Lux Lucet

The Eccles Building in Washington D.C., home office of the Federal Reserve.

“We have a 2 percent symmetric inflation objective. For a number of years now, inflation has been running under 2 percent, and I consider it an important priority to make sure that inflation doesn’t chronically undershoot our 2 percent objective.” So said outgoing Federal Reserve chair Janet Yellen last week in the course of assessing her on the job performance over the past year.

According to her, everything else is pretty awesome. Unemployment’s down. The economy’s growing at a 3 percent clip. The stock market may be a little pricey but it’s really nothing to get too excited about.

Why, if it weren’t for that persistently low inflation, she’d be batting close to 1.000 and having an all around MVP year here in 2017.

What shall we say to all this? It seems to me that the first order of business is to translate Yellen’s inflation comments into plain English. Academics, politicians and others who wish to hide their meaning from the general public love to use obscure language. But one of the chief jobs of any Christian teacher, whether he’s a blogger or a preacher it makes no difference, is to penetrate the fog to permit a fruitful discussion.

That said, here’s my translation of Janet Yellen’s Fed Speak: “Our objective here at the Fed is to steal 2 percent of the value of the deplorables’ savings each year by creating credit a pace that is faster than the actual rate of growth of the economy. This, combined with our holding interest rates near 5,000 year lows to keep the rubes from earnings any interest in their savings accounts, represents a one-two punch to the middle class. By employing these policy tools, we enlightened folks here at the Fed can strip mine wealth from unsuspecting nobodies, who don’t deserve what they have anyway, and put it into more worthy hands, namely, those master of the universe types who own the banks and pay our salaries. Unfortunately, I was not as successful in this regard as I would like to have been.”

Now that’s more like it. We’re finally getting somewhere. No doubt, Janet Yellen would be greatly offended by my translation, as would pretty much any other central banker, mainstream economist, investor, or financial commentator. Perhaps some of the defenders central bank orthodoxy in academia, the press and in government really do honestly think that debt-based, central bank issued, fiat currencies actually serve the public interest. But that hardly gets them off the hook. They should know better, for the evidence is overwhelming that the current system – which is of, by and for the bankers – is a massive, and profoundly immoral, wealth transfer mechanism.

Inflation, Where Does It Come From?

Inflation – and by inflation I mean inflation in the sense that Janet Yellen used it: a general rise in prices; in my view this is not the proper definition of inflation, but I’ll go with it for now – does not originate where most people think it does.

Back in the mid to late 70’s when inflation was raging, it was common to see news articles blaming everything from crop failures to greedy oil sheiks for the spiraling cost increases seen at that time. Today, people seem to accept as a law of nature that college tuition, medical care, and housing skyrocket. The sun rises in the east, sets in the west, and college tuition goes up 10 percent a year.

But inflation, as Janet Yellen implied in her remarks last week, is really a creature of the central bankers.

And how to central bankers create inflation? They do so by creating additional dollars at a rate that exceeds the rate of growth of the economy.

So just how does the Fed create the massive increase in credit needed to cause a general rise in prices? The answer may surprise you: they create dollars out of thin air and use these dollars to buy treasury bonds – treasury bonds are debt instruments issued by the US federal government – from large banking institutions.

The process works like this. First, the government spends more money than it takes in in tax revenue. This creates a budget shortfall called a deficit – the deficit is the annual amount by which the federal government’s expenditures exceed its revenues, the debt, on the other hand, is the total of all annual deficits; as of this writing, the official US federal government debt is over $20 Trillion.

Second, the US Treasury Department borrows the funds needed to make up for this budget shortfall by issuing treasury bonds.

Third, these bonds are sold at auction to large financial institutions known as primary dealers.

Fourth, the Fed purchases some of these treasuries from the primary dealers by crediting their accounts at the Fed with dollars. It is by the purchase of treasuries that the Fed controls interest rates. The more treasuries the Fed buys, the lower interest rates will go. Low interest rates mean that businesses and individuals can borrow more money, thus bidding up the price of goods and services and creating price inflation.

But here’s the 64 thousand dollar question, Where does the Fed get the dollars to buy up the treasuries from the primary dealers and credit their accounts? The short answer is this: The Fed creates the dollars in the form of credit out of nothing.

I know, this sounds unbelievable. But it’s the truth. Just listen to what the Fed itself said about the process of credit creation in a pamphlet published by the Boston Fed titled “Putting it Simply.”

When you or I write a check there must be sufficient funds in our account to cover the check, but when the Federal Reserve writes a check [in this case, a check to the primary dealers to purchase treasuries] there is no bank deposit on which that check is drawn. When the Federal Reserve writes a check, it is creating money.

This is extraordinary. What the Fed does when it buys treasuries is the moral equivalent of counterfeiting. You and I, if we want to buy something, have to work for it. But the Fed, when it wants to buy treasuries from the primary dealers, just creates dollars out of thin air and credits them to the accounts of these large financial institutions.

As these newly created credit dollars find their way into the economy, they dilute the value of existing dollars, which is another way of saying the newly created money drives price inflation.

During the financial crisis of 2008, the Fed used a similar process to bail out banks that found themselves with large portfolios of non performing home loans. The Fed simply bought them from the banks by crediting their accounts with newly created money. To make matters worse, the Fed paid the banks top dollar to purchase these non performing loans – these were the infamous Mortgage Backed Securities (MBS) we heard so much about during the crisis – the true market value of which was far less.

This was great for the bankers who got bailed out. But for ordinary citizens who were taxed via inflation to pay for this bailout, not so much.

In the world of politics, a “gaff” is defined as when a politician accidentally tells the truth. Horrors! Something like this definition holds true for central bankers as well. It’s hard to say what inspired one of the most famously opaque institutions in America to actually come clean with the truth about how the system works, but I’m glad they did.

Unsurprisingly, this pamphlet is now out of print, but it is quoted in reliable sources, one of which is found here.