The writer is a lawyer by training who deals with and is involved in technology. Manager of a cryptocurrency investment fund, and lives in the USA. The author of the book “A Brief History of Money” and the recording of the KanAmerica.Com podcast.
Ben Bernanke, chairman of the Federal Reserve from 2006-2014, best described what has happened in the world in the last twenty years, in a speech from 2002: “The US government has technology and a printing press, and it allows it to produce as many dollars as it wants.” Indeed, since 2008, the Fed has created more than 8 trillion dollars, about two-thirds of which was foreign to cover the federal government’s deficits, and the remainder to the housing market in the form of mortgage-backed bonds.
● The secret meeting of the bankers and the great crisis: the day the Federal Reserve was born
● Is the corona virus left behind? China’s recovery is already here
How were printers born?
But the Federal Reserve not only created money directly, it also influenced, through the mechanism of interest, the amount of money that the commercial banks “created” through credit, and in a mechanism known as “fractional reserve banking”.
The idea was born somewhere in 1656, a Dutch merchant named Johan Flamstrochen arrived in Sweden and asked the king for a license to establish the first bank in the country. At the bank, customers could deposit coins of various types for safekeeping, and receive bills from the bank for them confirming the total of their deposits. The notes also confirmed to their holders that the funds are available for withdrawal at the demand of the holder of the note. Thus, the transfer of the bill became a convenient way to transfer the ownership of coins, which also made the bills, de facto, the first paper money in the country.
After the Crown had been promised a considerable share of the revenue, two charters were granted to Mr. Palmstrochen. One for the establishment of a “deposit bank” as described above, and the other for the establishment of a “loan bank”, which will give its customers credit derived from its owners’ capital. Banks of this type have already existed in Italy for several centuries. This credit was also given by Flamstrochen through the paper notes, backed as mentioned by the owner’s capital deposited in the bank.
In the absence of competitors, Palmstrochen’s banks were a resounding success. But soon he felt that the owner’s capital in the loan bank ran out and there was no more money to provide credit. That’s when Mr. Flamstrochen thought of a brilliant idea that changed the world forever: after all, there is a lot of money sitting in the deposit bank, but the chance that all the depositors will come at the same moment and ask for their money is very low. “Why won’t I make additional loans with the new paper money against some of these deposits?” said to himself.
Said and done. And so were added loans given in paper bills that were not backed one by one with metal money in the bank’s vaults. The method worked perfectly for about two years, until the crowd attacked the bank and demanded to change the paper back to the metal money. Or then, in the absence of enough silver metal to cover the notes, the bank went bankrupt. Mr. Flamstrochen stood trial, was deported from Sweden, and died shortly after, but the idea he invented lives and flourishes to this day. Banks lending more money than is deposited in their vaults has become the standard and the mechanism is known as “fractional reserve banking” and is actually a machine for creating new money, in the form of debt.
Two main factors affect the amount of money produced: one is the reserve ratio that the bank will maintain, that is, the ratio between the credit given to the total deposits, and the other is the interest rate, that is, the price of money, which will dictate the borrowers’ willingness to borrow. In 1893, when the banks did not have the Federal Reserve, a government savior in times of need, the reserve ratio in the US stood at 22%-25%. In 1923, after the establishment of the Fed, the ratio fell to 13%, and by 1953 the number dropped to 7 On the eve of the crisis in 2008, the reserve ratio at the major mortgage lenders was 1.5%, and at the end of March 2020, in response to the Corona crisis, the Fed lowered the reserve ratio to zero.
But not only the banks entered the business of money production. Governments also had a role. Since the invention of money, about 6,500 years ago, until about 50 years ago, the basis of money was usually gold. But even though the bills printed by governments in the last centuries were denominated and exchangeable for gold, the amount of bills printed was greater than the amount of gold. And yet, the amount was limited. In the USA, for example, the law stated that the treasury would have a 40% gold cover for the banknotes in circulation, the percentage was reduced after World War II to 25%. All this changed in 1968 when Congress canceled, at the request of President Johnson, the obligation to cover the money in circulation with gold. In 1971, gold disappeared from the monetary system, when President Nixon unilaterally canceled the international monetary agreements (“Bretton Woods Agreements”) that were signed after World War II, and established the peg of the dollar to gold. Without the physical restrictions, interest rates and the reserve ratio were the only factors that defined the amount of money produced.
A step up in the 21st century
After the dot.com crisis at the beginning of the millennium, the Fed lowered the basic interest rate in the economy to 1%-1.75% (a negative record since 1958). This low interest rate allowed Wall Street to inflate the real estate bubble of 2002-2006, which ended as you remember in a crisis that endangered the stability of the entire global financial system.
