Money out of Thin Air

The exponential explosion of dollar-denominated credit…through the "miracle of fractional banking"…

Foreign central banks are shifting into overdrive on their holdings of U.S. debt last week, as evidenced by their balances at the Fed increasing by $9 billion to a new record. Hahaha! Dorks!

Just to show those jerk foreigners that they haven’t cornered the market in stupidity, U.S. banks also bought up a nice $4 billion themselves!

But, and if you really want to see something scary, walk with me over to where the Treasury holds sway, and we will cling to each other in fear and whimper pitifully as we watch vile specters swirl around us, and we note that they issued another $17 billion of debt in the same short week!

The whole scene reminds me of the end of the movie "Raiders of the Lost Ark," where our intrepid hero, Indiana Jones and his perky girlfriend are bound to a post, and the Nazis are opening the Lost Ark of the Covenant and all those angels are swirling around. At first the specters are beautiful and friendly, like what happens when you first start printing money and creating excess credit. Everything is wonderful and lovely! Then, right before our very eyes, the angels metamorphose into shrieking, devouring demons, and everyone is killed and the earth is swept bare, except our hero and his lovely sidekick.

Fractional Reserve Banking: $5.8 Billion in One Week

But getting back into something more attuned to reality as it really exists, we note that the Fed increased raw, fungible credit by $5.8 billion, too! In one week! And, I might add, to a new record, another new all-time new high, never before seen since the inception of the entire Federal Reserve System! A veritable avalanche of raw, naked credit, the original high-powered money if ever there were such a thing, the fabled Money Out Of Thin Air of story and song, money that can be multiplied by almost a hundred-fold, a thousand-fold, a million-fold, a zillion-fold, all through the miracle of fractional banking!

I say this even though people at the supermarket always look at me like I have lost my mind when I stand by the checkout counter and tell them about it, because taking a very, very rough estimate of the multiplier, I look at Required Reserves, $41.64 billion, and divide that by Savings/other Deposits of $4084.8 billion. And what happens when you do that?

Well, if you are like me, and you have my powerful skills with calculators, then you get some weird series of answers because you did something wrong with all those confusing buttons and then, in desperation, you finally ask someone who is just walking by to please use come over here and figure this damn thing out for me, then we get the surprising answer of 0.01.

This means that for every dollar of deposits, banks actually have only one cent of reserves in case people come looking for their money. Okay. Now, taking a look at Total Assets of the U.S. banking system, we find roughly $4,381 billion. And when we compare that to the reserves of $41 billion, it is, likewise, one puny cent of reserves against a dollar’s worth of some of those loans going bad.

Fractional Reserve Banking: A Dime Vs. A Penny

That one cent in reserves, that one measly penny, is backing up both a growing contingency of souring loans going bad, AND people wanting their money! Whew!

And now, as part of your homework for today, I want you to go and get a textbook, any textbook, on economics, and look up the authors’ example of fractional reserve banking. What is the standard amount of reserves that THEY use to illustrate the use of fractional reserves? Ten percent! They, meaning guys who write textbooks, would have an entire dime’s worth of reserves for every dollar of deposits! And we have, in real life, a lousy penny! A penny!

And if you spend any time reading that section, you will note that nowhere in the text do the authors of those textbooks ever imply that reserves would get down to one lousy penny! Does that imply something to you?

And why is this possible, anyway? Because we have a fiat currency, and a guy named Greenspan who will stoop to anything, and another guy named Bernanke and his printing press, and if the banks ever need any money, for anything, they can just let those two know, and they and their Federal Reserve will just – presto! – print up some credit, and buy the holdings of the banks, which also went up last week, as I noted above somewhere. In short, they commit monetary fraud on a grand scale.

They will even print up actual currency! Which I add with that hysterical arching of my eyebrows and high-decibel voice, arms flailing about like my arms were on fire, although without the leaping up and down because the old knees aren’t what they used to be, they did just that, last week! Again! They printed up $4.4 billion in cash! Dollar bills! And they have printed up, in the last year, $38 billion! Lovely stacks and stacks, pallet after pallet, of tens and twenties and fifties and hundreds! About $138 for every man, woman and child in the whole country.

Fractional Reserve Banking: A Decade’s Worth of $4.5 Billion Weeks

$4.5 billion in one week doesn’t sound like that much, I admit, but it is for one lousy week, and can’t you see where this is headed? Now imagine not just one week, but a month’s worth of $4.5 billion weeks, a year’s worth of $4.5 billion weeks, a decade’s worth of $4.5 billion weeks! It adds up!

And you think, and pardon me while I try and stifle this laughter, that the dollars that you are putting away today – tee hee! – into your retirement plan – giggle! – are going to maintain their – snort snort! – purchasing power when you – hahahaha! – retire? Pardon me, but hahahahahahaha! I can’t help myself! Hahahaha!

