QE Is Not Money Printing, It Is Betrayal

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It is difficult, in my opinion, to take any interest in money in general and not have some degree of fascination with the workings and history of the British coining system. The basic unit of gold coinage in early English money was the Crown introduced by Henry VII in the early 16th century. The Crown was valued at five shillings; the shilling itself was 12 pennies of silver. For most English the penny was the basic unit, hand hammered. The Guinea was introduced under Charles II to replace the Laurel Pound as the standard gold coin, made from gold imported from Ghana (known as Guinea then).

These metallic coins, including the smallest denomination, the farthing (hammered from brass), were valuable because of the metal they contained. They were also targets for fraud and deceit since any holder might clip a small piece from the edges; the shavings would be accumulated and turned into bullion by the offender. Spending a clipped coin was an act of small-scale devaluation and fraud, but it was increasingly common and even expected. It was estimated that by the 1690's clipping had stripped handmade coins of about half their original weight.

The Treaty of Union in 1707 that brought the Kingdom of Great Britain into existence from England and Scotland also reorganized the coinage system under a common currency. Article 16 of the Articles of Union specified 20 shillings per pound and 12 pence per shilling. And the coins were to be milled rather than hammered by hand.

Milling had become more common in response to the clipping epidemic, including the use of milled edges; the kind of ridges that we see along the periphery of quarters and dimes of today. The end of handmade coins finished the clipping deception, but it began the illustrious "industry" of counterfeiting. In other words, if a person couldn't devalue a coin they would have to resort to faking it outright.

Nowhere was counterfeiting more of an issue than in the early United States. The lack of availability of hard money, gold and silver, including British coins, led to various and interspersed episodes of paper currency. On January 11, 1776, the Continental Congress resolved,

"that if any person shall hereafter be so lost to all virtue and regard for his country, as to ‘refuse to receive said bills in payment,' or obstruct or discourage the currency or circulation thereof, . . . such person shall be deemed, published, and treated as an enemy of his country, and precluded from all trade or intercourse with the inhabitants of these colonies."

The Continental "dollar" had begun as a means to pay for Congressional obligations, especially the army. Since the Congress had no ability to tax, that power resting with the individual colonies themselves, the best they could do was to issue paper claims on future procurements of real money. A dollar's value at the time was quite literally a bet on the American fortunes of war - should the patriots lose, there would be no Congress to pay out the currency holder's claims.

The British were quite cunning in their views on this paper money, seeing an opportunity to undermine their breakaway colonies. Tories in America were encouraged by the British, even openly, to counterfeit all the "Continentals" they could hire to be printed. It was even advertised in Tory newspapers, supplying Continental counterfeits for merely the cost of the paper.

The Congress and the Continental Army thus had two major financial problems with the paper dollars. They had to overcome both the hurdles to its acceptance at something close to par value as many patriots soured on the prospects for military success in the war years, and then contend with what amounted to massive devaluation through the infusion of wartime deceit. George Washington wrote to John Jay in 1777 that a "wagonload of money will scarcely purchase a wagonload of provisions."

The Continental episode was, however, rare in early American experience. Paper currency was almost never issued by the Federal Government, and it was exceedingly exceptional to have even an attempt at such uniformity. An American living before 1862 would likely only have seen a paper dollar in the form of a bank note.

Dollars then were, like Continentals, claims on real money, but the money obtainable by private banks (and some businesses) rather than Congress. Because they were issued by local banks, their acceptance, and thus value, were derived by proximity to the user. Anyone in Boston in the 1820's would have little trouble getting very close to par in commercial transactions on paper dollars issued by the Suffolk Bank, or any of the banks in Suffolk's note-brokering syndicate. But traveling to New York or Chicago with Suffolk notes would devalue them further as they traveled further. They were also less familiar in appearance, and thus susceptible to be counterfeited.

Since banking was mostly a local affair in those days, recipients of notes issued by far-away banks had no idea whether they were "good". Banks did have the habit, under fractional lending, of issuing far too many notes per their "reserves" of real money (gold). There was simply no easy way of knowing if a paper dollar was as good as gold, and it was simply assumed there was a good probability that it wasn't. Currency "value" was a matter of faith owing to the technological limitations of good knowledge and transparency. A run might at any moment wipe out a bank's supply of gold money reserves and leave paper currency holders with nothing more than expensive decorations.