After the bubble burst in 2008, and in an attempt to prevent a total collapse, the Fed returned and lowered the interest rate, which rose in 2005-2006 to 5.25%, to zero. At the same time, the Fed for the first time in its history began to massively print and circulate money out of thin air. The prints were called “quantitative easing” (Quantitative easing QE). By the time the first quantitative easing ended, in 2010, the Fed had purchased $1.25 trillion in mortgage-backed bonds, injecting new money into the banks to replace the toxic mortgages held by the financial institutions. The Fed also purchased about half a trillion dollars of government debt, and did not stop. Over the next few years and in order to stabilize the economy, the Fed continued to print. Between November 2010 and the middle of 2011, the Fed purchased another 600 billion dollars of government debt as part of what will be called Quantitative Easing 2. In September 2012, the Fed returned to the printer, and began Quantitative Easing 3, in which it printed and purchased 40 billion dollars a month, Mainly of mortgage backed bonds. At the end of that year, the monthly amounts were increased to 85 billion dollars. By the time he stopped the purchases, at the end of 2014, another $1.5 trillion had been printed and the Fed’s balance sheet had grown to $4.5 trillion.
With the outbreak of the Corona virus, the Fed resumed printing on steroids, over 4.5 trillion new dollars by the middle of 2022. In total, the Fed printed over 8 trillion dollars between 2008 and the middle of 2022. And it was not alone. The other major central banks in the world (the European, Japanese, and Chinese) also ) did not put their hand in the printer, between 2008 and 2022 all the major central banks together, including the Fed, printed a total of 27 trillion new dollars out of thin air.
Besides the central banks, the commercial banks also engaged in massive production of debt-money. In the USA alone, a total of 65 trillion new dollars have been created since the beginning of the 21st century. A massive increase, of almost four times, in the money supply.
The sea of silver affects
The massive money printings had far-reaching effects all over the world, from the industrial plants in China to the high-tech towers in Herzliya, from the stock prices on Wall Street to the apartment prices in Or Yehuda. After all, more than demand, what determines the price of products is the availability of money to pay for them. In the hundred years between 1895 and 1995, the US population grew by almost four times, about 190 million inhabitants, but the house prices according to the index, remained unchanged. For more than 110 years, the Case Shiller index for housing prices moved, according to the index, within A narrow band of plus and minus 12%. But suddenly, between the years 2000-2022, the index jumped twice, and between March 2020 and June 2022 alone, it jumped by about 45%. The median house price in America, for example, rose in the current century in line with the index by almost twice, from -$203,000 to approximately $392,000. There was one reason for this – $8 trillion of new mortgages taken out by households to purchase a residential home. Over a third of the amount, approximately $2.7 trillion, originated from direct printing by the Fed since 2009.
When credit became widespread and cheap, and consumers and companies were ready to take from it without limit to purchase shares, real estate and consumer products, the cost of living also rose. The reason for this is simple: the production of money and credit was always faster than the ability to produce products and lines and meet the growing demand.
Jerome Powell, Chairman of the Federal Reserve / Photo: Associated Press, Jess Rapfogel
The massive money printing had a dramatic effect on the American economy in general and the capital markets in particular. Thus, share prices have increased by almost four times since the beginning of the 21st century, and a significant part of the share purchase was made on credit. In 2021, for example, the credit rate for leveraged purchases of shares averaged about $850 billion.
But not only investors bought shares on credit. Companies also financed their own purchases of their own shares in this way. Between 2009 and 2022, the companies spent over 7 trillion dollars on their own share purchases. According to the rating agency Fitch, the companies invested 60-120% of their net cash flow for these purchases. According to Fortune magazine, in 2019 more than half of the self-purchases (about 728 billion dollars) were made on credit. For example, the giant IBM spent a total of 176 billion dollars on own purchases of its shares in the years 1999-2019. In those 20 years, it also increased its long-term debts from about 14 billion dollars to about 131 billion. By the way, the company’s shares fell by 61%, in accordance with the index, in the aforementioned period.
Who benefits from the credit bubble?
This property bubble, financed by credit, mainly benefited the capitalists. That top decile owns about 90% of the stocks and about 45% of the real estate wealth in America. At the same time, the massive printing and debt eroded the purchasing power of Americans, and between the years 2000-2021, the median wage remained, according to the index, almost unchanged. Meanwhile , key products that cannot be imported such as education, health services, and of course real estate became more expensive by 60%-120% beyond the index increase.
In 2022, the disruption also reached grocery prices and the official index, and the Fed panicked. The wage data, which indicate constant growth, also guarantee that inflation is far from being contained. The fear of an inflationary spiral led the central bank of the United States to raise interest rates aggressively, and even reduce its balance sheet, in the hope that the economy and inflation would cool down. But what comes easily does not disappear so easily, and in an economy immersed in huge debts and built on their endless recycling and growth, rising interest rates and suffocating Credit can quickly deteriorate into a widespread recession and social crisis.
Since the beginning of the 21st century, what stands at the center of the economy and dictates most of what happens in it is one factor – the Federal Reserve and its monetary policy. In more than 16 of the 22 years of this century, the base interest rate (FFR) was below the inflation rate, and in almost half of the period it was at zero, a phenomenon like it has never been seen before. Since the Fed took upon itself the management of the economy through the manipulation of interest rates and money production, it also became responsible for the results. Bernanke’s words from 20 years ago about the wonderful machine for printing dollars bit the Fed, and became a huge burden on its leaders today. Caught between the risk of continued and increasing inflation, and a severe recession in an economy mired in endless debt, current chairman Jerome Powell is trying to walk a tightrope. But only days will tell what will happen to him, and the fate of the world economy involved in his wake.