Submitted by Maurizio D'Orlando of AsiaNews.it
Currency Wars And The Fed’s Demise
The Federal Reserve has decided to buy US Treasury bills for about US$ 600 billion in all, in monthly installments of about US$ 75 billion over eight months, until June 2011. However, this action will not achieve the desired goal of economic growth, nor will it change the US labour market, this according to most analysts and security traders surveyed by Bloomberg in its quarterly “Global Poll”. In fact, more than half of 1,030 experts who took part in the survey, expressed doubts about the Federal Reserve’s move. For more than 70 per cent of them, the Fed’s second round of quantitative easing (QE2) is largely an attempt to adjust the exchange rate of the US dollar against other currencies. Thus, according to such set of views, the Federal Reserve (de facto but not de jure the US central bank) wants to redress the trading disadvantage US manufacturers have accumulated over the last few decades and cut the US trade deficit.
For many, the QE2 is seen aimed at contrasting by design those economies which have set their manufacturing structure upon an export-driven growth model. It is no accident that the sharpest critics of the Fed’s QE2 have come from China and Germany, both of which reiterated their positions at the recent G20 summit in Seoul, South Korea. The huge injection of liquidity in the US system conceals, in reality the desire to manipulate the US dollar exchange rates, said Donald Tsang, president of the Executive Council of Hong Kong. For him the risks are much higher. "International investors should tighten their seat belts and get prepared for unprecedented turbulence in currency markets, bond markets, stock markets and the property market," said Tsang.
The end result could be something similar to the Asian crisis of 1997 and 1998.
However, such criticism is too often self-serving in nature.
Currency wars and trade deficits: China’s QE
The US trade balance has been in negative territory since 1980 (picking up speed in 1985) against countries like Canada, Japan and Germany who have seen their trade surplus against Uncle Sam grow. The negative balance (for US goods) accelerated further in 1997, two years after China’s yuan was devalued, and customs duties began to be progressively removed, easing the way of Chinese products into the US market. The US trade balance, then, fell down the cliff when in December 2001 China joined the World Trade Organisation (WTO), the international body imposing regulations to world trade with the general aim to remove (or at least reduce) tariff barriers within a framework of binding agreements and treaties .
When it joined the WTO, China was allowed to keep a highly undervalued currency, as well as tight controls on capital movement and the exchange rate, as we had pointed out back in 2003. AsiaNews was one of the first media to estimate the yuan’s undervaluation (about 40-45 per cent) by using a specific reference point, i.e. its purchasing power parity exchange rate with the US dollar. In practice, we observed, the exemptions have “enabled China to maintain the devaluation at a [more or less] constant level as it was established by the Chinese monetary authorities on 1 January 1994”. We said it years ago, and little has changed since then.
China has been doing it for all these years what the Federal Reserve did on 3 November. It has artificially kept its currency below its (theoretical) market value, printed yuan and bought dollars (from Chinese exporters) in order to buy (so far) US Treasury securities. It is quantitative easing, Chinese- style, as Prof Morici shrewdly noted. This has given Beijing the means to accumulate surpluses uninterruptedly and maintain an average 10 per cent growth even in this phase of the current depression. Today, China’s QE is reflected in the country’s distorted domestic demand. Instead of profiting hundreds of millions of underpaid workers, such huge liquidity has been hoarded, placed in shelter investment assets by Communist Party apparatchiks, which explains the mainland’s current real estate bubble and the many empty buildings dotting the country’s urban landscape.
Those, who in the past sang the praise of “globalisation” (based on such rigged exchange rates formula) and said that it would have cushioned against difficult economic times, today should be rather quiet, hold their peace and meditate about today’s crisis, which is for all intents and purposes the first Global Depression. However, we cannot blame only the Americans; the fault is global and there is enough to go around. For at least ten years, the rest of the world accepted Chinese goods, sold at a 40 per cent discount, in order to subvention a soft transition for the Asian giant as it tried to replace a Stalinist command economy with today’s ‘Communist-Capitalist’ system. Under the circumstance, China is not in a position to lecture others.
The Fed’s responsibilities
Having said this, there is nothing that justifies the Federal Reserve’s decision to start a currency war by launching its QE2 as a way to redress America’s trade imbalance. In fact, Donald Tsang’s argument is not very plausible. Even if this were QE2’s final outcome, the Fed’s move was not started off or triggered by the need to redress trade imbalances, but rather from a domestic imperative, namely the survival of the US banks and financial system. All one needs to do is read Bernanke’s speech to find out.