The problem of counterfeiting and paper currency was not unique to the United States. The Tipu Sultan of Mysore issued tiny copper and gold coins during his rule in the 1780's and 1790's. The diminutive gold Fannam was struck at the Patan mint at only 7mm in diameter. The size of the coin made counterfeiting extremely difficult, a clever innovation that was typical of the "Tiger of Mysore". The Sultan was one of the few in India that held out against the British, even recognizing the independence of the United States before nearly every other country. He often defeated the British militarily with advanced tactics and weapons, including the first large-scale use of iron-cased rockets. He was first defeated in 1789 by General Lord Charles Cornwallis, the very same general that surrendered to Washington at Yorktown.

The problem of counterfeiting in India has not abated, it seems. In 2012, the Home Affairs Ministry issued a report detailing what it classified as a major counterfeiting problem. The Ministry observed "large quantities" of "Fake Indian Currency Notes" (FICN) were being forwarded into the Indian economy from Nepal, Bangladesh, Sri Lanka, Malaysia and Pakistan. While there does not exist a formal war currently between India and Pakistan, hostility remains and the Indian government has noted the connection of FICN and Pakistan in its attempts to declare the counterfeiting an act of "terrorism". Some wartime innovations, it seems, never go out of fashion.

Counterfeiting and FICN have taken renewed importance in recent months as the Indian rupee has been pressured and devalued on foreign "markets". Since May 2, 2013, (a date that meaningfully coincides with the release of the April US jobs report of the BLS's Establishment Survey) the rupee has lost more than 20% against the US dollar. There is no way the drop in value can be due to acts of Pakistani terrorism in a flood of FICN, nor can it be fully explained by the Reserve Bank of India's (RBI) recent 80 billion rupee ($1.3 billion) bond purchase.

While the bond buying measure from the RBI is not technically quantitative easing, it does hold the same basic premises. The RBI itself stated that it would conduct these open market operations and "thereafter calibrate them both in terms of quantum and frequency." There may be some issue with the translation, but I doubt that the word "quantum" was assigned randomly or for poetic reasons. Central banks do love their self-image of hard science.

The mere mention of quantitative easing is intentionally evocative of acuities toward science, objectivity and precision. Yet many hold very visceral reactions toward the program, even the idea and mere mention of those two innocuous words placed together. The recoil is based on the modern conception of shaving pennies or shillings. "Money printing" is intentionally devaluing the currency, replicating the inappropriate fractioning of reserves by imprudent 19th century banks. Quantitative easing is equated with money printing, and thus legal fraud.

Far be it for me to defend quantitative easing or the Federal Reserve, which I am going to do nothing of the sort here, but it may sound that way, QE is not money printing in any meaningful sense. The increase in the supply of marginal and elastic dollars inside the US and globally is first and foremost the responsibility of the banks, and not just US banks. Currency, for the most part, is issued like the 19th century bank note dollars that traded below par for the simple distance factor.

That is not to say that paper dollars are issued by banks; they are not. Paper currency still takes the form of Federal Reserve Notes, but in the marginal monetary and banking system they are largely irrelevant. Dollars in the banking system, what is called liquidity, are created and dispersed by bank balance sheet accounting. These marginal liquidity units are digital representations of currency, ledger balances that shift daily, even by the minute. Bankruptcy and insolvency are not when you run out of Federal Reserve Notes in your bank vault, they come when you have to settle your accounts with the liquidity provider and there are no positive numbers on the right side of the computerized ledger (or when your ledger does not match your counterparty's, and that counterparty happens to be JP Morgan).

Given that global banks are the primary "money printers" in the dollar trade system (and the dollar swap standard), the Fed's role under interest rate targeting is to backstop the wholesale money markets where banks obtain short-term funding from each other. The implicit promise of interest rate targeting had been enough for the global dollar fraction to expand through accounting, regulatory and derivative leverage, providing the financing for the myriad bubbles of recent decades. The Fed did not create the bubbles directly, just provided the conditions for banks to do it for them.

Implicit in that implicit liquidity promise was seamless money integration. The Federal Reserve only operates through its Open Market Desk at the Federal Reserve Bank of New York. The federal funds market is the only place the liquidity backstop actually applies - the eurodollar market is an entirely different structure and setup. But evolution in wholesale money and the accounting at Wall Street banks made the two markets operate flawlessly as if they were a single dollar system. There was uninterrupted operation for decades to provide the empirical basis for modeling such dollar liquidity confidence.

That was an important step because of the dollar's role as reserve currency. An industrial business in Mumbai, India, that wishes to purchase copper from Australia better have US dollar financing (I suppose the Aussie miners would accept Australian dollars, but where would the Mumbai industrialist obtain them?). Given that there is very little foreign bank presence in India, that means Indian banks must have access to global dollar funding in order for Indian trade to occur.

