Timothy Alexander Guzman, Silent Crow News – A major economic crisis is looming in the Caribbean. Puerto Rico, a US Commonwealth will be the center of attention in the world of finance in the coming months ahead. Puerto Rico’s economy has been in a recession since 2006 and its bonds are close to junk status. Puerto Rico is facing an alarming economic downturn that is clearly unsustainable. The economy is headed for a major collapse, one not seen since the great depression, this time it could be far worse. Puerto Rico has $70 billion in debt and an underfunded government pension system that will be eventually face cuts which only adds to more economic uncertainties for the population. Unemployment levels are at 14.7 percent and a mass migration of the Puerto Rican people to the United States in search of better opportunities has taking hold. Puerto Rico’s economy is dependent upon the United States government and its corporations, which many are pharmaceutical conglomerates. It is politically and socially a “Colonial Possession” of the United States since the Spanish-American war of 1898. However, Puerto Rico is not alone. The United States has other colonial possessions namely Guam, American Samoa in the Pacific and the U.S. Virgin Islands. France and Great Britain also has “Colonial Possessions” or “Overseas Territories” in a number of regions throughout the world. Puerto Rico is no exception to the rule; it is a colony that has been exploited politically and economically for more than a century under US rule.
Puerto Rico’s economy is in a dire situation. As of October 2013, the official number of people who are unemployed is at 14.7 percent, perhaps a lot higher if you count those that have dropped out of the labor force because they are no longer looking for employment opportunities. The Public debt is currently at $70 Billion and increasing daily. Early this month an article written by Justin Velez-Hagan who is executive director of The National Puerto Rican Chamber of Commerce for Forbes magazine titled ‘Default: Puerto Rico’s Inevitable Option’ describes what lead to Puerto Rico’s debt crises:
With triple tax exemption (federal, state, and local), combined with higher-than-average yields, Puerto Rican bonds became so popular in recent years that it was able to rack up $70 billion of debt now held by institutional investors and mutual funds alike. The debt-to-GDP ratio is now nearly 70% and growing, not including pension obligations, which raises the ratio to over 90%. With a per capita debt load of $19,000 and growing, Puerto Ricans shoulder almost 4 times the burden of U.S. leader Massachusetts which carries a deficit of $5,077 per citizen
Puerto Rico’s debt is 4 times larger than Massachusetts who Velez-Hagan acknowledges as the most indebted state per citizen with $19,000. The Washington Post also sounded alarm bells concerning Puerto Rico’s economic crises. In ‘Puerto Rico, with at least $70 billion in debt, confronts a rising economic misery’ Michael A. Fletcher describes what the commonwealth faces with cuts to pensions and government jobs and a rise in taxes all across the board including small and big businesses causing a migration of Puerto Ricans to major US cities:
The economy here has been in recession for nearly eight years, crimping tax revenue and pushing the jobless rate to nearly 15 percent. Meanwhile, the government is burdened by staggering debt, spawning comparisons to bankrupt Detroit and forcing lawmakers to severely slash pensions, cut government jobs and raise taxes in a furious effort to avert default.
The implications are serious for Americans outside Puerto Rico both because a taxpayer bailout would be expensive and a default would be far more disruptive than Detroit’s record bankruptcy filing in July. Officials in San Juan and Washington are adamant that a federal bailout is not on the table, but the situation is being closely monitored by the White House, which recently named an advisory team to help Puerto Rican officials navigate the crisis.
The island’s problems have ignited an exodus not seen here since the 1950s, when 500,000 people left for jobs on the mainland. Now Puerto Ricans, who are U.S. citizens, are again leaving in droves. They are choosing the uncertainty of the job market in Orlando or New York City or Philadelphia over what they view as the certainty that their dreams would be crushed by the U.S. territory’s grinding economic problems.
