Bernanke: Wealth for Wall Street, Poverty for the People

It was just two years ago, a wealth transfer so brazen as to leave one breathless. The $700 billion Bush bailout met with so much hostility from the public that one congressman said his calls were running 50-50: 50 percent "no," and 50 percent "Hell no!"

Determined not to let it happen again, people across the country began linking arms in activism and tea parties. By last week they had changed Congress. Dozens of bailout supporters from the house and the senate had been turned out of office. So you’d guess that would pretty much put a lid on bailouts and wealth transfers, at least for now, right?

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With timing either stunningly inept or provocatively cavalier, on the very day after the election the Federal Reserve announced its latest money-creating, wealth transferring operation, euphemistically called Quantitative Easing II (QEII).

In an operation larger than either Bush’s $700 billion bailout or Obama’s $787 billion stimulus bill, the Federal Reserve Open Market Committee has decided to buy $900 billion in "longer-term" U.S. treasury bonds by the middle of next year; $600 billion in new purchases and $300 billion more by re-investing principal payments from assets it already holds.

That the policy is aimed at inflating stock prices is widely understood on Wall Street. As Art Cashin of UBS Financial Services wrote, its apparent purpose is "to lift the stock market and promote a wealth effect." In his Washington Post defense of the move, Bernanke admitted as much, saying stock prices got a boost last time and "higher stock prices will boost consumer wealth."

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There may be some truth in Peter Schiff’ suggestion that the Fed’s new policy is an attempt to make a virtue out of necessity: that the government foresees increasing difficulties finding enough lenders for its runaway debt. In any event, it should be noted that the $900 billion QEII operation is close to the amount of U.S. treasuries held by China, $868 billion. But when the Chinese buy U.S. treasuries, they do so with real money they earned from actually making and selling things. The Fed buys them with money it created out of nothing.

As the Fed adds $6oo billion in treasuries to the asset side of its balance sheet, at the same time it adds to the liabilities side of its balance sheet by creating reserves in the banking system to the same extent. In other words the act adds to commercial banks’ deposits with the Fed by the amount of the purchases, $600 billion.

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While we use the term money printing as a euphemism for these activities by the Fed, it is a process vastly more efficient than just printing cash and shoving it out helicopter doors. Because of the fractional reserve nature of the U.S. banking system, banks are empowered to lend out multiples of their reserves. When bank lending gets going in earnest, these new enlarged bank reserves created by the Fed become the basis for the expansion of money and credit many times over. In The Dollar Meltdown: Surviving the Impending Currency Crisis with Gold, Oil, and Other Unconventional Investments, I liken this to a car at the race track. Revving its engines at the starting line, nothing happens — until the clutch is popped. Then it takes off in a cloud of smoke and burning rubber. Similarly, these bank reserves are a powerful engine of monetary expansion and dollar destruction that will take off in earnest as commercial bank lending gets underway.

In the meantime, the dollar is already plunging and commodity prices are beginning to run in the manner described in the book, even before the massive inflationary effects of QEI — $1.7 trillion in Fed securities purchases — have begun to be meaningfully assimilated in consumer prices. By the first quarter of next year today’s commodity price hikes will be hitting hard at the consumer level. The burden of these higher prices on the household budget will be like any tax, borne at the expense of cutbacks elsewhere. This is how stagflation is created. In a depressed economic environment, higher prices — the result of the Fed’s monetary policy — impede savings, slow growth, and depress conditions further, even as prices continue to rise. And now the Fed is doubling down with QEII. All this for the sake of another wealth transfer to Wall Street from the taxpayers of America who will bear the cost in lower living standards.

Is that what the election last week was supposed to accomplish? If not, then Dr. Paul is right and it’s high time to put the Fed out of our misery.