How the Federal Reserve Destroyed the Functioning American Democracy and Bankrupt the Nation

Federal Reserve Logo

Posted by Chris Hamilton
Monday, November 13, 2017

Against the adamant wishes of the Constitution’s framers, in 1913 the Federal Reserve System was Congressionally created.  According to the Fed’s website, “it was created to provide the nation with a safer, more flexible, and more stable monetary and financial system.”  Although parts of the Federal Reserve System share some characteristics with private-sector entities, the Federal Reserve was supposedly established to serve the public interest.

A quick overview; monetary policy is the Federal Reserve’s actions, as a central bank, to achieve three goals specified by Congress: maximum employment, stable prices, and moderate long-term interest rates in the United States.  The Federal Reserve conducts the nation’s monetary policy by managing the level of short-term interest rates and influencing the availability and cost of credit in the economy.  Monetary policy directly affects interest rates; it indirectly affects stock prices, wealth, and currency exchange rates.  Through these channels, monetary policy influences spending, investment, production, employment, and inflation in the United States.

I suggest what truly happened in 1913 was that Congress willingly abdicated a portion of its responsibilities, and through the Federal Reserve, began a process that would undermine the functioning American democracy.  “How”, you ask?  The Fed, believing the free-market to be “imperfect” (aka; wrong) believed it (the Fed) should control and set interest rates, determine full employment, determine asset prices; not the “free market”.  And here’s what happened:

  • From 1913 to 1971, an increase of  $400 billion in federal debt cost $35 billion in additional annual interest payments.
  • From 1971 to 1981, an increase of $600 billion in federal debt cost $108 billion in additional annual interest payments.
  • From 1981 to 1997, an increase of $4.4 trillion cost $224 billionin additional annual interest payments.
  • From 1997 to 2017, an increase of $15.2 trillion cost “just” $132 billion in additional annual interest payments.

Stop and read through those bullet points again…and then one more time.  In case that hasn’t sunk in, check the chart below…

What was the economic impact of the Federal Reserve encouraging all that debt?  The yellow line in the chart below shows the annual net impact of economic growth (in growing part, spurred by the spending of that new debt)…gauged by GDP (blue columns) minus the annual rise in federal government debt (red columns).  When viewing the chart, the problem should be fairly apparent.  GDP, subtracting the annual federal debt fueled spending, shows the US economy is collapsing except for counting the massive debt spending as “economic growth”.
Same as above, but a close-up from 1981 to present.  Not pretty.
Consider since 1981, the Federal Reserve set FFR % (Federal Funds rate %) is down 94% and the associated impacts on the 10yr Treasury (down 82%) and the 30yr Mortgage rate (down 77%).  Four decades of cheapening the cost of servicing debt has incentivized and promoted ever greater use of debt.

Again, according to the Fed’s website, “it was created to provide the nation with a safer, more flexible, and more stable monetary and financial system.”  However, the chart below shows the Federal Reserve policies’ impact on the 10yr Treasury, stocks (Wilshire 5000 representing all publicly traded US stocks), and housing to be anything but “safer” or “stable”.

Previously, I have made it clear the asset appreciation the Fed is providing is helping a select few, at the expense of the many, HERE.

But a functioning democratic republic is premised on a simple agreement that We (the people) will freely choose our leaders who will (among other things) compromise on how taxation is to be levied, how much tax is to be collected, and how that taxation is to be spent.  The intervention of the Federal Reserve into that equation, controlling interest rates, outright purchasing assets, and plainly goosing asset prices has introduced a cancer into the nation which has now metastasized.

In time, Congress (& the electorate) would realize they no longer had to compromise between infinite wants and finite means.  The Federal Reserve’s nearly four decades of interest rate reductions and a decade of asset purchases motivated the election of candidates promising ever greater government absent the higher taxation to pay for it.  Surging asset prices created fast rising tax revenue.  Those espousing “fiscal conservatism” or living within our means (among R’s and/or D’s) were simply unelectable.

