Dec 2008 Prediction – Federal Reserve sets stage for Weimar-style Hyperinflation

The Federal Reserve has bluntly refused a request by
a major US financial news service to disclose the recipients of more
than $2 trillion of emergency loans from US taxpayers and to reveal the
assets the central bank is accepting as collateral. Their lawyers
resorted to the bizarre argument that they did so to protect ‘trade
secrets.Is the secret that the US financial system is de facto
bankrupt? The latest Fed move is further indication of the degree of
panic and lack of clear strategy within the highest ranks of the US
financial institutions. Unprecedented Federal Reserve expansion of the
Monetary Base in recent weeks sets the stage for a future Weimar-style
hyperinflation perhaps before 2010

On November 7 Bloomberg filed suit under the US
Freedom of Information Act (FOIA) requesting details about the terms of
eleven new Federal Reserve lending programs created during the
deepening financial crisis.

The Fed responded on December 8 claiming its
allowed to withhold internal memos as well as information about ‘trade
secretsand ‘commercial information.The central bank did confirm
that a records search found 231 pages of documents pertaining to the

The Bernanke Fed in recent weeks has stepped in to
take a role that was the original purpose of the Treasurys $700
billion Troubled Asset Relief Program (TARP). The difference between a
Fed bailout of troubled financial institutions and a Treasury bailout
is that central bank loans do not have the oversight safeguards that
Congress imposed upon the TARP. Perhaps those are the ‘trade secrets
the hapless Fed Chairman,Ben Bernanke, is so jealously guarding from
the public.

Coming hyperinflation?

The total of such emergency Fed lending exceeded $2
trillion on Nov. 6. It had risen by an astonishing 138 percent, or
$1.23 trillion, in the 12 weeks since Sept. 14, when central bank
governors relaxed collateral standards to accept securities that
weren’t rated AAA. They did so knowing that on the following day a
dramatic shock to the financial system would occur because they, in
concert with the Bush Administration, had decided to let it occur.

On September 15 Bernanke, New York Federal Reserve
President, Tim Geithner, the new Obama Treasury Secretary-designate,
along with the Bush Administration, agreed to let the fourth largest
investment bank, Lehman Brothers, go bankrupt, defaulting on untold
billions worth of derivatives and other obligations held by investors
around the world. That event, as is now widely accepted, triggered a
global systemic financial panic as it was no longer clear to anyone
what standards the US Government was using to decide which institutions
were ‘too big to failand which not. Since then the US Treasury
Secretary has reversed his policies on bank bailouts repeatedly leading
many to believe Henry Paulson and the Washington Administration along
with the Fed have lost control.

In response to the deepening crisis, the Bernanke
Fed has decided to expand what is technically called the Monetary Base,
defined as total bank reserves plus cash in circulation, the basis for
potential further high-powered bank lending into the economy. Since the
Lehman Bros. default, this money expansion rose dramatically by end
October at a year-year rate of growth of 38%, has been without
precedent in the 95 year history of the Federal Reserve since its
creation in 1913. The previous high growth rate, according to US
Federal Reserve data, was 28% in September 1939, as the US was building
up industry for the evolving war in Europe.

By the first week of December, that expansion of the
monetary base had jumped to a staggering 76% rate in just 3 months. It
has gone from $836 billion in December 2007 when the crisis appeared
contained, to $1,479 billion in December 2008, an explosion of 76%
year-on-year. Moreover, until September 2008, the month of the Lehman
Brothers collapse, the Federal Reserve had held the expansion of the
Monetary Base virtually flat. The 76% expansion has almost entirely
taken place within the past three months, which implies an annualized
expansion rate of more than 300%.

Despite this, banks do not lend further, meaning the
US economy is in a depression free-fall of a scale not seen since the
1930s. Banks do not lend in large part because under Basle BIS lending
rules, they must set aside 8% of their capital against the value of any
new commercial loans. Yet the banks have no idea how much of the
mortgage and other troubled securities they own are likely to default
in the coming months, forcing them to raise huge new sums of capital to
remain solvent. Its far saferas they reason to pass on their toxic
waste assets to the Fed in return for earning interest on the acquired
Treasury paper they now hold. Bank lending is risky in a depression.