Bloomberg Businessweek also published an article with concerns affecting the “Muni-Bond Market” that can rattle Wall Street’s Mutual Fund companies. ‘Puerto Rico’s Borrowing Binge Could Rock the Muni-Bond Market’ stated the facts:
The island’s plight affects almost anyone with a mutual fund invested in the municipal-bond market. Exempt from local, state, and federal taxes in the U.S., Puerto Rican bonds are held by 77 percent of muni funds, according to research firm Morningstar (MORN). About 180 funds, including ones run by OppenheimerFunds, Franklin Templeton Investments (BEN), and Dreyfus (BK), have 5 percent of their assets or more in Puerto Rican bonds.
General-obligation bonds, or GOs, which account for about 15 percent of the commonwealth’s public debt, carry the lowest investment-grade rating from Moody’s Investors Service (MCO) and S&P. A downgrade could force many mutual funds to sell part of their Puerto Rican holdings, flooding the market. “Puerto Rico could represent a systemic issue for the municipal-bond market,” says Carlos Colón de Armas, an economist and former official of the Government Development Bank, which conducts the island’s capital-markets transactions. “We are now in a situation where the bonds are trading like junk. I think the ratings agencies have been careful not to lower the GOs further, to avoid creating havoc in the muni-bond market.”
The Obama administration is sending a team of economic advisors according to Bloomberg News last month “With a $70 billion debt load and a substantially underfunded government pension system, the island has fueled market speculation it may need a bailout from Washington.” The report also stated what was on the agenda:
Most of the group’s work will focus on improving Puerto Rico’s management of federal funds to ensure officials are getting the amounts they are entitled to and putting them to effective use, according to the officials. “There is less here than some people think,” said Jeffrey Farrow, who served as the Clinton White House’s liaison on Puerto Rican affairs. “This is pretty straightforward and an extension of what they have been doing in the past, but more intense, formalized and public.”
The first team of officials was scheduled to be from the Environmental Protection Agency and the Health, Education and Housing and Urban Development departments, officials said. Puerto Rico’s education, health and housing departments are among of the biggest recipients of federal funding and have also been responsible for past Puerto Rico budget shortfalls.
The EPA’s intervention may stem from concerns regarding the ability of the Puerto Rico Electric Power Authority to comply with new federal air quality regulations that take effect in 2015.
The Environmental Protection Agency (EPA) is one of the agencies participating under Washington’s request. Washington has required that the Puerto Rico government and the Puerto Rico Electric Power Authority (PREPA) comply with new federal air quality regulations by 2015. The online news source Caribbean Business reported back on July 11th, 2013 ‘PREPA falling behind on 2015 EPA Deadline’ that Puerto Rico is in a race to meet Washington’s air-quality standards by 2015:
A high-ranking regulatory official is concerned that the Puerto Rico Electric Power Authority (Prepa) isn’t moving fast enough to comply with strict federal air-quality standards taking effect in two years, as industry sources told CARIBBEAN BUSINESS that key decisions on the compliance process won’t be taken until next spring. Prepa plans to either close or convert most of its oil-firing units to natural gas to comply with the new air-quality standards, but it won’t select a liquefied natural gas (LNG) supplier and decide on a method to deliver the gas to north-coast plants until March 2014, according to industry sources. That means the final contracts would probably not be enacted and finalized until the fourth quarter of 2014, they added.
Meanwhile, Prepa has an agreement with Texas-based Excelerate Energy to construct an offshore LNG terminal to feed the massive Aguirre powerplant in Guayama. A formal application with the Federal Energy Regulatory Commission was filed in April and the project remains in the permitting phase. Excelerate officials have said they expect the facility to be in service in early 2015, but that outlook depends on getting timely federal approval on its environmental impact statement and several permits.