The table below, which is a modest examination by this author of the Federal Reserve’s balance sheet, makes this clear right away. Undoubtedly, this table does not pretend to be an exhaustive analysis and reclassification of the original balance; for that to be the case, it would have to be more comprehensive.
4 March 2009 3 November 2010 increase US Treasury Securities (total value) (a) $ 474,607 $ 839,990 76.99 per cent of which of which of which Federal securities, notes and bonds $ 412,914 $ 772,975 87.20 per cent Federal agency debt securities (b) $ 38,252 $ 149,681 291.30 per cent Mortgage-backed securities (c) $ 68,862 $ 1,051,037 1426.29 per cent Total (a) + (b) + (c) $ 520,028 $ 1,973,693 279.54 per cent Total Federal Reserve balances $ 1,943,478 $ 2,340,440 20.43 per cent Proportion of (a) + (b) + (c)] out of total Federal Reserve balances. 26.76 per cent 84.33 per cent
4 March 2009
3 November 2010
US Treasury Securities (total value) (a)
76.99 per cent
Federal securities, notes and bonds
87.20 per cent
Federal agency debt securities (b)
291.30 per cent
Mortgage-backed securities (c)
1426.29 per cent
Total (a) + (b) + (c)
279.54 per cent
Total Federal Reserve balances
20.43 per cent
Proportion of (a) + (b) + (c)] out of total Federal Reserve balances.
26.76 per cent
84.33 per cent
Figures are in millions of dollars. The chosen date, 4 March 2009, is the last one referable directly the previous Bush administration after President Obama and his administration took office in early February 2009. The date of 3 November looks at the situation before this month’s QE2.
For the sake of understanding, when we speak above about federal notes were are not talking about ordinary bank notes, but securities in large figures that, unlike bonds cashable on due date, are cashable at any time. As for the federal agencies that issued debt securities, we mean organisations like Fannie Mae and Freddie Mac that issued subprime loans (but not AIG, whose debt titles are registered separately).
A frightening US public debt
Looking at these numbers, certain things come to mind right away. With a portfolio of US$ 773 billion, the Federal Reserve is on its way of becoming the main holder of US Treasury securities. Within about one month from the start out of QE2, it will overtake China, which currently holds US$ 868 billion.
This is a patent economic inconsistency. What it means is that the Fed is unable to sell a good chunk of its securities (failing to attract both US and foreign investors) to meet, if nothing else, the federal government’s current spending commitments. This is not surprising though since the US government debt is not “60 per cent of current gross domestic product, “but rather “840 per cent,” according to Laurence Kotlikoff (a little less according to this author, but of the same magnitude).
Secondly, one does not have to be a graduate in economics to realise that the increases in ‘federal securities, notes and bonds’ (+ 87.20 per cent) and federal agency debt securities (+ 291.30 per cent) are huge for such a short period of time (12 months). As for mortgage-backed securities (+ 1,426.29 per cent), the jump is frightening and deserves a closer look, which we shall do below.
In the meantime, if we take these three items together, we see that they have represent the largest part of the total Federal Reserve Balances, going from 26.76 to 84.33 per cent in the period under consideration. The Fed’ balance sheet has thus been completely turned around. What this means is that what Ben Bernanke had said would not happen when he appeared before the US Congress has actually happened, namely the monetisation (conversion) of government debt into currency.
The scandal of mortgage notes
As for, mortgage-backed securities (MBSs), they saw a 14-fold rise. As of November of this year they constitute 44.91 per cent of the total Federal Reserve assets side of the balance sheet (albeit this not exactly so). However, don’t be fooled by the name. We are not talking about securities that are backed by mortgages on real property. We are talking about what journalists call “cash for trash”.
First, most MBSs are not directly issued by big financial institutions, but by ad hoc companies (SPV, special purpose vehicles), empty boxes that contain hundreds of thousands of mortgage notes of various kinds. A huge scandal is brewing right now, one that the main US media have chosen to ignore so far. At the core of it are thousands of mortgage notes signed by officials who were not entitled to sign them and who practically had no control over the documents. In one case, at a court hearing, one official said under oath that after she left high school she went to college for a year but never graduated. Yet, despite her lack of training in either economics or law, she was appointed “notary” after a couple of years. And all she did was sign papers she did not read and that were full of material and factual errors. Notes such as these are worthless, and it would not take long for lawyers to prove it. Up to now, no one knows what proportion of the Fed’s portfolio is constituted by such MBS, how many worthless mortgage notes it has, or how big its percentage of risk of insolvency is. Any private company, whether financial, commercial or industrial would have to make financial provisions in its balance sheet for such a situation. However, on the Federal Reserve’s balance sheet, these mortgages are recorded at their full nominal value. Putting aside the doubts that Kotlikoff (and more modestly by AsiaNews) raised about the sustainability of the US federal debt and the solvability of the United States, mortgage-backed securities represent almost half of the Federal Reserve’s balance sheet, and that is scary.
