I have always liked the childhood story Rumpelstiltskin. My favorite part is Rumpelstiltskin’s ability to turn straw into gold. I’ve often wondered if you could really do this. While I have not been able to find little trolls in the forest that could pull this off, I did find something that the Fed and the Banks do each month that comes pretty close.
The United States annual budget is currently around $3.82 trillion. Taxes collected account for $2.17 trillion of this amount. The rest, $1.65 trillion, is a shortfall and has to be borrowed to cover expenses.[1] The Government (the taxpayers) borrow 100% of this $1.65 trillion each year; 60% of this is borrowed from ourselves, while 40% is borrowed from foreign countries. How do we borrow from ourselves to pay ourselves?
The Federal Reserve and the Treasury sells our debt. They do this each month at an event called the Treasury Auction. Our debt is sold in the form of a bond. Think U.S. Savings Bonds but on a giant scale. Only certain banks and countries can buy these bonds at first, because the amounts are so large. In a typical month, the Fed and Treasury can sell $113 billion of bonds. The largest foreign holder of our debt is China. They buy and hold roughly 8% of our debt each month. The Government (YOU) on the other hand buys 60% each month.
Let me say that again. YOU buy $67 Billion of your own debt each month.
In order to do this, the government has to make money out of thin air! In simple terms this is how it is done:
1. The Fed asks the Treasury to sell $113 billion in bonds (our monthly shortfall). The Fed knows they can sell 40% of the bonds each month.
2. The Fed then goes to a select group of banks called Primary Dealers and asks them to buy the other 60% by lending them the money to do it.
3. The dealers take the money from the Fed as a short term loan with a low interest rate, and purchase the bonds.
4. The Treasury now has $67 billion it can spend, and is left with a bond it has to pay back to the bond holder over time at a low fixed interest rate.
Sounds pretty good so far. Most nations of the world do this to raise money. Think of it as taking a loan against your credit card. As long as you generate excess money (cash) each month to pay the card back, this is not a problem.
But the money to pay back our card comes out of the $3.82 trillion budget. We have not generated excess cash (taxes) from our economy for years. When we have in the past it has not gone to pay down the debt, but has been spent by Congress. This is why we have to borrow ($1.65 trillion) in the first place!
Over time, the amount you have to borrow to pay back the money you have borrowed gets bigger and bigger. That means the amount you have to make out of Thin Air gets bigger and bigger. Finally you end up with an amount owed that is so large, you can never pay it back. Think Greece and Italy right now.
Back to the banks:
1. China and other countries that buy our bonds use excess capital (positive tax revenue) to purchase them in most cases.
2. We go into debt to buy our own debt.
3. The banks in turn collect a small transaction fee for helping the Fed.
4. This fee covers the cost of borrowing the money and buying the bonds.
5. This is a massive money maker for the Primary Dealers. Even a 1% transaction fee on $67 billion is $670 million. That is each month.
If we were to have a failed bond auction, it would create a global lack of confidence in our country. The 40% of our bonds bought by the rest of the world would be at risk.
This would call into question our status as a global leader. To avoid this, no matter how much in bonds comes up for sale each month, the Primary Dealers make sure to buy them all.
Up until the fall of 2011, it was rare for any country to have a failed bond auction. Europe is having them daily at the present time due to worries over their debt levels.
It gets better:
1. The Primary Dealers can turn around and sell the bonds, in smaller amounts, on the secondary market. The secondary market includes Hedge Funds, Pensions, 401k plans, and anyone else who wants them. There is a small fee for this, of course.
2. The Primary Dealers then give back the original amount they borrowed from the Fed, and the Fed is set to do it all over again next month.
This is how you end up holding your own debt. Like I said, sounds pretty good so far.
There is one little problem- the Government owes the bond holders an interest payment as well as a principle payment at the end of the bond’s maturity date. As of today, our debt on these bonds has passed $15,000,000,000,000.00 ($15 trillion). You (taxpayer) owe yourself $10.3 trillion, and foreign governments are owed $4.7 trillion.
Since President Obama and the Democratic-controlled Congress have been in office, our debt has gone up by $4.4 trillion.[2] This does not take into account the cost of the health care bill, jobs program, or anything else we have to spend money on.
Governments have always used this “bank trick” to sell debt. That, in itself, is not the real problem. The true problem is out- of-control spending that forces us to absorb larger and larger debt payments year after year. It puts us at a disadvantage internationally as we have to “be nice” to the countries that buy our debt. It takes away our spending power and our ability to grow our economy.
Interest rates in the U.S. have to be kept low, not to help the economy but to keep our interest payments on bonds low. In Europe alone a simple 1% increase in interest rates amounts to $38 billion in extra payments per year for some countries. At current debt loads, a 1% increase in the U.S. would mean $150 billion in extra payments each year.
This has to stop! If we continue at our current rate of spending, all of our taxes will eventually go to servicing our debt. This can not be fixed by simply raising taxes on the rich.
Even if you took ALL THE MONEY FROM THE “1% PEOPLE,” YOU WOULD ONLY COVER THE DEBT SHORT FALL FOR ONE YEAR. [3]
The next year you would still be $1.65 trillion short, and now you would have no way to solve the debt problem other than taking it from the 99%.
In the upcoming elections, you must support candidates who understand this. The way out of this downward spiral is to grow the economy and force spending cuts. You do this by a balanced budget amendment for Congress. You do this through less costly regulation on business. You do this through better tax laws, and putting true Capitalism first.
We need to send a message to Washington Inc. that enough is enough. A larger economy equals a bigger tax base. Spending cuts help free up money to loan out to businesses to grow. Growing businesses in the private sector, combined with less government spending, is the only way out of our current global crisis.
Make sure you vote wisely.
Joe Henry and Peter Vessenes
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Resources
[1] http://seekingalpha.com/article/285091-a-look-at-who-really-owns-u-...
[3]http://www.alternet.org/economy/145705/the_richest_1%25_have_captur...
Additional Resources
http://mercatus.org/publication/how-much-federal-spending-borrowed-...
http://nationalpriorities.org/en/publications/2011/presidents-budge...
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