Guest Post

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Bernanke vs Greenspan?

Submitted by Andrew Fruth of AcceptanceTake

Bernanke and Greenspan appear to have differing opinions on whether the Fed will monetize the debt.

Bernanke, on behalf of the Federal Reserve, said in 2009 at a House Financial Services Committee that “we’re not going to monetize the debt.”

Greenspan, meanwhile, on Meet the Press in 2011 that “there is zero probability of default” because the U.S. can always print more money.

But they can’t both be true…

There is only 0% probability of formal default if the Fed monetizes the debt. If they refuse, and creditors refuse to buy bonds when current bonds rollover, then the U.S. would default. But Ben said the Fed will never monetize the debt back on June 3, 2009. That’s curious, because in November 2010 in what has been termed “QE2” the Fed announced it would buy $600 billion in long-term Treasuries and buy an additional $250-$300 of Treasuries in which the $250-$300 billion was from previous investments.

Is that monetization? I would say yes, but it’s sort of tricky to define. For example, when the Fed conducts its open market operations it buys Treasuries to influence interest rates which has been going on for a long time — way before the current U.S. debt crisis.

So then what determines whether the Fed has conducted this egregious form of Treasury buying we call “monetization of the debt?”

The only two factors that can possibly differentiate monetization from open market operations is 1) the size of the purchase and 2) the intent behind the purchase.

This is how the size of Treasury purchases have changed since 2009:

Since new data has come out, the whole year of 2011 monetary authority purchases is $642 billion – not quite as high as in the graph, but still very high.

Clearly you can see the difference in the size of the purchases even though determining what size is considered monetization is rather arbitrary.

Then there’s the intent behind the purchase. That’s what I think Bernanke is talking about when he says he will not monetize the debt. In Bernanke’s mind the intent (at least the public lip service intent) is to avoid deflation and to boost the economy – not to bail the United States out of its debt crisis by printing money. Bernanke still contends that he has an exit policy and that he will wind down the monetary base when the time is appropriate.

So In Bernanke’s mind, he may not consider buying Treasuries — even at QE2 levels — “monetizing the debt.”

The most likely stealth monetization tactics Bernanke can use — while still keeping a straight face — while saying he will not monetize the debt, will be an extreme difference between the Fed Funds Rate and the theoretical rate it would be without money printing, and loosening loan requirements/adopting policies that will get the banks to multiply out their massive amounts of excess reserves.

If, for example, the natural Fed Funds rate — the rate without Fed intervention — is 19% and the Fed is keeping the rate at 0%, then the amount of Treasuries the Fed would have to buy to keep that rate down would be huge — yet Bernanke could say he’s just conducting normal open market operations.

On the other hand, if the banks create money out of nothing via the fractional reserve lending system and a certain percentage of that new money goes into Treasuries, Bernanke can just say there is strong private demand for Treasuries even if his policies were the reason behind excessive credit growth that allowed for the increased purchase of Treasuries.

Maybe Bernanke means he will not monetize a particular part of the debt that was being referred to in the video. Again, though, he could simply hide it under an open market operations 0% policy or encourage the banking system to expand the money supply.

Whatever the case, if you ever hear Bernanke say “the Federal Reserve will not monetize the debt” again, feel free to ignore him. When he says that, it doesn’t necessarily mean he won’t buy a large quantity of Treasuries with new money created out of nothing.

Remember, Greenspan says there’s “zero probability of default” because the U.S. can always print more money. Does Greenspan know something here? There’s only zero probability if the Fed commits to monetizing the debt as needed. If Greenspan knows something there will be monetization of the debt, even if Bernanke wants to call it something else.

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Obama’s Fiscal Projections: A Doorway to a New Dimension of Reality

Submitted by Andrew Fruth of AcceptanceTake

Get ready to travel to a new dimension of sound, sight, and mind because President Obama has proposed to spend less on discretionary spending in 2022 than in 2011 in real and nominal terms.  That means he expects to spend fewer dollars in 2022, even after being debased by inflation, on discretionary functions than he did in 2011.  These projections come from a President that increased the entire U.S. debt by over 45% in a matter of 4 years.  We may have a credibility problem:

A closer look at the 2013 budget shows that Obama, in inflation and population adjusted dollars, wants to decrease discretionary spending from $1261 billion dollars in 2013 to $982 billion in 2022 for a decrease of 22.1%!  So, for the exception of Social Security, Medicare, Medicaid, other mandatory programs, interest, TARP, and a very small amount for “adjustments for disaster costs,” Obama plans to cut spending by 22.1% in adjusted dollars. Do we have any believers out there?:

But it doesn’t stop there.  Look at the interest rates the government expects to pay on its public debt.  The net interest row does not include intergovernmental debt.  All years are estimates except for 2011:

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
2.27% 1.94% 1.96% 2.30% 2.75% 3.22% 3.60% 3.85% 4.04% 4.18% 4.27%

Public debt is set nearly to double from 2011 to 2022 and increase by $9.358 trillion.  Yet, by 2022, the government expects to pay interest rates on the public debt that are less than they paid on the total U.S. debt in the 1990s.

