Frederick Sheehan is the co-author of Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve.

His new book, Panderer for Power: The True Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession, was published by McGraw-Hill in November 2009. He was Director of Asset Allocation Services at John Hancock Financial Services in Boston. In this capacity, he set investment policy and asset allocation for institutional pension plans.

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The Euro and You described a fundamental problem of world finance. The quantity of debt grows as the quality recedes. The problem of bad loans is no longer just the pre-2008 mortgages, CDOs, and LBOs. Debt issued after the bust is defaulting, such as Greek sovereign bonds, issued in June 2010. Some securities are born to part investors from their money, but it’s remarkable the extent and variety of such instruments issued in 2011. The world choked on similar bonds and derivatives only three years ago, many of which are still held at false prices on financial institutions’ books.

Of all the past century’s downgrades, none has been greater than the borrower’s promise that stands behind a “security,” a word that once credibly described a paper contract backed by appropriate collateral. In Debt and Delusion, Peter Warburtin wrote: “It is easy to forget that, as recently as in the 1960s, the government budgets of the OECD countries were in approximate balance and that net issues of debt were comparatively rare. The outstanding stock of debt in public hands was a meager $800 billion at the end of 1970. At that time debt issue was typically reserved for the financing of large construction projects or investment by power generation companies by publicly owned companies.” Today, PIMCO’s Bill Gross manages $244 billion in a single bond fund.

The starting pistol was sounded on August 15, 1971, 40 years ago. On that date, the United States broke its long-standing promise to pay one ounce of gold to a foreign government that redeemed $35 for the same. (The ability of American citizens to redeem dollars for gold with the U.S. government was modified during World War I and ceased after the War.) As a prelude to the loosy-goosy financial contracts today, it is worth reviewing the wording of the contractual relationship between the United States government and the holder of its currency before and after. (A book should be written on the parallels between the century-long degradation of language, the American legal system, money, credit, debt, and the American people.)

The face of a $20 bill, a gold certificate, issued in 1882, stated: “This certifies that there have been deposited in the Treasury of the United States, twenty dollars in gold coin, repayable to the bearer on demand.” The bearer of $20.67 received one ounce of gold in exchange. This is a simple legal contract. It is easy to understand. There was no theory. No economists were employed to interpret what did not require interpretation.

A 2011 Federal Reserve Note states: “This note is legal tender for all debts, public and private.” As contracts go, this makes no sense. Nor does it make sense to a three-year-old. My extensive survey of three-year-olds did not uncover a single child, who, in exchange for a $20 bill, preferred another $20 bill rather than receive a one-ounce gold coin. (The current value of the one-ounce coin versus that of the $20 bill is not germane to this survey.)

The abstraction of money is related to the manner in which securities today are often backed by abstract or non-existent collateral. Contradictory theories employ at least 100,000 economists (probably multiples of this figure), among whom, there may not be a handful who ever write or think about money. Read (if you must) the theoretical papers or newspaper columns of these imposters. They retreated into a soothing bubble bath of differential calculus generations ago.

Many of the malignant securities issued in 2010 and 2011 have fallen into disfavor. Credit markets have suffered loss of liquidity, momentary or protracted. These issues, collateralized by hope and imagination, are on the books though, often at institutions that already hold wads of securities still valued at wishful prices (for purposes of accounting, capital requirements, and falsifying the institutions’ dubious solvency). We should expect that when Federal Reserve Chairman Ben Bernanke revs up his money machine, more will flow.

It is a safe bet that Ben is preparing to welcome more unmentionable securities on the Fed’s balance sheet. (“Federal Reserve officials are starting to build a case for a new program of buying mortgage-backed securities to boost the ailing economy….” – Wall Street Journal, October 21, 2011.)

Guessing at why the Fed will splurge is a chicken-or-egg game. Is the Fed preparing for a downdraft in the stock market with its tried-and-false response: by creating more money? Or, is it preparing to transmit (by electronic keystroke) more dollars to absorb securities held at banks, insurance companies, money-market funds, and mutual funds that should be carried at a much lower value?

The Fed washed its hands of credit analysis on January 6, 2011, when it issued its weekly H.4.1 “Factors Affecting Reserve Balances.” The federal agency that vaunts its “transparency” (i.e.: the Fed) implanted a note that transferred all capital losses to the taxpayer. The January 6, 2011, “Factors Affecting Reserve Balances” stated that beginning on January 1, 2011, all capital losses in the Federal Reserve’s mangy and non-transparent portfolio would henceforth be transferred to the Treasury Department. In a sense, this is only an accounting frivolity, since the taxpayer ultimately pays for the New York Fed’s reckless mismanagement of its highly leveraged portfolio (103:1); that could soon, absent the January 6 sleight-of-hand, mirror Enron’s jambalaya.

After the 2008 credit meltdown, the Fed, led by Simple Ben, fought for greater regulatory control of the banking system. The cranks who warned against Federal Reserve regulatory authority have been vindicated, on a comically inflated scale.