Puerto Rico’s plan to convert most of its oil-firing units to natural gas will have an impact on its economy. Puerto Rico Electric Power Authority (PREPA) does not have the economic capacity to invest in the construction of new plants that would supply natural gas. “While the cash-strapped public utility can’t afford to build its own plants, there is interest from large energy companies to construct new generation units through public-private partnerships (P3s)” the report stated. “That is especially the case because the move to natural gas isn’t just about compliance, but about bringing down power costs.” Caribbean Business said that Edgardo Fábregas, a former member of PREPA’s board confirmed that the public utility is considering a plan to construct a gas-fired plant “The former Prepa board member said the public utility was considering a longer-term plan to construct, through a P3 initiative, a massive natural gas-fired plant, probably on the site of Arecibo’s Cambalache plant, which is rarely used.” The report also said that Fábregas admitted to the costs associated with the project:
To do a project right, building a plant that could “flex up or down” rapidly and would have the capacity to power the entire north coast, would cost $7 billion, and take six years to build. The project would allow for the elimination of the Palo Seco and San Juan plants, Fábregas said. “We have to move to natural gas as soon as we can, but at the end of the day, you have to renew your system. I understand the cost and time implications involved, but if we don’t start, we will never finish,” he added.
According to Robert Bryce, a senior fellow with the Center for Energy Policy and the Environment at the Manhattan Institute for Policy Research, a conservative think tank based in New York City produced a report called ‘The High Cost of Renewable-Electricity Mandates’. He wrote about the effects of Washington’s new air-quality proposal:
Motivated by a desire to reduce carbon emissions, and in the absence of federal action to do so, 29 states (and the District of Columbia and Puerto Rico) have required utility companies to deliver specified minimum amounts of electricity from “renewable” sources, including wind and solar power. California recently adopted the most stringent of these so-called renewable portfolio standards (RPS), requiring 33 percent of its electricity to be renewable by 2020. Proponents of the RPS plans say that the mandated restrictions will reduce harmful emissions and spur job growth, by stimulating investment in green technologies.
But this patchwork of state rules—which now affects the electricity bills of about two-thirds of the U.S. population as well as countless businesses and industrial users—has sprung up in recent years without the benefit of the states fully calculating their costs. There is growing evidence that the costs may be too high—that the price tag for purchasing renewable energy, and for building new transmission lines to deliver it, may not only outweigh any environmental benefits but may also be detrimental to the economy, costing jobs rather than adding them. The mandates amount to a “back-end way to put a price on carbon,” says one former federal regulator. Put another way, the higher cost of electricity is essentially a de facto carbon-reduction tax, one that is putting a strain on a struggling economy and is falling most heavily, in the way that regressive taxes do, on the least well-off among residential users.
To be sure, the mandates aren’t the only reason that electricity costs are rising—increased regulation of coal-fired power plants is also a major factor—and it is difficult to isolate the cost of the renewable mandates without rigorous cost-benefit analysis by the states.
The new mandate is called Renewable Portfolio Standards (RPS) that automatically “require electricity providers to supply a specified minimum amount of power to their customers from sources that qualify as “renewable,” a category that includes wind, solar, biomass, and geothermal.” The report clarified what the results of the new energy plan would bring:
The federal Environmental Protection Agency (EPA) is similarly bullish on the state programs. The RPS rules are designed “to stimulate market and technology development,” the agency says, “so that, ultimately renewable energy will be economically competitive with conventional forms of electric power. States create RPS programs because of the energy, environmental, and economic benefits of renewable energy.”
Although supporters of renewable energy claim that the RPS mandates will bring benefits, their contribution to the economy is problematic because they also impose costs that must be incorporated into the utility bills paid by homeowners, commercial businesses, and industrial users. And those costs are or will be substantial. Electricity generated from renewable sources generally costs more—often much more—than that produced by conventional fuels such as coal and natural gas. In addition, large-scale renewable energy projects often require the construction of many miles of high-voltage transmission lines. The cost of those lines must also be incorporated into the bills paid by consumers.