You may notice a slight difference between the interest rate in the table above and the interest rate shown in 2011 on the chart below.  Unlike the table above, the chart below measures average interest rates on the federal debt outstanding, so it includes intergovernmental debt interest.  The interest rates on the intergovernmental debt brought the average up from the table above to the chart below.

The differences, however, are slight.  The 1990s still had significantly higher interest rates in the 1990s than Obama projects, even for 2022:

You might be thinking that the government plans on the Federal Reserve buying up Treasuries to keep Treasury rates low.  Well, maybe, but the government only projects the “GDP chained price index” to range from 1.6%-2.1% from 2011 to 2022.  Needless to say, unless banks, as a whole, are deleveraging throughout the whole period, the Federal Reserve’s intervention in the Treasury market would create more than 2.1% price increases.

But wait, that can’t be because if the banks are deleveraging, then it’s really unlikely the economy is going to be growing as strong as Obama projects.  From 2012 through 2018, Obama projects the economy will grow between 2.7%-4.1% YOY in real terms.  Then the real growth rate drops off to 2.7%-2.5% from 2019-2022.  For comparison’s sake, the economy grew in the 2%-4% range from 2003-2006 during the boom times.

So, then, where is the $9.358 (minus whatever amount has been borrowed so far in fiscal year 2012) trillion at 1.94%-4.36% going to come from if not the Federal Reserve?  Pick you choice: a) the free market in the U.S. b) China c) Japan d) not going to happen.  I would provide an answer key for this question, but I don’t want to insult your intelligence.

So, if the government does plan on borrowing this much, assuming it can get it from somewhere other than the Fed, what happens if interest rate levels rise to rates similar to those found in the 1990s and 1980s?  Well, fortunately, in my book The Debtor’s Ultimatum: Defy, Debase, or Default I’ve done the research.  By the way, the following chart doesn’t even include the interest on the additional interest that would develop over this time from higher interest rates.

Here’s the Hypothetical Average Interest Rate Paid on the Public Debt Alone:

Government Numbers for both the chart above and below are sourced from the Midsession Review 2012, so the data are a little bit different from the data mentioned previously that is from the 2013 budget.

Here’s the Net Interest on Public Debt Alone in Billions of $:

Yeah, and there’s even more.  The government receipts projections are incredibly optimistic.  Part of that optimism is due to projected increase in economic growth and part of it is due to Obama’s proposal to let the Bush tax cuts finally expire.  We’ll see if either of those possibilities comes to pass.  I have my doubts about both.

Rather than pontificate, I’ll let you look at the 2013 budget data yourself.  The following are federal receipts, in trillions of dollars.  2012-2017 are estimates:

2003 2004 2005 2006 2007 2008 2009 2010
1.78 1.88 2.15 2.41 2.57 2.52 2.10 2.16
2011 2012 2013 2014 2015 2016 2017
2.30 2.47 2.90 3.22 3.45 3.68 3.92

Did you notice that crazy jump from 2012-2013?  The government is expecting some pretty big economic growth.  We know those increases in receipts are not due to inflation, because the government expects hardly any at all.

Funny, in the 2012 budget, the government had the following data with only 2010 being a non-estimate:

2010 2011 2012 2013 2014 2015 2016
2.16 2.17 2.63 3.00 3.33 3.58 3.82

Notice the big jump from 2011 to 2012 they projected and compare it to the jump from 2011-2012 in the 2013 budget table.  They’re really counting on that surge of receipts, and if they’re off by a year, they’ll just delay the surge another year or so.

Take a look at the 2011 budget.  Only 2009 is a non-estimate year:

2009 2010 2011 2012 2013 2014 2015
2.10 2.17 2.57 2.93 3.19 3.46 3.63

Yep, once again, the projected jump from 2010-2011 was far less than actually occurred.

The President’s budget assumes no increase in nominal dollar spending from 2011-2022, interest rates to stay in the 2%-4% range despite needing to borrow around $9 trillion over the next decade, the Fed to not be a major player in buying that debt, because inflation numbers are low, and expects revenues to get a sudden boost, even after being wrong about his revenue predictions over and over again.  And to top it all off, all of these predictions come from a President who has increased the total U.S. debt by over 45% in his first term of office.  Oh, yes we can’t!