Money and Finance

Richard Duncan quotes

Longer excerpt from The New Depression (taken from my Kindle highlights, so the excerpts aren't necessarily the paragraphs I have put them in below, and there may be things in between that I didn't highlight).

“The amount of government bonds bought by foreign central banks is public information. The Fed’s Flow of Funds data reveal that “official” (i.e., government) buyers from the “rest of the world” (ROW) bought $1.13 trillion worth of U.S. government bonds between 1996 and 2007. That was equivalent to 90 percent of all new bonds the government sold during that period. However, they did not buy up 90 percent of the government bonds sold in each auction during those years. That is clear from the information released following every treasury auction. That means that central banks used the dollars they accumulated to buy a combination of new bonds at auction and older government bonds that had been sold in earlier years (i.e., both new bonds as they were sold by the government and older bonds already owned by other investors). That explains a great deal about the behavior of U.S. interest rates during that period.

When foreign central banks bought bonds that had been issued in earlier years, bonds then owned by other investors, they pushed up the price of those bonds and drove down their yields. That explains Chairman Greenspan’s so-called “conundrum” over why government bond yields wouldn't rise despite the 17 rate hikes by the Fed between June 2004 and June 2006, which were designed to push them up. In other words, the Fed lost control over U.S. interest rates and, therefore, over the economy as the result of central banks outside the United States creating fiat money and investing it in U.S. government bonds.

By the end of 2007, “official” investors from the ROW owned 34 percent of all U.S. government debt, up from 16 percent in 1996….The investment of $1.13 trillion into government bonds only absorbed 28 percent of the nearly $4 trillion in dollar reserves central banks accumulated between 1996 and 2007. Where was the other $2.8 trillion invested? Fannie Mae, Freddie Mac, and the other smaller government-sponsored enterprises (GSEs) absorbed $929 billion of it.

Of course, when Fannie and Freddie issued debt, they used the proceeds to acquire mortgages. Thus, the official foreign buyers (composed almost entirely of central banks) were indirectly responsible for pumping $929 billion into the inflating U.S. property bubble.

With $1.13 trillion, official foreign buyers acquired the equivalent of 90 percent of all new governments bonds sold between 1996 and 2007; and with another $929 billion they acquired 19 percent of all the debt issued or backed by the GSEs over that period. What did they do with the remaining $1.94 trillion they are believed to have acquired as foreign exchange reserves? Those dollars may have been invested in U.S. corporate bonds or in U.S. equities. The Flow of Funds data do not disclose the stakes held by “official” buyers in U.S. corporate bonds and in U.S. equities. Therefore, it is only possible to speculate. However, those dollars must have been invested in U.S. dollar-denominated assets and they must have put very considerable upward pressure on the prices of the assets in which they were invested.

The increase in the share of U.S. assets held by foreign investors over this 12-year period is striking. The ROW’s share of U.S. Treasury securities increased from 28 percent of the total in 1996 to 46 percent in 2007. The ROW’s share in GSE debt rose from 5 percent to 21 percent; in corporate bonds from 14 percent to 24 percent; and in U.S. equities from 6 percent to 11 percent.

It is important to emphasize that much of the increase in the ROW’s ownership of U.S. securities was the result of central banks creating fiat money, buying dollars, and investing those dollars in U.S. dollar-denominated assets. No other conclusion is possible. Wherever that money was invested, it drove up asset prices, resulting in a significant impact on the U.S.

To the extent that it went into bonds, it drove up bond prices and drove down bond yields. That reduction in yields resulted in many investments being made that would not have been undertaken at a higher level of borrowing costs. To the extent that the dollars were invested in equities, they pushed up stock prices and created a wealth effect that permitted more consumption to occur than would have been possible otherwise. In short, those dollars distorted the U.S. economy by funding bad investments and excessive consumption, thus increasing its vulnerability to the downturn that got underway in late 2007.

Bernanke liked to explain that countries such as China, Japan, Korea, and Taiwan had such a high propensity to save that it simply wasn't possible for them to find profitable investment opportunities for so much savings in their own countries (despite the very high rates of economic growth that most of those countries experienced). Therefore, they were compelled to lend to the United States, thereby causing America’s massive current account deficit. That line of reasoning became known as Bernanke’s global savings glut theory.

That argument ignores one very important fact: Most of the money those countries invest in the United States is not derived from savings. The money those countries invest is newly created fiat money. When the PBOC created $460 billion worth of yuan in 2007 to manipulate its currency by buying dollars, that $460 billion worth of yuan was not “saved,” it was created from thin air as part of government policy designed to hold down the value of its currency so as to perpetuate China’s low-wage trade advantage. That is a very important difference. It introduces a third variable in addition to saving and investment, fiat money creation.”

–Richard Duncan, The New Depression

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Money and Finance