Sacrificing the Fed
It is very likely that “turbulences” will hit currency markets once the QE2 is implemented. Contrary to what China, Germany and Hong Kong’s Donald Tsang claim, namely that QE2 is part of a deliberate and planned currency war, we at AsiaNews think otherwise. Our criticism is no less damning however when it comes to the health of the US financial system or forgiving towards what the Federal Reserve has done.
For us, the Fed’s decision to initiate a second round of quantitative easing was not really motivated by a desire to lead the United States and the world out of the current economic crisis, but rather from the need to save US banks and their top officials from the consequences of an unimaginable mess (or deceitful system), which was built up over at least the past decade. The only deliberate thing here is the decision to sacrifice precisely the very same Fed itself. This was decided not only to save big financial corporations and their leaders, but also to lay the ground for either a world Federal Reserve, a sort of SuperFed, or (if the former fails) at least one for a North American Fed that would rise out of the ashes left by the existing Federal Reserve, now destined to explode as a result of hyperinflation.
Who controls the priests of money?
Last but not least, let us not forget the Fed’s gold stock , all 261,635,072 ounces of them. In the Fed’s balance sheet, their relative value is given as US$ 11.04 billion, based on US$ 42.3 per ounce. Altogether, they represented 0.57 per cent of the Fed’s assets on 4 March 2009, and 0.47 per cent on 3 November 2010. If however, we look at gold’s actual market value (US$ 911 per ounce in March 2009 and US$ 1,350 per ounce in November 2010), the value of Federal Reserve’s gold stock changes. Thus, they were worth US$ 238.5 billion on 4 March 2009 (12.26 per cent of balance sheet assets), and US$ 353.3 billion on 3 November 2010 (15.09 per cent).
A balance sheet should correctly reflect economic reality. By contrast, the Federal Reserve’s Statistical Releases are pure fantasy. The same can be said for almost all other central banks with the power to print money with legal tender. Many of them do not even release a balance statement. Of course, all this is perfectly legal, but is it right and legitimate? Is it right that an obscure esoteric sanhedrin of private bankers, under no one’s control but their own, can issue money, a public good like few others?
 See Federal Reserve, “Factors affecting reserve balances,” in Federal Reserve Statistical Releases 5 March 2009, and “Factors affecting reserves balances,” in Federal Reserve Statistical Release, 4 November 2010.
 See Tyler Durden, “The Nine Most "Inconvenient" RoboSigning Admissions BofA Would Love To Disappear,” in Zero Hedge, 13 November 2010. All the officials who spoke said that they signed piles of paper, thousands in fact, without checking what was on them. They only made sure that they were putting their signature where their name was.
 “Real numbers show that the (real) ratio between total public debt and GDP, depending on how public debt is defined, stands at between 450 and 900 per cent of GDP,” in Maurizio d’Orlando, The world’s economic crisis, the real global warming,” in AsiaNews, 10 June 2010. See also; ibid. “This year, US public debt could reach end game,” in AsiaNews, 3 March 2010; ibid., “As the world waits for hyperinflation and a world government, Bernanke becomes “Person of the Year,” in AsiaNews, 29 December 2009. See also by the same author, “Clashes between US, China and Iran may account for record gold prices,” in AsiaNews, 12 May 2006; “War scenarios: Iran, oil embargo and the collapse of the world's financial system,” in AsiaNews, 7 August 2006; “Chinese stocks and the risk of economic crisis,” in AsiaNews, 22 May 2007. See many other articles published on AsiaNews dealing with subprime, toxic securities, bank rescue, etc. See again Maurizio d’Orlando, “Subprime lending to trigger world’s worst financial crisis since 1929,” in AsiaNews, 19 September 2007; ibid., “Depth of the abyss of economic, social, political chaos,” in AsiaNews, 30 September 2008; ibid., “Paulson plan: useless and harmful to democracy,” in AsiaNews, 6 October 2008; ibid., “The way out of the crisis is neither Left nor Right,” in AsiaNews, 25 November 2008; and ibid., “Economic crisis: US, China and the coming monetary storm,” in AsiaNews, 9 December 2008