Wild-and-wooly securities that cratered after the credit cycle turned (circa 2007) are back, for instance: low doc, cov lite, payment-in-kind toggle notes, the proceeds of which pay private-equity firms up-front dividends. Century bonds (Mexico, the University of Southern California) sold swiftly, never a good sign. “Synthetic junk bonds” warned the Financial Times that “resemble transactions linked to U.S. mortgages, which proliferated before the crisis” and “staple deals” counseled the Wall Street Journal that “came under sharp criticism during the buyout boom for causing a number of conflicts of interest” have been structured by the banks that Ben Bernanke regulates. This highlights the greatest conflict of interest: the false claim that the Federal Reserve regulates the banks.

One security in the pipeline (possibly on hold during the current market mayhem) is a “synthetic deutsche mark,” that would “create shadow trading in legacy currencies in a synthetic market.” Paul Volcker said somewhere the only financial advancement of the past 30 years is the ATM card. Comparing the collateral behind Peter Warburtin’s bond market to the absence of such behind the synthetic deutsche mark (a currency that ceased to exist over a decade ago) outlines the enormous waste of capital, human ingenuity, and savings over the past 40 years.  With nothing learned, this will continue, until uncollateralized paper spawns a New Era in post-fiat origami.

Category: Economy, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

6 Responses to “What They Are Doing”

  1. MayorQuimby says:

    With all due respect, what a bunch of nonsense.

    There is not NEARLY as much fiat currency in circulation as people imagine. In fact, most would be SHOCKED at how little $$$ actually exist.

    ALL that is needed is to write off bad debts, embrace the deflationary corrections needed (including defaulting of bad sovereign debts) and credit expansion can occur in a healthy and sustainable way. Yes it will be painful and no I do not expect anyone in the USA to accept that ANY pain is needed (but it is). So we will do this the hard way and might even destroy ourselves trying to prevent a credit collapse.

    But gold is no answer and is in fact far worse.

    1. Gold is gold, not money.

    2. Those countries with gold (ie Peru) can mess with our money supply and we would be powerless to counter it.

    3. Gold will not prevent gvmt from incurring too much debt (which is the problem ultimately).

    4. Nor will it prevent excessive inflation. In fact – with gold you get a 20 or 30% depreciation in the currency OVERNIGHT – ie all at once. There is no adjusting for this – you are just screwed.

    The Depression of the 1870′s AND 1930′s both occurred under gold standards.

    Gold is an inflexible archaic relic of failed societies. Let’s not retrace those hideous footsteps.

  2. Fredex says:

    Gold is money.

  3. Quim..,

    If I’m reading this, correctly, this..

    “…The abstraction of money is related to the manner in which securities today are often backed by abstract or non-existent collateral. Contradictory theories employ at least 100,000 economists (probably multiples of this figure), among whom, there may not be a handful who ever write or think about money. Read (if you must) the theoretical papers or newspaper columns of these imposters. They retreated into a soothing bubble bath of differential calculus generations ago…”

    esp. “…The abstraction of money is related to the manner in which securities today are often backed by abstract or non-existent collateral…”

    is the *Real Point.

    not, necessarily, that ~”Gold should be Money, per se..”
    ~~~

    Sheehan, in this Piece, is getting at the Root of ‘The Big Lie’…as opposed to ~”Hacking at Branches..”

    also, here..”… the enormous waste of capital, human ingenuity, and savings over the past 40 years. With nothing learned, this will continue, until uncollateralized paper spawns a New Era in post-fiat origami…”

    gives rise to the Great cost of these “Paper”-Games..

    you may care to re-Read this..~

  4. Long term says:

    Not clear if this is an excerpt from the book or original composition by BR, who is not a goldbug.

    This article is not clearly focused, thus it is easy to see why Quim began writing against a gold standard. I think the author must be frustrated more at the level of leverage going on these days versus the fact that we have a fiat currency. But his passion for gold seems to spill into the argument too much.

    I was impressed by the [The January 6, 2011, “Factors Affecting Reserve Balances”...] piece of information. That was info that made an impact on me. I will assert that healthy economies are ones in which people have jobs and goods/services are produced. I’m not sure this end could be achieved without significant debt. It is more the rich/poor gap and insane multiples of leverage that are our current societal problems versus debt, which we can print out of.

    ~~~

    BR: Sorry if thats ambiguous — it is by Fred Sheehan, and its a blog post — not a book excerpt

  5. MayorQuimby says:

    Mark-

    The article makes the fallacious argument that because fiat is being run poorly, gold is preferable. In fact, the article states that any child would prefer a coin of yellow metal to money.

    And you can bet your bottom Thaler that the author has crates filled with yellow metal in his basement safe.

    But the problem we have today is the unevedistribution of wealth so whatever you think might happen, in the end….the correction that is needed is to make warren Buffett much poorer and joe six pack much wealthier.

  6. victor says:

    Most gold bugs are just that, gold bugs, it’s not going to happen. All fiat money fails so they say; but then the Swiss Frank? The Economist has an article about world debt. It is estimated at some $48T; the author proposes that half of it will eventually be defaulted on (creditors will write it off) and the other half will be repaid gradually via deflated money, low interest rates and inflation. The unfunded liabilities are not included in the $48T. They would run, world wide in the hundreds of trillions. A huge structure collapsing under its own weight comes to mind.