So industry in India gets a dollar loan from an Indian bank that obtains dollars from a global bank participating in the eurodollar market in London. That global bank is willing to extend dollar financing to the Indian bank because of interest rate environments and the characteristics of the Indian bank itself, but also because that global bank has full faith in the eurodollar market to provide dollar liquidity at costs and availability within some defined tolerance. The last part of that equation, liquidity at reasonable cost and availability, comes directly from perceptions of integration across the New York/London dollar funding market divide, due in large part to perceptions about the Fed's ability to meet wholesale demands at the interest rate target. It should re-emphasized here that there are no movements of paper Federal Reserve Notes anywhere in this chain; all of these "dollar" transfers are simple changes to the ledger balances of the participants at various points.

Before August 9, 2007, there was no reason to assume potential delinquency on the Fed's part of keeping global dollar operations seamless. As I mentioned before, the implicit promise of the interest rate targeting scheme came to be seen as good as gold, and was incorporated into funding and risk models as such. After the eurodollar market first froze in the summer of 2007, or more precisely, fragmented, the implicit interest rate target promise of Fed liquidity was uncovered as fully inadequate. Without banks in New York willing to bridge that geographical divide to supply eurodollars, the Fed's liquidity efforts would only extend to this side of the dollar market. London was hung out to dry.

We saw that most clearly in September and October 2008, where "dollars" in London cost a huge premium over "dollars" in New York - LIBOR shot skyward while the effective federal funds rate mostly traded below target. Global liquidity in dollar terms fragmented to the point of panic. And it was nearly repeated in November and December 2011.

QE in the American version has been a psychological experiment in two directions. The first direction was an appeal to inflationary expectations in the attempt to influence consumer and business behavior. Owing to that historical context of money printing and devaluation, the Fed was hoping QE would look enough like money printing to get businesses and consumers to spend money they didn't have through borrowing, and cheap borrowing thanks to QE's cousin ZIRP. Unfortunately, "free money" of this kind is not at all free as consumers and businesses realize the ramifications of having to pay back debt regardless of how low the interest rate goes.

The second psychological manipulation was directed at the banking system itself. If the implicit promise of the liquidity backstop in interest rate targeting was not enough to remove the fragmentation in dollar funding markets, QE would deliver a very visible and explicit liquidity promise. The Fed policy would go way beyond mere talk about dollar availability, it would actually create ledger balances of them in the trillions; all to reassure the banking system that it was safe to go back into dollar "printing" again across the globe. They exist for everyone to see, viewable every week in the H.4.1 release ($2,175,545,000,000 currently).

Under the explicit umbrella of QE 3 and QE 4, global banks have been back in the business of "printing" dollars, making sure any request from Mumbai banks for dollar funding has been met. In the process of doing so, an innumerable amount of leverage has been built upon the explicit promise of, and near limitless horizon for, QE. So quantitative easing itself is not at all like money printing, it is more akin to the British encouragement of Tory money printing (to be clear, I'm not accusing the Fed of acting like a hostile foreign government).

If there were a slogan for QE that fit its actual role in the system, it would be, "making conditions right for a return to bank balance sheet expansion and the expansion of global dollar positions." It was believed that such dollar expansion would foster global trade, and thus economic growth both global and domestic (as all those consumers and businesses would be lining up to borrow again). So a very measured, precisely calibrated, scientifically applied dose of psychological encouragement toward 21st century dollar expansion was supposed to be a win-win-win.

As India and Brazil teeter on the brink of currency collapse, we can plainly see what QE did not do. It did not rid the wholesale dollar markets of fragmentation at all. Without the explicit egis of QE in the US for flow, the explicit money stock promise rings so very hollow. Banks are not willing to expand dollar funding without persistent dollar policy, meaning that these dollar markets are as unserviceable as they were in 2007. It was only an illusion, another money illusion created by a pseudo-science ideology.

The creation of currency crises raging currently all trace exactly to perceptions of QE taper in the US. The Indian economy and the Brazilian economy, the worlds' tenth and sixth largest, fall apart on Bernanke's proclivity to buy $85 billion a month, or $65 billion. This is not directly like shaving a shilling or counterfeiting a Suffolk bank note, though I would not quibble with anyone that believes contrary. They all carry the same stain of intentionally misdirecting or misleading; perhaps there is only intent to consider. Clipping coins intends to deceive for the selfish good of whomever is clipping; QE is perpetrated as deceit for our own collective good. The end result in both is that whoever is on the receiving end is poorer for the deception. QE betrayed the world in a futile dollar promise, and now we get to watch as banks, systems and nations realize they were again the fools.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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