Wiping the tears away from my eyes, my ribs really hurting from all that laughing, I note that the Federal Reserve and the Treasury are debasing your money right in front of your eyes, and yet you think – hahahahaha! – that when you retire, every one of those dollars you are depositing today will be every bit as valuable years and years from now? Hahahaha! And you admit that you are watching the Fed and the Treasury debasing your money right in front of your own eyes, week after week after week, and yet you STILL believe that a dollar today is the same as a dollar tomorrow? Hahahahaha! Stop! Stop! You’re killing me! Hahahaha!

Now far be it from me, taking a long breath and trying to calm down and be serious for a minute because I am such a classy guy deep down, to suggest that there is any connection at all between the Fed creating money out of thin air to buy up government bonds, and thus effectively extinguishing the debt through that particular fraud, and the fact that the banks suddenly decided to acquire more government bonds. Must be a mere, umm, coincidence. (Hahahaha! Now I’m killing myself!)

So, in one stellar example, we have all had a good laugh, I have demonstrated the perils of a fiat currency, the danger of fractional banking, related it all to "Raiders" (which is a helluva good movie, a classic, really), and now I’ve predicted that we are all going to die, except for the PWOG, which is an acronym for People Who Own Gold, because you know what a sucker I am for acronyms, especially silly- sounding ones, because things are going to get really, really ugly one day real soon, and this may be the only bit of levity that we get out of it.


The Mogambo Guru,
For the Daily Reckoning

Decemeber 15, 2003

P.S. Doug Casey, editor of the newsletter International Speculator, thinks that "the precious metals are the only place to be. But I’ve said for years that, this cycle, gold isn’t just going to go through the roof. It’s going to the moon."

Man! As a guy who has a little gold, and my wife has some gold fillings in her teeth that I have had my eye on, and which I am including in my pathetic net-worth calculations, this kind of happy-talk about gold being in a record- setting bull market mania really appeals to me in the greedy, I’m going-to-be-so-rich-I can’t-wait way. If you had listened to the Mogambo and bought some gold, too, then you would also be doing a little dance and singing "We’re in the money! We’re in the money!" Well, maybe not quite yet. But soon!

Richard Daughty is general partner and C.O.O. for Smith Consultant Group, serving the financial and medical communities, and the editor of the Mogambo Guru economic newsletter, an avocational exercise the better to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning, and other fine publications.

"FINI!" says the cover headline on today’s Liberation.

The man in the picture looks like any one of the thousands of subway bums in Paris: Pathetic. Worn out. Helpless.

But before we had a chance to feel sorry for the poor man, the paper announced that he was the object of so much of the world’s attention for the last 6 months – Saddam Hussein.

Daily Reckoning readers are likely to be offered a little more of the enemy’s flank today. Stocks, bonds and the dollar might rise nicely on the news of Saddam’s capture. ‘Sell!’ is our advice. Saddam’s regime may have posed no threat to U.S. security, but his capture could well be one of those decisive irrelevancies that mark the end of a trend.

We could never quite get in sync with it, but all America seems to hate Saddam and love debt. Hardly a single voter ever met the man, but the Butcher of Baghdad is universally – and no doubt deservedly – loathed. By contrast, Americans have had plenty of introductions to debt, and rarely did they come away unimpressed. Practically every encounter led to an intimate affair of some sort. Now, while Saddam provides a distraction, what better time for the lover to stick a knife in their backs?

Unless Saddam can find a bucket of anthrax somewhere…there is not likely to be much more good news out of Iraq, Washington, or anywhere else. No more tax cuts. No more spending increases. No more rate cuts.

We have been watching the stock market rise…and the dollar fall…for the last few months. It all seemed so gentle, so sweet. As if breaking records in new debt, in federal deficits, in trade imbalances and bankruptcies made no difference whatsoever. Somehow, it would all turn out all right, like a romantic comedy with a happy ending. America’s incredible trade deficit might be resolved by a lower dollar…the stock market might rise steadily, in keeping with corporate profits…and the economy – isn’t it already in recovery? The lumps could leave the theater with light hearts and empty heads.


And now Saddam has been captured. Now, the way is clear to build a model democracy in Iraq. Heck, if it works, we might try to import it back to Washington.

This pleasant delirium…the intoxicating jig of democracy- building…rising stocks…increasing debt…and a gently falling dollar…will have to end sometime. Why not now?

Meanwhile, Addison brings more news:

Addison Wiggin, writing in Paris…

– "Ladies and gentlemen, we got him!" said the U.S. military commander in Iraq yesterday. Already today, the European and London lumps have punched the air, shouted "Yes!" and added more than 1% to their indices in celebration. With the Butcher of Baghdad’s bearded mugshot in Monday’s press, the euro dropped sharply in early Asian trade overnight.