What Edgardo Fábregas forgets to mention is that Bryce’s analysis on the price of producing electricity through renewable energy sources can be astronomical. It is an amazing prediction given by the EPA under the Obama administration’s directives. It is important to note that the major players in the RPS programs are connected to Wall Street and major banks that includes Goldman Sachs who is one of President Obama’s major campaign contributors. Author and journalist Matt Taibbi wrote an article on the history of Goldman Sachs and the US government’s relationship for Rolling Stone magazine called ‘The Great American Bubble Machine’. Taibbi explains how Goldman Sachs would benefit from Washington’s air-quality mandates:
The new carbon credit market is a virtual repeat of the commodities-market casino that’s been kind to Goldman, except it has one delicious new wrinkle: If the plan goes forward as expected, the rise in prices will be government-mandated. Goldman won’t even have to rig the game. It will be rigged in advance.
Here’s how it works: If the bill passes, there will be limits for coal plants, utilities, natural-gas distributors and numerous other industries on the amount of carbon emissions (a.k.a. greenhouse gases) they can produce per year. If the companies go over their allotment, they will be able to buy “allocations” or credits from other companies that have managed to produce fewer emissions. President Obama conservatively estimates that about $646 billion worth of carbon credits will be auctioned in the first seven years; one of his top economic aides speculates that the real number might be twice or even three times that amount.
The feature of this plan that has special appeal to speculators is that the “cap” on carbon will be continually lowered by the government, which means that carbon credits will become more and more scarce with each passing year. Which means that this is a brand new commodities market where the main commodity to be traded is guaranteed to rise in price over time. The volume of this new market will be upwards of a trillion dollars annually; for comparison’s sake, the annual combined revenues of all electricity suppliers in the U.S. total $320 billion.
One other important factor to consider regarding Puerto Rico’s energy demands in the future is the supply of natural gas. Puerto Rico is hoping to secure a steady supply of natural gas from the United States for the next 100 years. “A key part of the plan is to secure a long-term LNG contract with the U.S., which has the most economical prices in the world, the result of a boon in U.S. natural gas exploration, which has unearthed a supply that experts say will last a century” according to the Caribbean Business report. In the 2012 State of the Union Address, US President Barack Obama said “We have a supply of natural gas that can last America nearly 100 years, and my administration will take every possible action to safely develop this energy.” F. William Endahl, a research associate at Global Research wrote a ground breaking report, ‘The Fracked-up USA Shale Gas Bubble’ wrote that the 100 year supply of natural gas is in fact an inaccurate prediction:
In a sobering report, Arthur Berman, a veteran petroleum geologist specialized in well assessment, using existing well extraction data for major shale gas regions in the US since the boom started, reached sobering conclusions. His findings point to a new Ponzi scheme which well might play out in a colossal gas bust over the next months or at best, the next two or three years. Shale gas is anything but the “energy revolution” that will give US consumers or the world gas for 100 years as President Obama was told.
Berman wrote already in 2011, “Facts indicate that most wells are not commercial at current gas prices and require prices at least in the range of $8.00 to $9.00/mcf to break even on full-cycle prices, and $5.00 to $6.00/mcf on point-forward prices. Our price forecasts ($4.00-4.55/mcf average through 2012) are below $8.00/mcf for the next 18 months. It is, therefore, possible that some producers will be unable to maintain present drilling levels from cash flow, joint ventures, asset sales and stock offerings.” 
Berman continued, “Decline rates indicate that a decrease in drilling by any of the major producers in the shale gas plays would reveal the insecurity of supply. This is especially true in the case of the Haynesville Shale play where initial rates are about three times higher than in the Barnett or Fayetteville. Already, rig rates are dropping in the Haynesville as operators shift emphasis to more liquid-prone objectives that have even lower gas rates. This might create doubt about the paradigm of cheap and abundant shale gas supply and have a cascading effect on confidence and capital availability.” 