Hence the banks exchange $2 trillion of presumed
toxic waste securities consisting of Asset-Backed Securities in
sub-prime mortgages, stocks and other high-risk credits in exchange for
Federal Reserve cash and US Treasury bonds or other Government
securities rated (still) AAA, i.e. risk-free. The result is that the
Federal Reserve is holding some $2 trillion in largely junk paper from
the financial system. Borrowers include Lehman Brothers, Citigroup and
JPMorgan Chase, the USs largest bank by assets. Banks oppose any
release of information because that might signal ‘weaknessand spur
short-selling or a run by depositors.

Making the situation even more drastic is the
banking model used first by US banks beginning in the late 1970s for
raising deposits, namely the acquiring of ‘wholesale depositsby
borrowing from other banks on the overnight interbank market. The
collapse in confidence since the Lehman Bros. default is so extreme
that no bank anywhere, dares trust any other bank enough to borrow.
That leaves only traditional retail deposits from private and corporate
savings or checking accounts.

To replace wholesale deposits with retail deposits
is a process that in the best of times will take years, not weeks.
Understandably, the Federal Reserve does not want to discuss this. That
is clearly also behind their blunt refusal to reveal the nature of
their $2 trillion assets acquired from member banks and other financial
institutions. Simply put, were the Fed to reveal to the public
precisely what ‘collateralthey held from the banks, the public would
know the potential losses that the government may take.

Congress is demanding more transparency from the
Federal Reserve and US Treasury on its bailout lending. On December 10
in Congressional hearings by the House Financial Services Committee,
Representative David Scott, a Georgia Democrat, said Americans had
‘been bamboozled,slang for defrauded.

Hiccups and Hurricanes

Fed Chairman Ben S. Bernanke and Treasury Secretary
Henry Paulson said in September they would meet congressional demands
for transparency in a $700 billion bailout of the banking system. The
Freedom of Information Act obliges federal agencies to make government
documents available to the press and public.

In early December the Congress oversight agency,
GAO, issued its first mandated review of the lending of the US
Treasurys $700 billion TARP program (Troubled Asset Relief Program).
The review noted that in 30 days since the program began, Henry
Paulsons office had handed out $150 billion of taxpayer money to
financial institutions with no effective accountability of how the
money is being used. It seems Henry Paulsons Treasury has indeed
thrown a giant ‘tarpover the entire taxpayer bailout.

Further adding to the troubles in the worlds former
financial Mecca, the US Congress, acting on largely ideological
grounds, shocked the financial system when it refused to give even a
meager $14 billion emergency loan to the Big Three automakers-General
Motors, Chrysler and Ford.

While it is likely that the Treasury will extend
emergency credit to the companies until January 20 or until the newly
elected Congress can consider a new plan, the prospect of a
chain-reaction bankruptcy collapse of the three giant companies is very
near. What is being left out of the debate is that those three
companies account for a combined 25% of all US corporate bonds
outstanding. They are held by private pension funds, mutual funds,
banks and others. If the auto parts suppliers of the Big Three are
included, an estimated $1 trillion of corporate bonds are now at risk
of chain-reaction default. Such a bankruptcy failure could trigger a
financial catastrophe which would make what has happened since Lehman
Bros. appear as a mere hiccup in a hurricane.

As well, the Federal Reserves panic actions since
September, by their explosive expansion of the monetary base, has set
the stage for a Zimbabwe-style hyperinflation. The new money is not
being sterilizedby offsetting actions by the Fed, a highly unusual
move indicating their desperation. Prior to September the Feds
infusions of money were sterilized, making the potential inflation
effect ‘neutral.’

Defining a Very Great Depression

That means once banks begin finally to lend again,
perhaps in a year or so, that will flood the US economy with liquidity
in the midst of a deflationary depression. At that point or perhaps
well before, the dollar will collapse as foreign holders of US Treasury
bonds and other assets run. That will not be pleasant as the result
would be a sharp appreciation in the Euro and a crippling effect on
exports in Germany and elsewhere should the nations of the EU and other
non-dollar countries such as Russia, OPEC members and, above all, China
not have arranged a new zone of stabilization apart from the dollar.

The world faces the greatest financial and economic
challenges in history in coming months. The incoming Obama
Administration faces a choice of literally nationalizing the credit
system to insure a flow of credit to the real economy over the next 5
to 10 years, or face an economic Armageddon that will make the 1930s
appear a mild recession by comparison.