– "Saddam Capture Sure To Boost Markets," says a headline at So sure is everyone now that markets will get a "boost," we can’t help but pass on the warning offered this morning by Dave Lewis at Chaos-onomics: beware the "ego trade."

– "Of the many ways I discovered to lose money in this game," says Lewis, a former hedge fund manager who has since retired to the woods of Upstate New York to contemplate his navel and trade his own accounts, "one of the more seductive occurs when a news item, which I believe has positive (or negative) implications for a market, is released and the market, after moving in the direction I expect, reverses, while my view remains stable. This sets up the classic ego trade, ‘this news is so clearly positive (negative) that I’m just going to double up.’ Who knows how the big money will be using this catalyst to reposition, if at all, or even what other political events might also be catalyzed by the event. Better, I think, to let the dust settle a bit before leaping in and forming a concrete judgment."

– Back in March, when daisy-cutters were laying waste to dunes in the desert, U.S. blue chips enjoyed their longest rally in over two and a half years. London’s FTSE 100 shot up from a 7-year low, adding more than 17% in just 10 days’ trade. Even the pacifist Eurolumps from the chocolate- making countries loved the gunfire. On 21 March, the U.S. announced a "massive escalation" of aerial bombardment; the German Dax put on 4%, while the cheese-eaters in Frogland added 3.4% to the CAC 40.

– But there’s the rub. In March, Western stock markets were re-testing lows from October of last year. Investors seemed happy to buy and hold for a "death dividend." Only, they forgot to get out. With Saddam and his beard now safely behind bars, there isn’t much bull left in the War on Terror.

– As you might expect, the dollar rallied overnight in Asian trade – all the way back to $1.22 against the euro! A puny little gain of just one penny. Your editors, holed up in the Paris office, were hoping that with Saddam’s hairy derrière in the hoosegow, the price of Bordeaux would roll back to more acceptable levels. Alas, the Butcher of Baghdad is no match for the two-headed ghoul that has been stalking the dollar of late: the "twin deficits – fiscal and trade." Expect the dollar to begin running scared again. Soon. Maybe even today.

– "Consumers Turn Gloomy Despite Good News," Reuters tells the world this morning. The almighty U.S. consumer – savior of the world’s only growth engine – has failed to impress with his Christmas shopping. And the preliminary reading from the University of Michigan Consumer Sentiment indicator indicates the index will drop to 89.6, rather than rising to 96 as many economists expected. "This result is hard to believe," Stephen Stanley, senior economist with RBS Greenwhich told Reuters. Stanley suggested the index was out of sync with the other bullish numbers being spewed forth by the financial media.

– Perhaps. Or…could it be that we’re not giving the debt- doused American consumers the credit (sic!) they deserve? Is it possible that they are as skeptical of the ‘recovery’ scenario numbers as the gloomy gusses who pen the Daily Reckoning?

– If so, our fellow gloomster, Stephen Roach at Morgan Stanley, thinks he’s found an explanation. Roach: "This jobless recovery has just celebrated its second anniversary. Never in the modern-day history of the U.S. business cycle has there been such a profound shortfall of hiring. For months we’ve been hearing that’s about to change. The recent sharp acceleration in the U.S. economy, in conjunction with a modest improvement on the overall hiring front in the past four months, have led most to believe that an old-fashioned hiring-led recovery is just around the corner. Don’t bet on it. The global labor arbitrage tells me there’s something new and big going on that will continue to defy the optimistic spin that is now being put on a still very sluggish American labor market."

– The ‘job picture’ remains uncertain, and yet, we learned Friday that current account deficit widened…significantly. The U.S. trade deficit for the first ten months of this year came in at $409 billion… just $9 billion shy of last years historic $418 billion. The "politically sensitive" Chinese current account deficit lept up to $13.6 billion for the month of October.

– "Oil stocks were muted on expectations the crude price could recede," says of this morning’s London trade. Ah yes, black gold. New York’s benchmark crude contract for January delivery added $1.20 to $33 last week.

– OPEC ministers are blaming speculators – and why not? America gobbles up one-quarter of the world’s daily oil production, but only has 2% of its reserves. "[The price] is on the high side, but not too high, bearing in mind the decline in the U.S. dollar", the UAE oil minister told the Tehran Times. "Our revenue (purchasing power) has lost 20 to 25 percent since the beginning of this year. What we gained in terms of oil prices, we lost in terms of currencies."

– There’s a way round this, of course: stop quoting oil in dollars.