What Berman and others have also concluded is that the gas industry key players and their Wall Street bankers backing the shale boom have grossly inflated the volumes of recoverable shale gas reserves and hence its expected supply duration. He notes, “Reserves and economics depend on estimated ultimate recoveries (EUR) based on hyperbolic, or increasingly flattening, decline profiles that predict decades of commercial production. With only a few years of production history in most of these plays, this model has not been shown to be correct, and may be overly optimistic….Our analysis of shale gas well decline trends indicates that the Estimated Ultimate Recovery per well is approximately one-half the values commonly presented by operators.”  In brief, the gas producers have built the illusion that their unconventional and increasingly costly shale gas will last for decades.
However, Caribbean Business says that “Prepa has invited several suppliers to bid on a project to supply the north-coast plants with natural gas. It is spelling out its gas needs at its Palo Seco and San Juan plants, letting the energy companies decide the best way to supply the natural gas” and that “Prepa has made some progress on its natural gas conversion plan, which energy experts say is the only way to bring down the high cost of electricity.” Allowing energy companies decide how to supply gas would add to the price in the long run. Russia Today recently reported that “fracking technology” is causing major environmental problems within the United States. Since 2008, the state of Texas has been experiencing more earthquakes than ever before:
Between 1970 and 2007, the area around the Texas town of Azle (pop. 10,000) experienced just two earthquakes. The peace and quiet began to change, however, at the start of 2008, when 74 minor quakes were reported in the region. Now an increasing number of people, including scientists, are speculating that natural gas production by fracking – a process that forces high pressure water and chemicals into rock in order to extract natural gas reserves – is the culprit. The problem, however, is proving the claims.
Cliff Frolich, earthquake researcher at the University of Texas, said waste water injection wells from fracking could be responsible for the recent spate of earthquake activity. “I’d say it certainly looks very possible that the earthquakes are related to injection wells,” he said in an interview with KHOU television.
Frolich left room for doubt when he said thousands of such wells have operated in Texas for decades with no quakes anywhere near them. Frolich co-authored a 2009 study on earthquake activity near Cleburne, just south of Azle, which concluded: “The possibility exists that earthquakes may be related to fluid injection.” A recent government study lent credence to Frolich’s findings.
There have been Anti-fracking protests around the world. Fracking or “hydraulic fracturing” is a water-intensive process where millions of gallons of water, sand, and chemicals combined are injected underground with intensive pressure to fracture rocks that surround an oil or gas well. This process then releases extra oil and gas from the rock which flows into the well. “Fracking Technology” is proving to be environmentally dangerous for the health and safety of communities located in close proximity to these well sites. It causes many problems for the air we breathe and long-term environmental damage. For example, water can become contaminated from the toxins fracking has caused. It is an environmental hazard.
EPA rules and regulations also have the potential to impose a “carbon tax option” for states according to The Hill, A Washington D.C. based daily newspaper reported last month that Brookings Institution economist Adele Morris said that a carbon excise tax can be imposed on states:
Morris, a carbon tax supporter, argues that a carbon excise tax could be part of the “menu of specific approaches” that the agency gives states that will craft plans to meet the federal guidelines. Morris suggests that the EPA could “allow states to adopt a specific state-level excise tax or fee on the carbon content of fuels combusted by the power plants regulated under this rule.”
In other words, an excise tax associated with renewable energy supplies can be added only leading to higher energy costs for households, businesses and major industries. It would also allow Puerto Rico to contribute to the environmental degradation because of its future demands of natural gas which has no guarantee of supplies for the next 100 years. It is a recipe for disaster for both the economy and the environment.
Will new EPA rules bankrupt farmers?
It is estimated that Puerto Rico imports at least 85% of the food supply from the United States according to the Latin American Herald Tribune. ‘Puerto Rico Imports 85 Percent of Its Food’ stated that “Puerto Rico imports 85 percent of the food its residents consume due to the lack of competitiveness among companies in this U.S. commonwealth, Agriculture Secretary Javier Rivera told Efe.” Agriculture Secretary Rivera admits that the majority of food is imported from the United States even though Puerto Rico has the capability to produce its own food, but cannot compete with US food suppliers. Rivera continued “Although we have the technical capacity, we’re not able to produce competitively” Why? “The secretary attributed the drop in production to the high operating costs of growing food on the island, which are, in turn, a result of high labor costs, as well as rising energy and fertilizer prices. Rivera acknowledged that therefore many farmers – of which there are fewer than 2,000 on the island, according to recent statistics – have come to depend on government subsidies to stay in business.” With new EPA regulations, remaining farmers will bear higher-energy costs because of the EPA’s new federal air quality regulations that will start in 2015. Agriculture on the island would be affected and farmers would be economically bankrupt when energy prices begin to rise.
