{"id":15745,"date":"2010-11-22T15:34:33","date_gmt":"2010-11-22T20:34:33","guid":{"rendered":"http:\/\/countingpips.com\/fx\/?p=15745"},"modified":"2010-11-22T15:34:33","modified_gmt":"2010-11-22T20:34:33","slug":"robert-prechter-explains-the-fed-part-ii","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/fx\/2010\/11\/22\/robert-prechter-explains-the-fed-part-ii\/","title":{"rendered":"Robert Prechter Explains The Fed, Part II"},"content":{"rendered":"

The world’s foremost Elliott wave expert goes “behind the scenes” on the Federal Reserve <\/span>
\n November 22, 2010 <\/span><\/h3>\n

By Elliott Wave International<\/span><\/h3>\n

This is Part II of our three-part series “Robert Prechter \t\t Explains The Fed.” You can \t\t read Part I here<\/a> <\/span><\/strong>— and come back later this week for Part \t\t III.<\/p>\n

Money, Credit and the Federal Reserve Banking System<\/em>
\nConquer the Crash<\/em>, Chapter 10
\nBy Robert Prechter<\/p>\n

… Let\u2019s attempt to define what gives the dollar objective \t\t value. As we will see in the next section, the dollar is \u201cbacked\u201d primarily \t\t by government bonds, which are promises to pay dollars. So \t\t today, the dollar is a promise backed by a promise to pay an \t\t identical promise. What is the nature of each promise? If the \t\t Treasury will not give you anything tangible for your dollar, \t\t then the dollar is a promise to pay nothing. The Treasury should \t\t have no trouble keeping this promise.<\/p>\n

In Chapter 9 [of Conquer the Crash<\/em>], I called the \t\t dollar \u201cmoney.\u201d By \t\t the definition given there, it is. I used that definition and \t\t explanation because it makes the whole picture comprehensible. \t\t But the truth is that since the dollar is backed by debt, it \t\t is actually a credit, not money. It is a credit against what \t\t the government owes, denoted in dollars and backed by nothing. \t\t So although we may use the term \u201cmoney\u201d in referring \t\t to dollars, there is no longer any real money in the U.S. financial \t\t system; there is nothing but credit and debt.<\/p>\n

As you can see, defining the dollar, and therefore the terms \t\t money, credit, inflation and deflation, today is a challenge, \t\t to say the least. Despite that challenge, we can still use \t\t these terms because people\u2019s minds have conferred meaning \t\t and value upon these ethereal concepts.<\/p>\n

Understanding this fact, we will now proceed with a discussion \t\t of how money and credit expand in today\u2019s financial system.<\/p>\n

How the Federal Reserve System Manufactures Money<\/em><\/p>\n

Over the years, the Federal Reserve Bank has transferred purchasing \t\t power from all other dollar holders primarily to the U.S. Treasury \t\t by a complex series of machinations. The U.S. Treasury borrows \t\t money by selling bonds in the open market. The Fed is said \t\t to \u201cbuy\u201d the \t\t Treasury\u2019s bonds from banks and other financial institutions, \t\t but in actuality, it is allowed by law simply to fabricate a \t\t new checking account for the seller in exchange for the bonds. \t\t It holds the Treasury\u2019s bonds as assets against — as \u201cbacking\u201d for \t\t — that new money. Now the seller is whole (he was just a middleman), \t\t the Fed has the bonds, and the Treasury has the new money.<\/p>\n

This transactional train is a long route to a simple alchemy \t\t (called \u201cmonetizing\u201d the debt) in which the Fed turns \t\t government bonds into money. The net result is as if the government \t\t had simply fabricated its own checking account, although it pays \t\t the Fed a portion of the bonds\u2019 interest for providing \t\t the service surreptitiously. To date (1st edition of Prechter’s Conquer \t\t the Crash<\/em> was published in 2002 — Ed.), the Fed has monetized \t\t about $600 billion worth of Treasury obligations. This process \t\t expands the supply of money.<\/p>\n

In 1980, Congress gave the Fed the legal authority to monetize \t\t any agency\u2019s debt. In other words, it can exchange the \t\t bonds of a government, bank or other institution for a checking \t\t account denominated in dollars. This mechanism gives the President, \t\t through the Treasury, a mechanism for \u201cbailing out\u201d debt-troubled \t\t governments, banks or other institutions that can no longer \t\t get financing anywhere else. Such decisions are made for political \t\t reasons, and the Fed can go along or refuse, at least as the \t\t relationship currently stands. Today, the Fed has about $36 \t\t billion worth of foreign debt on its books. The power to grant \t\t or refuse such largesse is unprecedented.<\/p>\n

Each new Fed account denominated in dollars is new money, \t\t but contrary to common inference, it is not new value<\/em>. \t\t The new account has value, but that value comes from a reduction \t\t in the value of all other outstanding accounts denominated \t\t in dollars. That reduction takes place as the favored institution \t\t spends the newly credited dollars, driving up the dollar-denominated \t\t demand for goods and thus their prices. All other dollar \t\t holders still hold the same number of dollars, but now there \t\t are more dollars in circulation<\/em>, and each one purchases \t\t less in the way of goods and services. The old dollars lose \t\t value to the extent that the new account gains value.<\/p>\n

The net result is a transfer of value to the receiver\u2019s \t\t account from those of all other dollar holders. This fact is \t\t not readily obvious because the unit of account throughout \t\t the financial system does not change even though its value \t\t changes.<\/p>\n

It is important to understand exactly what the Fed has the power \t\t to do in this context: It has legal permission to transfer wealth \t\t from dollar savers to certain debtors without the permission \t\t of the savers. The effect on the money supply is exactly the \t\t same as if the money had been counterfeited and slipped into \t\t circulation.<\/p>\n

In the old days, governments would inflate the money supply \t\t by diluting their coins with base metal or printing notes directly. \t\t Now the same old game is much less obvious. On the other hand, \t\t there is also far more to it. This section has described the \t\t Fed\u2019s secondary role. The Fed\u2019s main occupation \t\t is not creating money but facilitating credit. This crucial \t\t difference will eventually bring us to why deflation is possible.<\/p>\n

[Next: Prechter explains “how the Federal Reserve has \t\t encouraged the growth of credit.”]<\/p><\/blockquote>\n

Come\u00a0back later this week for Part III of the series “Robert \t\t Prechter Explains The Fed.” Or, read more now\u00a0in the \t\t free Club EWI report, “Understanding \t\t the Federal Reserve System<\/a>.”<\/span><\/p>\n

\n

This \t\t article was syndicated by Elliott Wave International and \t\t was originally published under the headline Robert Prechter Explains The Fed, Part II<\/strong><\/a>. <\/span> EWI is the world’s largest market forecasting firm. Its staff \t\t of full-time analysts led by Chartered Market Technician \t\t Robert Prechter provides 24-hour-a-day market analysis to \t\t institutional and private investors around the world.<\/em><\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":"

This is Part II of our three-part series “Robert Prechter Explains The Fed.” You can read Part I here — and come back later this week for Part III.<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-15745","post","type-post","status-publish","format-standard","hentry"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts\/15745","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/comments?post=15745"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts\/15745\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/media?parent=15745"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/categories?post=15745"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/tags?post=15745"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}