This Congressionally created mess has culminated in the accumulation of national debt beyond our means to ever repay.  As the chart below highlights, the Federal Reserve set interest rate (Fed. Funds Rate=blue line) peaked in 1981 and was continually reduced until it reached zero in 2009.  The impact of lower interest rates to promote ever greater national debt creation was stupendous, rising from under $1 trillion in 1981 to nearing $21 trillion presently.  However, thanks to the seemingly perpetually lower Federal Reserve provided rates, America’s interest rate continually declined inversely to America’s credit worthiness or ability to repay the debt.

The impact of the declining rates meant America would not be burdened with significantly rising interest payments or the much feared bond “Armageddon” (chart below).  All the upside of spending now, with none of the downside of ever paying it back, or even simply paying more in interest.  Politicians were able to tell their constituencies they could have it all…and anyone suggesting otherwise was plainly not in contention.  Federal debt soared and soared but interest payable in dollars on that debt only gently nudged upward.

  • In 1971, the US paid $36 billion in interest on $400 billion in federal debt…a 9% APR.
  • In 1981, the US paid $142 billion on just under $1 trillion in debt…a 14% APR.
  • In 1997, the US paid $368 billion on $5.4 trillion in debt or 7% APR…and despite debt nearly doubling by 2007, annual interest payments in ’07 were $30 billion less than a decade earlier.
  • By 2017, the US will pay out about $500 billion on nearly $21 trillion in debt…just a 2% APR.

The Federal Reserve began cutting its benchmark interest rates in 1981 from peak rates.  Few understood that the Fed would cut rates continually over the next three decades.  But by 2008, lower rates were not enough.  The Federal Reserve determined to conjure money into existence and purchase $4.5 trillion in mid and long duration assets.  Previous to this, the Fed has essentially held zero assets beyond short duration assets in it’s role to effect monetary policy.  The change to hold longer duration assets was a new and different self appointed mandate to maintain and increase asset prices.

But why the declining interest rates and asset purchases in the first place?

The Federal Reserve interest rates have very simply primarily followed the population cycle and only secondarily the business cycle.  What the chart below highlights is annual 25-54yr/old population growth (blue columns) versus annual change in 25-54yr/old employees (black line), set against the Federal Funds Rate (yellow line).  The FFR has followed the core 25-54yr/old population growth…and the rising, then decelerating, now declining demand that that represented means lower or negative rates are likely just on the horizon (despite the Fed’s current messaging to the contrary).

Below, a close-up of the above chart from 2000 to present.

Running out of employees???  Each time the 25-54yr/old population segment has exceeded 80% employment, economic dislocation has been dead ahead.  We have just exceeded 78% but given the declining 25-54yr/old population versus rising employment…and the US is likely to again exceed 80% in 2018.

Given the FFR follows population growth, consider that the even broader 20-65yr/old population will essentially see population growth grind to a halt over the next two decades.  This is no prediction or estimate, this population has already been born and the only variable is the level of immigration…which is falling fast due to declining illegal immigration meaning the lower Census estimate is more likely than the middle estimate.

So where will America’s population growth take place?  The 65+yr/old population is set to surge.

But population growth will be shifting to the most elderly of the elderly…the 75+yr/old population.  I outlined the problems with this previously HERE.

Back to the Federal Reserve, consider the impact on debt creation prior and post the creation of the Federal Reserve:

  • 1790-1913: Debt to GDP Averaged 14%
  • 1913-2017: Debt to GDP Averaged 53%
    • 1913-1981: 46% Average
    • 1981-2000: 52% Average
    • 2000-2017: 79% Average

As the chart below highlights, since the creation of the Federal Reserve the growth of debt (relative to growth of economic activity) has gone to levels never dreamed of by the founding fathers.  In particular, the systemic surges in debt since 1981 are unlike anything ever seen prior in American history.  Although the peak of debt to GDP seen in WWII may have been higher (changes in GDP calculations mean current GDP levels are likely significantly overstating economic activity), the duration and reliance upon debt was entirely tied to the war.  Upon the end of the war, the economy did not rely on debt for further growth and total debt fell.

Any suggestion that the current situation is like any America has seen previously is simply ludicrous.  Consider that during WWII, debt was used to fight a war and initiate a global rebuild via the Marshall Plan…but by 1948, total federal debt had already been paid down by $19 billion or a seven percent reduction…and total debt would not exceed the 1946 high water mark again until 1957.  During that ’46 to ’57 stretch, the economy would boom with zero federal debt growth.

