reading
his own obituary, talked back saying that "reports of my demise are
Grossly (sic) exaggerated". One should think that Bill Gross owes
an explanation to his followers who might have shorted bonds based on his
analysis and suffered losses as a consequence. This is quite an embarrassment
for someone who likes to picture himself as the Bond King. He is seeking
solace in the words of Alan Greenspan, uttered before a Congressional
committee, calling the bull flattener a "conundrum". He concludes
that the Fed King sitting on his throne, scepter in
hand, is no less mystified than his subaltern who should be excused for the
mistake in calling the bond bull dead.
Could the Bond King be so naive? Has it not
occurred to him that the wily old hypocrite on the throne, scepter in hand, might pretend to be mystified because he
has a hidden agenda? His carefully selected word "conundrum" could
be red herring. While publicly pretending that he does not understand it,
privately Greenspan may be congratulating himself upon his success in
punishing those who shorted bonds, and intimidating those who were ready to
short the dollar.
Here is my solution to Greenspan's
"conundrum". The bull flattener was deliberately inflicted upon the
yield curve by Greenspan himself through his highly secret check-kiting in
conspiracy with the Bank of Japan. It involves the swap of
non-interest-bearing yen balances and interest-bearing Treasury debt in ever
greater volume, over and above the need to finance the American trade deficit
with Japan, huge as though the latter may be. The purpose of the conspiracy
is to confuse the issue, thereby nipping the run on the dollar in the bud.
Bill Gross now talks about a bond market
tsunami with several more waves to come. Sorry, the bear market in bonds may
not be in the offing for some time to come, because of the unscheduled
tsunami. Oh well, if he has made a mistake once, he can be mistaken again.
But an even greater mistake was made by Greenspan himself who let the genie
of tsunami out of the bottle while crying "conundrum". Call it
tsunami or call it deflation if you like, it may not be possible to put the
genie back into the bottle.
As Greenspan's deceit dawns upon them, bond
speculators will not let themselves be outfoxed. They will repurchase the
bonds of the ownership of which they have been tricked out by the wily old
fox. Worse still, they will buy more, expecting that nice back-wind from the
Fed to make pyramiding risk-free. As a result bond prices will rise, interest
rates will fall, and linkage will cause commodity prices to fall, too. As
they do, Greenspan will have the urge to cry "conundrum" once more,
this time out of genuine fear. But just as you cannot cry "wolf"
too many times because the wolf will appear to put an end to your crying, you
cannot cry "conundrum" too many times either.
The
deflation-cat chasing its own tail
Greenspan will have a job to contain declining
prices. Guess what will he do? Use helicopter drop of Federal Reserve notes,
as Milton Friedman has suggested? That makes a good joke, but now the
situation is deadly serious. He will try to contain deflation through the old
Keynesian recipe, open market purchases of bonds, putting new money into
circulation in the hope that it will flow to the commodity market. But isn't
this just the nice back-wind speculators have been waiting for to make bond
pyramiding risk-free?
The deflation-cat is now ready to chase its
own tail. Bond speculators buy bonds causing commodity prices to fall, which
prompts open-market purchases of the Fed trying to coax speculators into
buying commodities. Instead, speculators will buy more bonds, risk-free, and
the vicious circle is on.
Behold the deflationary denouement of the
regime of irredeemable currency.
March 7, 2005
Dr. Antal E. Fekete
References
Bill Gross, Too
Much! (The weak dollar - causes and consequences)
Investment Outlook, PIMCO
November, 2004, www.321gold.com
Bill Gross, I've
Got to Admit It's Getting Better, Getting Better All the Time
Investment Outlook, PIMCO
March 2005, www.321gold.com
Antal E. Fekete, Causes and Consequences of Kondratiev's Long-Wave Cycle,
January, 2005, www.financialsense.com
Antal E. Fekete, Stop Greenspan from Plunging America into
a Depression,
June, 2003
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