Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
Stock Market Volatility (VIX) - 25th Mar 24
Stock Market Investor Sentiment - 25th Mar 24
The Federal Reserve Didn't Do Anything But It Had Plenty to Say - 25th Mar 24
Stock Market Breadth - 24th Mar 24
Stock Market Margin Debt Indicator - 24th Mar 24
It’s Easy to Scream Stocks Bubble! - 24th Mar 24
Stocks: What to Make of All This Insider Selling- 24th Mar 24
Money Supply Continues To Fall, Economy Worsens – Investors Don’t Care - 24th Mar 24
Get an Edge in the Crypto Market with Order Flow - 24th Mar 24
US Presidential Election Cycle and Recessions - 18th Mar 24
US Recession Already Happened in 2022! - 18th Mar 24
AI can now remember everything you say - 18th Mar 24
Bitcoin Crypto Mania 2024 - MicroStrategy MSTR Blow off Top! - 14th Mar 24
Bitcoin Gravy Train Trend Forecast 2024 - 11th Mar 24
Gold and the Long-Term Inflation Cycle - 11th Mar 24
Fed’s Next Intertest Rate Move might not align with popular consensus - 11th Mar 24
Two Reasons The Fed Manipulates Interest Rates - 11th Mar 24
US Dollar Trend 2024 - 9th Mar 2024
The Bond Trade and Interest Rates - 9th Mar 2024
Investors Don’t Believe the Gold Rally, Still Prefer General Stocks - 9th Mar 2024
Paper Gold Vs. Real Gold: It's Important to Know the Difference - 9th Mar 2024
Stocks: What This "Record Extreme" Indicator May Be Signaling - 9th Mar 2024
My 3 Favorite Trade Setups - Elliott Wave Course - 9th Mar 2024
Bitcoin Crypto Bubble Mania! - 4th Mar 2024
US Interest Rates - When WIll the Fed Pivot - 1st Mar 2024
S&P Stock Market Real Earnings Yield - 29th Feb 2024
US Unemployment is a Fake Statistic - 29th Feb 2024
U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - 29th Feb 2024
What a Breakdown in Silver Mining Stocks! What an Opportunity! - 29th Feb 2024
Why AI will Soon become SA - Synthetic Intelligence - The Machine Learning Megatrend - 29th Feb 2024
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Robert Prechter Explains Money, Credit and the Federal Reserve Banking System, Part II

Interest-Rates / Central Banks Nov 22, 2010 - 12:52 PM GMT

By: EWI

Interest-Rates

Best Financial Markets Analysis ArticleThis is Part II of our three-part series "Robert Prechter Explains The Fed." You can read Part I here -- and come back later this week for Part III.


Money, Credit and the Federal Reserve Banking System

Conquer the Crash, Chapter 10 By Robert Prechter

... Let’s attempt to define what gives the dollar objective value. As we will see in the next section, the dollar is “backed” primarily by government bonds, which are promises to pay dollars. So today, the dollar is a promise backed by a promise to pay an identical promise. What is the nature of each promise? If the Treasury will not give you anything tangible for your dollar, then the dollar is a promise to pay nothing. The Treasury should have no trouble keeping this promise.

In Chapter 9 [of Conquer the Crash], I called the dollar “money.” By the definition given there, it is. I used that definition and explanation because it makes the whole picture comprehensible. But the truth is that since the dollar is backed by debt, it is actually a credit, not money. It is a credit against what the government owes, denoted in dollars and backed by nothing. So although we may use the term “money” in referring to dollars, there is no longer any real money in the U.S. financial system; there is nothing but credit and debt.

As you can see, defining the dollar, and therefore the terms money, credit, inflation and deflation, today is a challenge, to say the least. Despite that challenge, we can still use these terms because people’s minds have conferred meaning and value upon these ethereal concepts.

Understanding this fact, we will now proceed with a discussion of how money and credit expand in today’s financial system.

How the Federal Reserve System Manufactures Money

Over the years, the Federal Reserve Bank has transferred purchasing power from all other dollar holders primarily to the U.S. Treasury by a complex series of machinations. The U.S. Treasury borrows money by selling bonds in the open market. The Fed is said to “buy” the Treasury’s bonds from banks and other financial institutions, but in actuality, it is allowed by law simply to fabricate a new checking account for the seller in exchange for the bonds. It holds the Treasury’s bonds as assets against -- as “backing” for -- that new money. Now the seller is whole (he was just a middleman), the Fed has the bonds, and the Treasury has the new money.

This transactional train is a long route to a simple alchemy (called “monetizing” the debt) in which the Fed turns government bonds into money. The net result is as if the government had simply fabricated its own checking account, although it pays the Fed a portion of the bonds’ interest for providing the service surreptitiously. To date (1st edition of Prechter's Conquer the Crash was published in 2002 -- Ed.), the Fed has monetized about $600 billion worth of Treasury obligations. This process expands the supply of money.

In 1980, Congress gave the Fed the legal authority to monetize any agency’s debt. In other words, it can exchange the bonds of a government, bank or other institution for a checking account denominated in dollars. This mechanism gives the President, through the Treasury, a mechanism for “bailing out” debt-troubled governments, banks or other institutions that can no longer get financing anywhere else. Such decisions are made for political reasons, and the Fed can go along or refuse, at least as the relationship currently stands. Today, the Fed has about $36 billion worth of foreign debt on its books. The power to grant or refuse such largesse is unprecedented.

Each new Fed account denominated in dollars is new money, but contrary to common inference, it is not new value. The new account has value, but that value comes from a reduction in the value of all other outstanding accounts denominated in dollars. That reduction takes place as the favored institution spends the newly credited dollars, driving up the dollar-denominated demand for goods and thus their prices. All other dollar holders still hold the same number of dollars, but now there are more dollars in circulation, and each one purchases less in the way of goods and services. The old dollars lose value to the extent that the new account gains value.

The net result is a transfer of value to the receiver’s account from those of all other dollar holders. This fact is not readily obvious because the unit of account throughout the financial system does not change even though its value changes.

It is important to understand exactly what the Fed has the power to do in this context: It has legal permission to transfer wealth from dollar savers to certain debtors without the permission of the savers. The effect on the money supply is exactly the same as if the money had been counterfeited and slipped into circulation.

In the old days, governments would inflate the money supply by diluting their coins with base metal or printing notes directly. Now the same old game is much less obvious. On the other hand, there is also far more to it. This section has described the Fed’s secondary role. The Fed’s main occupation is not creating money but facilitating credit. This crucial difference will eventually bring us to why deflation is possible.

[Next: Prechter explains "how the Federal Reserve has encouraged the growth of credit."]

Come back later this week for Part III of the series "Robert Prechter Explains The Fed." Or, read more now in the free Club EWI report, "Understanding the Federal Reserve System."

This article was syndicated by Elliott Wave International and was originally published under the headline Robert Prechter Explains The Fed, Part II. EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.


© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in