  • 1941…Fed debt = $58 b (Debt to GDP = 44%)
  • 1946…Fed debt = $271 b (Debt to GDP = 119%)
    • 1948…Fed debt = $252 b <$19b> (Debt to GDP = 92%)
    • 1957…Fed debt = $272 b (Debt to GDP = 57%)

If the current crisis ended in 2011 (recession ended by 2010, by July of  2011 stock markets had recovered their losses), then the use of debt as a temporary stimulus should have ended?!?  Instead, debt and debt to GDP are still rising.

  • 2007…Federal debt = $8.9 T (Debt to GDP = 62%)
  • 2011…Federal debt = $13.5 T (Debt to GDP = 95%)
  • 2017…Federal Debt = $20.5 T (Debt to GDP = 105%)

July of 2011 was the great debt ceiling debate when America determined once and for all, that the federal debt was not actually debt.  America had no intention to ever repay it.  It was simply monetization and since the Federal Reserve was maintaining ZIRP, and all oil importers were forced to buy their oil using US dollars thanks to the Petrodollar agreement…what could go wrong?

But who would continue to buy US debt if the US was addicted to monetization in order to pay its bills?  Apparently, not foreigners.  If we look at foreign Treasury buying, some very notable changes are apparent beginning in July of 2011:

  1. The BRICS (Brazil, Russia, India, China, S. Africa…represented in red in the chart below) ceased net accumulating US debt as of July 2011.
  2. Simultaneous to the BRICS cessation, the BLICS (Belgium, Luxembourg, Ireland, Cayman Island, Switzerland…represented in black in the chart below) stepped in to maintain the bid.
  3. Since QE ended in late 2014, foreigners have followed the Federal Reserve’s example and nearly forgone buying US Treasury debt.

China was first to opt out and began net selling US Treasuries as of August, 2011 (China in red, chart below).  China has continued to run record trade driven dollar surplus but has net recycled none of that into US debt since July, 2011.  China had averaged 50% of its trade surplus into Treasury debt from 2000 to July of 2011, but from August 2011 onward China stopped cold.

As China (and more generally the BRICS) ceased buying US Treasury debt, a strange collection of financier nations (the BLICS) suddenly became very interested in US Treasury debt.  From the debt ceiling debate to the end of QE, these nations were suddenly very excited to add $700 billion in near record low yielding US debt while China net sold.

The chart below shows total debt issued during periods, from 1950 to present, and who accumulated the increase in outstanding Treasurys.

The Federal Reserve plus foreigners represented nearly 2/3rds of all demand from ’08 through ’14.  However, since the end of QE, and that 2/3rds of demand gone…rates continue near generational lows???  Who is buying Treasury debt?  According to the US Treasury, since QE ended, it is record domestic demand that is maintaining the Treasury bid.  The same domestic public buying stocks at record highs and buying housing at record highs.

Looking at who owns America’s debt 2007 through 2016, the chart below highlights the four groups that hold nearly 90% of the debt:

  1. The combined Federal Reserve/Government Accounting Series
  2. Foreigners
  3. Domestic Mutual Funds
  4. And the massive rise in Treasury holdings by domestic “Other Investors” who are not domestic insurance companies, not local or state governments, not depository institutions, not pensions, not mutual funds, nor US Saving bonds.

Treasury buying by foreigners and the Federal Reserve has collapsed since QE ended (chart below).  However, the odd surge of domestic “other investors”, Intra-Governmental GAS, and domestic mutual funds have nearly been the sole buyer preventing the US from suffering a very painful surge in interest payments on the record quantity of US Treasury debt.

No, this is nothing like WWII or any previous “crisis”.  While America has appointed itself “global policeman” and militarily outspends the rest of the world combined, America is not at war.  Simply put, what we are looking at appears little different than the Madoff style Ponzi…but this time it is a state sponsored financial fraud magnitudes larger.

The Federal Reserve and its systematic declining interest rates to perpetuate unrealistically high rates of growth in the face of rapidly decelerating population growth have fouled the American political system, its democracy, and promoted the system that has now bankrupted the nation.  And it appears that the Federal Reserve is now directing a state level fraud and farce.  If it isn’t time to reconsider the Fed’s role and continued existence now, then when?