Leaving aside what appears to have been blatant
political manipulation by the present US Administration of key economic
data prior to the November election in a vain attempt to downplay the
scale of the economic crisis in progress, the figures are
unprecedented. For the week ended December 6 initial jobless claims
rose to the highest level since November 1982. More than four million
workers remained on unemployment, also the most since 1982 and in
November US companies cut jobs at the fastest rate in 34 years. Some
1,900,000 US jobs have vanished so far in 2008.

As a matter of relevance, 1982, for those with long
memories, was the depth of what was then called the Volcker Recession.
Paul Volcker, a Chase Manhattan appendage of the Rockefeller family,
had been brought down from New York to apply his interest rate shock
therapyto the US economy in order as he put it, ‘to squeeze inflation
out of the economy.He squeezed far more as the economy went into
severe recession, and his high interest rate policy detonated what came
to be called the Third World Debt Crisis. The same Paul Volcker has
just been named by Barack Obama as chairman-designate of the newly
formed Presidents Economic Recovery Advisory Board, hardly grounds for

The present economic collapse across the United
States is driven by the collapse of the $3 trillion market for
high-risk sub-prime and Alt-A home mortgages. Fed Chairman Bernanke is
on record stating that the worst should be over by end of December.
Nothing could be farther from the truth, as he well knows. The same
Bernanke stated in October 2005 that there was ‘no housing bubble to go
bust.So much for the predictive quality of that Princeton economist.
The widely-used S&P Schiller-Case US National Home Price Index
showed a 17% year-year drop in the third Quarter, trend rising. By some
estimates it will take another five to seven years to see US home
prices reach bottom. In 2009 as interest rate resets on some $1
trillion worth of Alt-A US home mortgages begin to kick in, the rate of
home abandonments and foreclosures will explode. Little in any of the
so-called mortgage amelioration programs offered to date reach the vast
majority affected. That process in turn will accelerate as millions of
Americans lose their jobs in the coming months.

John Williams of the widely-respected Shadow
Government Statistics report, recently published a definition of
Depression, a term that was deliberately dropped after World War II
from the economic lexicon as an event not repeatable. Since then all
downturns have been termed ‘recessions.Williams explained to me that
some years ago he went to great lengths interviewing the respective US
economic authorities at the Commerce Departments Bureau of Economic
Analysis and at the National Bureau of Economic Research (NBER), as
well as numerous private sector economists, to come up with a more
precise definition of ‘recession,’depressionand ‘great depression.’
His is pretty much the only attempt to give a more precise definition
to these terms.

What he came up with was first the official NBER
definition of recession: Two or more consecutive quarters of
contracting real GDP, or measures of payroll employment and industrial
production. A depression is a recession in which the peak-to-bottom
growth contraction is greater than 10% of the GDP. A Great Depression
is one in which the peak-to-bottom contraction, according to Williams,
exceeds 25% of GDP.

In the period from August 1929 until he left office
President Herbert Hoover oversaw a 43-month long contraction of the US
economy of 33%. Barack Obama looks set to break that record, to preside
over what historians could likely call the Very Great Depression of
2008-2014, unless he finds a new cast of financial advisers before
Inauguration Day, January 20. Required are not recycled New York Fed
presidents, Paul Volckers or Larry Summers types. Needed is a radically
new strategy to put virtually the entire United States economy into
some form of an emergency ‘Chapter 11bankruptcy reorganization where
banks take write-offs of up to 90% on their toxic assets, that, in
order to save the real economy for the American population and the rest
of the world. Paper money can be shredded easily. Not human lives. In
the process it might be time for Congress to consider retaking the
Federal Reserve into the Federal Government as the Constitution
originally specified, and make the entire process easier for all. If
this sounds extreme, perhaps revisit this article in six months again.

Source:, Dec 19 2008

F. William Engdahl is author of A Century of
War: Anglo-American Oil Politics and the New World Order (Pluto Press)
and Seeds of Destruction: The Hidden Agenda of Genetic Manipulation
( His newest book, Full Spectrum Dominance:
Totalitarian Democracy in the New World Order (Third Millennium Press)
is due out early in 2009.


One response


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