From the 1929 Great Depression to the Recession of 2014
Looking back to the 1930’s, Puerto Rico was in economic despair due to the effects of the Great Depression. In 1940, the Popular Democratic Party (PPD) under the leadership of Washington’s puppet governor Luis Munoz Marin came to power with 37.9% of the vote compared to 39.2% of the Republican-Socialist coalition. The PPD also won the 1944 elections with 64.8% of the vote. The PPD was determined to transform Puerto Rico’s economy from an Agricultural farm-based to an export-driven modern industrial economy.
The US and Puerto Rico governments wanted to fast track the urbanization in many areas from a rural society to a modern, industrial urban center that would resemble New York City’s economy. For a short period of time, the project did increase living wages, improved housing conditions, health care and education. It also led to equitable land reforms,. At the same time the plan increased unemployment rates because many Puerto Ricans were unqualified for the types of jobs the new Industrial economy provided. It increased the migration levels to the United States, namely New York, New Jersey and Pennsylvania.
Puerto Rico became more dependent on U.S. markets and created more public and private debts. The most important aspect of US economic and political control of Puerto Rico was the cultural transformation of the population. It became what sociologist call “Americanization”. They were subjected to American culture, media, laws, and even its foods under Washington’s economic and social plan. In ‘Economic History of Puerto Rico: Institutional Change and Capitalist Development’ by James L. Dietz, professor of economics and Latin American studies at California State University wrote:
Industrialization and the accompanying decline of agriculture after the late 1940s did nothing to expand and make permanent the relative autonomy of the early 1940s. Instead, the PPD program had just the opposite result: it laid the foundation for increased dominance by U.S. capital from the 1950s to the present. The PPD’s goal of eventual political independence, after the attainment of social justice and a solution to the island’s economic problems, faded further into the future and eventually disappeared altogether. It may be that Munoz and the PPD never really were committed to independence, as many have suggested, but it is more likely that, as the PPD’s redirection of the economy under Munoz’s leadership tied its destiny ever closer to that of the United States, what they had became what they wanted as what they had wanted slipped further and further from their grasp
In ‘How an Economy Grows and why it Crashes’ author and economist Peter Schiff stated that “The evidence supporting these claims is largely emotional. What is far more certain is that the government’s monopoly control of public projects and services almost always leads to inefficiency, corruption, graft, and decay.” Puerto Rico’s economy was under US control then as it is now. Dietz says that “From 1941 to 1949, the government followed a program of land reform, control over and development of infrastructure and institutions, administrative organization, and limited industrialization through factories owned and operated by the government.” Comparing to what Peter Schiff said the Puerto Rican government’s control of certain economic sectors led to numerous “inefficiencies” and “Decay.” The bleak economic growth of Puerto Rico did not improve through a program called ‘Operacion Manos a la Obra’ or ‘Operation Bootstrap’ in English. It was known as “Industrialization by Invitation” to attract foreign investment. It failed in the long-run. Dietz further wrote:
“Yet Operation Bootstrap made it difficult for Puerto Ricans to improve their standard of living through their own efforts, since it put control over that process in the hands of U.S. firms, whose interests did not necessarily coincide with those of the majority on the island. It is likely that no one consciously intended such results from a development program that seemed so promising, but Puerto Rico’s colonial relation with the United States prevented, or at a minimum made more difficult, a more independent existence for the economy and society”
Puerto Rico’s dependence on the US mainland became evident as the years went by, but right from the beginning of World War II, Puerto Rico’s economy suffered. “The war shut Puerto Rico off from its primary export market and source of imported goods, and meanwhile, there were no war industries to absorb surplus labor; consequently, unemployment increased” according to Dietz. Today, Puerto Rico is suffering from a recession that started in 2006. In another report by Caribbean Business ‘PR reverses growth forecast, now predicts another year of recession’ and stated the dire predictions by the government of Puerto Rico, “The Puerto Rico government has dropped expectations for economic growth this fiscal year as the island struggles to pull out of a marathon downturn dating back to 2006. The Planning Board said Friday it is now projecting that the economy will shrink by 0.8 percent in fiscal 2014, dropping its previous forecast for razor-thin growth of 0.2 percent.” Puerto Rico’s economy will continue to decline as the US economy continues with its own economic problems. It will become more difficult as time progresses for Puerto Rico.
