Will Fed and Central Bankers Give Up Alchemy to Save the World?

 This article was first published by me at Talkmarkets: http://www.talkmarkets.com/content/us-markets/will-fed-and-central-bankers-give-up-alchemy-to-save-the-world?post=74282

Will central bankers give up alchemy to save the world? I have have my doubts. First of all, most people don't know that central bankers are alchemists. In fact, most people have no clue that they are able to issue debt in the form of sovereign bonds, like treasury bonds, and turn them into gold!

That is right. Who needs gold when debt can be gold? No I am not saying you can't use gold as gold, because it is a valuable asset. But debt makes more gold available. Indeed, alchemy is the business of turning mundane things into gold. It has been an idea that has fascinated for thousands of years. Yet, the bankers did what Merlin could only hope to do, turn something as ungold-like as debt into gold.

This gold, that is in the form of sovereign bonds, is used in the derivatives markets. The debt is used as collateral, and is as if it were gold. Gold is used as collateral too, but not nearly as much as sovereign bonds are used. Even Greek bonds were gold and if the interest rates go down, the debt-as-gold becomes worth more and more. If interest rates go up, the collateral becomes less valuable.

Debt is gold, but it is not money. It is collateral, an asset. Same for gold, it is used as collateral and is not really money, but rather functions today as an asset.

So, the question is, would the central bankers give this system up for productive lending? Would they get rid of sovereign bonds? They should. After all, the real economy is almost a second thought to the bankers, who are obsessed with saving the biggest banks and growing them larger.

From a study done by Richard Werner, passed onto me by Ellen Brown, we are able to come up with  ideas as to why it makes sense for the bankers to get out of the business of turning debt into gold. The Study is entitled: The Quantity Theory of Credit and Some of Its Applications. Dr. Werner starts by analyzing the current situation with the following points:

1. Asset transactions are not a part of GDP. Credit for asset transactions does not help GDP.

2. Commercial banks create credit, and in fact create most of the credit.

3. In order for the economy to prosper, real GDP credit must increase, and asset transactions credit (speculative credit) must decrease.

4. Investment credit is better than financial and consumer credit.

5. Without regulation forcing banks to lend to the real economy, they will not look out for the greater good and may in fact hurt themselves by seeking only their own profit motives.

6. Government and society let banks create credit. Government and society could take that privilege away.

7. Credit controls can direct a society toward greater productivity.

8. Credit controls can avoid boom and bust.

9. Falling interest rates did not help Japan escape a liquidity trap way before rates went to zero.

10. Lower interest rates do not drive the real economy, but rather are a result of low growth. So, to say low rates lead to high growth and high rates leads to low growth is wrong. Correctly speaking, low growth leads to low rates and high growth leads to high rates.

11. If Greenspan once assumed equilibrium in the markets, he then said he was wrong, and that self regulation of markets was a flawed assessment.

So, then solutions to the situation we are in by Dr. Werner seem to be simple. 

1. Banks should not lend in non GDP transactions at all. No speculation of that sort should be allowed.

2. Central banks should bail out troubled banks by taking the bad loans off the books and nursing them to maturity or until there is a market for the assets.

3. Governments should stop the issuance of government bonds. Governments should borrow from banks in their own nations, instead.

4. Fiscal stimulation should come through bank borrowing, not the issuance of bonds.

So, will the central bankers take this advice. I seriously doubt it. For one thing, they are alchemists, and they like turning debt into gold. Greenspan did not let the fledgling derivatives market come under government supervision. It now is regulated a bit, but only to insure more collateral, debt-as-gold, in the system.

It would be necessary to use something other than bonds as collateral. I have advocated that long bonds should not be used as collateral. But economists and central bankers love the way that, along with a slow economy, keeps interest rates down. But really, it is just an indication of the separation between the real economy, with low money velocity, and the asset purchase economy, that is red hot along with the demand for bonds that goes along with it.

The Federal reserve could stop paying interest on excess reserves and get banks to lend to the real economy tomorrow. But they cannot afford the real economy to interfere with their economy of speculation and derivatives and bubbles. They cannot afford the real economy to cause a wage price inflation spiral.

So they can't have the real economy heating up. They can't raise rates to slow things down if they heat up in this environment, or they will undermine this house of cards and destroy the leverage at risk in this system.

The central bankers hold to that mindset. The seeming desire of many in their employ to seek out a cashless society and break the zero lower bound, makes it unlikely that they would accept the sensible old school ideas of Dr. Werner when they have an opportunity to really control the world in a frightening way. Dr. Werner could set the world on a better path. But count on resistance.

After all, central bankers have achieved what has alluded both dreamers and magicians for centuries, the ability to create gold out of debt!


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