Read More: https://econimica.blogspot.com/2017/11/how-federal-reserve-destroyed.html

Dutch Central Bank Warns Of Market Calm Before The Storm

With one foot out of the door of Germany’s finance ministry, the former head of the German economy, Wolfgang Schäuble, 75, delivered a fire and brimstone warning over the weekend, telling the FT in an interview that there was a danger of “new bubbles” forming due to the trillions of dollars that central banks have pumped into markets. Schäuble also warned of risks to stability in the eurozone, particularly those posed by bank balance sheets burdened by the post-crisis legacy of non-performing loans, something we warned about since 2012, and an issue which remains largely unresolved.

Taking a broad swipe at the current financial regime – which he helped design – Schauble warned that the world was in danger of “encouraging new bubbles to form”.

Economists all over the world are concerned about the increased risks arising from the accumulation of more and more liquidity and the growth of public and private debt. I myself am concerned about this, too,” he said echoing the concern voiced just one day earlier by IMF head Christine Lagarde, who said the world was enjoying its best growth spurt since the start of the decade, but warned of “threats on the horizon” from “high levels of debt in many countries to rapid credit expansion in China, to excessive risk-taking in financial markets”.

And while Schauble’s dramatic warning was not surprising – prominent economists have a habit of telling the truth once their tenure is over, and once they start selling books warning about all the consequences of policies they helped adopt – one day later a more surprising, and just as urgent warning was delivered by the Dutch central bank, DNB, which on Monday said that ultra-loose monetary policy in the euro zone has run its courseand excessive risks seem to be building up in financial markets making the financial sector vulnerable to a sudden correction.

“It increasingly feels uncomfortable to have low volatility in the markets on the one hand while on the other hand there are risks in the global economy,” said Klaas Knot, the president of the Dutch Central Bank, at the presentation of DNB’s biannual financial stability report according to Bloomberg.

Putting the current unstable equilibrium in its temporal context, Knot said that the current picture resembles that of the period before the financial crisis.

Taking a page out of Mark Faber playbook, the DNB labelled the threat of a sudden downturn in markets, brought on by a return of risk aversion, as an “acute” risk for the international financial sector, capable of starting a new financial crisis in weaker euro countries and beyond.

And, according to the Dutch central bank, only one thing could prevent a further build up of risks, eventually resulting in a crash: Knot reiterated a call to fellow board members at the European Central Bank to start phasing out monetary stimulus measures. The “time has come,” he said. “Economic growth has been above potential for months and the threat of deflation is gone.

“The program has achieved what realistically could be expected from it,” Knot said about QE, adding that it supported growth, and reduced investment costs.

Of course, Knot is merely the latest to fall for the paradox of reflexivity, where he sees the product of central bank intervention as the object that was meant to be cured by said intervention – a process which has pushed yields on European junk bonds below the yield on the US 10Y Treasury, among other market distortions. In reality, if one were to reduce or eliminate the tens of trillions in liquidity injections by central banks, the world would find itself right back in the eye of a financial crisis hurricane, prompting central banks to unleash even more “unorthodox” measures, culminating eventually with central banks purchasing equities, as JPM’s Marko Kolanovic previewed last week.

Later this month, the ECB – rapidly running out of German bunds to monetize – is expected to decide on the fate of the central bank’s bond-buying programme, potentially announcing another taper of its current QE which purchases €60 billion in sovereign bonds per month.

Still, even Knot admits that whatever the ECB’s decision, any slow down or restriction in ECB intervention will have to be gradual, confirming that the ECB remains trapped by the market and any sharp, adverse reaction will promptly force the ECB to resume nationalizing the European capital markets.

“Interest rates will stay very low for a very long time, even if we decide to phase out our bond buying program at our next meeting. Nobody at the ECB is talking about raising interest rates yet.”

And, soon enough – once markets get reacquainted with gravity – nobody at the ECB will be talking about any normalization whatsoever.

 

From: http://www.zerohedge.com/news/2017-10-09/dutch-central-bank-warns-market-calm-storm