The Collapsing US Dollar and the Fall of Rome
The US Dollar as a the world’s reserve currency is in its last stages because the US owes trillions of dollars in household, corporate and financial debt and future underfunded welfare liabilities. The demand for U.S. dollars kept prices and interest rates low. It allowed the U.S. government to acquire the economic power it needed to dominate the world economically. It allowed the Federal Reserve Bank to print dollars unconditionally. Although the US dollar is still dominate with more the 50% of foreign currency reserves in the world, a gradual transition for other currencies is coming in the near future. The dollar will eventually lose its value. Interest rates on every loan and credit card will rise.
This is a recipe for disaster, because if a country such as Puerto Rico cannot produce its own food and is dependent on a foreign source that is the most indebted nation in world history with more than $17 trillion dollars in debt which continues to increase each passing day is a serious problem for Puerto Rico’s future. Tyler Durden of zerohedge.com provided a chart in 2012 to show the fiscal danger the United States faces in the near future. Durden explains:
We present the following chart showing total US Federal debt/GDP as well as Deficit/(Surplus)/GDP since inception, or in this case as close as feasible, or 1792, which appears to be the first recorded year of historical fiscal data. We can see why readers have been so eager to see the “real big picture” – the chart is nothing short of stunning.
December 23rd marks the 100th anniversary of the Federal Reserve. Dissatisfaction with its track record has prompted calls to audit the Fed and end the Fed. At the least, Congress needs to amend the Fed, modifying the Federal Reserve Act to give the central bank the tools necessary to carry out its mandates.
The Federal Reserve is the only central bank with a dual mandate. It is charged not only with maintaining low, stable inflation but with promoting maximum sustainable employment. Yet unemployment remains stubbornly high, despite four years of radical tinkering with interest rates and quantitative easing (creating money on the Fed’s books). After pushing interest rates as low as they can go, the Fed has admitted that it has run out of tools.
At an IMF conference on November 8, 2013, former Treasury Secretary Larry Summers suggested that since near-zero interest rates were not adequately promoting people to borrow and spend, it might now be necessary to set interest at below zero. This idea was lauded and expanded upon by other ivory-tower inside-the-box thinkers, including Paul Krugman.
Negative interest would mean that banks would charge the depositor for holding his deposits rather than paying interest on them. Runs on the banks would no doubt follow, but the pundits have a solution for that: move to a cashless society, in which all money would be electronic. “This would make it impossible to hoard cash outside the bank,” wrote Danny Vinik in Business Insider, “allowing the Fed to cut interest rates to below zero, spurring people to spend more.” He concluded:
. . . Summers’ speech is a reminder to all liberals that he is a brilliant economist who grasps the long-term issues of monetary policy and would likely have made an exemplary Fed chair.
Maybe; but to ordinary mortals living in the less rarefied atmosphere of the real world, the proposal to impose negative interest rates looks either inane or like the next giant step toward the totalitarian New World Order. Business Week quotes Douglas Holtz-Eakin, a former director of the Congressional Budget Office: “We’ve had four years of extraordinarily loose monetary policy without satisfactory results, and the only thing they come up with is we need more?”