– As we mentioned on Friday, Reuters reported OPEC Secretary General Alvaro Silva saying, "There is talk of trading crude in euros. It’s one of the alternatives, either that or a basket of currencies. It is possible that the organization will discuss this and take a decision at a given time." But today, the Tehran Times reports Saudi oil minister Ali al-Naimi in Cairo saying: "Nobody is talking about the euro…As far as I know I have never said anything about the euro."

– Well, at least that’s clear. There is talk of trading crude in euros, but nobody is talking about it.

Bill Bonner, back in Paris…

*** Our new friend Gregor sends this note about the minutes from the Fed meeting released Friday:

"Based on the wonderful news that the job market may not recover until the end of 2005 or later (Fed minutes), the market surged! Obviously none of these investors are looking for jobs, like my son, a software engineer with a PhD who has been unable to find employment in 2 1/2 years! Apparently one trillion dollar deficits do not worry the Fed. They also subscribe to the wonderful notion that we have no inflation (only prices are going up!)

"Here are the two main excerpts from the minutes of the Fed’s meeting that spurred a large jump in Treasuries and helped to catapult the Dow Jones Industrial Average above 10,000:

"’On Employment:

"’Looking ahead, members generally anticipated that an economic performance in line with their expectations would not entirely eliminate currently large margins of unemployed labor and other resources until perhaps the latter part of 2005 or even later.’

"’On Inflation:

"’In their review of the outlook for inflation, members emphasized that the prospects for persisting slack in labor and other resources in combination with substantial further increases in productivity were likely to hold inflation to very low levels over the next year or two.’

"In the minutes, the Fed basically said that it expects resource utilization to remain low for the next one or two years, resulting in a ‘very low’ (sic!) inflation rate and requiring little in the way of future interest rate hikes. The minutes fit the view of those who believe the Fed won’t raise rates until 2005, and they put a timeline on what the Fed might mean by ‘considerable period.’ The minutes assuaged concerns that developed in the bond market after Tuesday’s FOMC meeting, when the Fed indicated it was less worried about risks for further disinflation and was more confident about the economic outlook!"

*** Another Daily Reckoning reader:

"I’ve enjoyed the ‘euro snobbiness’ bits about the difference in attitude, appearance and capabilities of European workers and airport experiences. I’m afraid I have to agree w/the writer. Every time I travel abroad and come back to the States, it’s as different as day and night. Why don’t more Americans see this or at least acknowledge it? Call it Euro or Asian snobbiness if you want, it’s true and I’d rather be surrounded by well-mannered, well-spoken, friendly and competent foreigners then rough, gruff, rude, crude, incompetent Americans."

*** "Talk of spreading democracy looms large in the National Security Strategy," writes George Soros in Atlantic Monthly. "But when President Bush says, as he does frequently, that freedom will prevail, he means that America will prevail.

"In a free and open society, people are supposed to decide for themselves what they mean by freedom and democracy, and not simply follow America’s lead. The contradiction is especially apparent in the case of Iraq, and the occupation of Iraq has brought the issue home. We came as liberators, bringing freedom and democracy, but that is not how we are perceived by a large part of the population. It is ironic that the government of the most successful open society in the world should have fallen into the hands of people who ignore the first principles of open society. At home Attorney General John Ashcroft has used the war on terrorism to curtail civil liberties. Abroad the United States is trying to impose its views and interests through the use of military force.

"The invasion of Iraq was the first practical application of the Bush doctrine, and it has turned out to be counterproductive. A chasm has opened between America and the rest of the world."

*** Back at home…

"I’ve got to find a new school for Edward…and I’m worried about Jules…"

Elizabeth worries about education. Her husband disapproves of it.

"And you’re not helping at all with your casual attitude. Jules is goofing off in school. You’ve got to encourage him to do better or he’ll never get in a good college.

"But he’ll get into whatever college he wants to get into," Dad replied, making it worse for himself. "If he wants to go to a top school, he knows he has to work hard to get good grades and do other things that make him an attractive candidate. So, if he doesn’t work hard to get good grades, it means he doesn’t really care about getting into a good school. Which is okay with me, because I don’t really think it really matters. What matters is that they come out of school with self-confidence, courage, ambition and intellectual curiosity."

"Yes, but good schools help develop those attitudes…"

"Maybe, maybe not. Remember that story of the old Black man in Alabama who had become a millionaire by building a bank during the Jim Crow era. He had barely gotten to the 8th grade. So a reporter asked him how he did it. He said: ‘When you’ve got no education, you’ve got to use your head.’"

"Well, good for him. But most people need to be encouraged to use their heads…and the better they do in school the better they use their heads…and the better colleges they get into, the better they do in life. So, please keep your contrarian comments on education to yourself and help me nag Jules to do his homework…"