Paul Craig Roberts, former Assistant Secretary of the Treasury, calls the idea “harebrained.” He is equally skeptical of quantitative easing, the Fed’s other tool for stimulating the economy. Roberts points to Andrew Huszar’s explosive November 11th Wall Street Journal article titled “Confessions of a Quantitative Easer,” in which Huszar says that QE was always intended to serve Wall Street, not Main Street. Huszar’s assignment at the Fed was to manage the purchase of $1.25 trillion in mortgages with dollars created on a computer screen. He says he resigned when he realized that the real purpose of the policy was to drive up the prices of the banks’ holdings of debt instruments, to provide the banks with trillions of dollars at zero cost with which to lend and speculate, and to provide the banks with “fat commissions from brokering most of the Fed’s QE transactions.”
A Helicopter Drop That Missed Its Target
All this is far from the helicopter drop proposed by Ben Bernanke in 2002 as a quick fix for deflation. He told the Japanese, “The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.” Later in the speech he discussed “a money-financed tax cut,” which he said was “essentially equivalent to Milton Friedman’s famous ‘helicopter drop’ of money.” Deflation could be cured, said Professor Friedman, simply by dropping money from helicopters.
But there has been no cloudburst of money raining down on the people. The money has gotten only into the reserve accounts of banks. John Lounsbury, writing in Econintersect, observes that Friedman’s idea of a helicopter drop involved debt-free money printed by the government and landing in people’s bank accounts. “He foresaw the money entering the economy through bank deposits, not through bank reserves which was the pathway available to Bernanke. . . . [W]hen Ben Bernanke fired up his helicopter engines he took the only path available to him.”
Bernanke created debt-free money and bought government debt with it, returning the interest to the Treasury. The result was interest-free credit, a good deal for the government. But the problem, says Lounsbury, is that:
The helicopters dropped all the money into a hole in the ground (excess reserve accounts) and very little made its way into the economy. It was essentially a rearrangement of the balance sheets of the creditor nation with little impact on the debtor nation.
. . . The fatal flaw of QE is that it delivers money to the accounts of the creditors and does nothing for the accounts of the debtors. Bad debts remain unserviced and the debt crisis continues.
Thinking Outside the Box
Bernanke delivered the money to the creditors because that was all the Federal Reserve Act allowed. If the Fed is to fulfill its mandate, it clearly needs more tools; and that means amending the Act. Harvard professor Ken Rogoff, who spoke at the November 2013 IMF conference before Larry Summers, suggested several possibilities; and one was to broaden access to the central bank, allowing anyone to have an ATM at the Fed.
Rajiv Sethi, Barnard/Columbia Professor of Economics, expanded on this idea in a blog titled “The Payments System and Monetary Transmission.” He suggested making the Federal Reserve the repository for all deposit banking. This would make deposit insurance unnecessary; it would eliminate the need to impose higher capital requirements; and it would allow the Fed to implement monetary policy by targeting debtor rather than creditor balance sheets. Instead of returning its profits to the Treasury, the Fed could do a helicopter drop directly into consumer bank accounts, stimulating demand in the consumer economy.
John Lounsbury expanded further on these ideas. He wrote in Econintersect that they would open a pathway for investment banking and depository banking to be separated from each other, analogous to that under Glass-Steagall. Banks would no longer be too big to fail, since they could fail without destroying the general payment system of the economy. Lounsbury said the central bank could operate as a true public bank and repository for all federal banking transactions, and it could operate in the mode of a postal savings system for the general populace.
Earlier Central Bank Ventures into Commercial Lending
That sounds like a radical departure today, but the Fed has ventured into commercial banking before. In 1934, Section 13(b) was added to the Federal Reserve Act, authorizing the Fed to “make credit available for the purpose of supplying working capital to established industrial and commercial businesses.” This long-forgotten section was implemented and remained in effect for 24 years. In a 2002 article on the Minneapolis Fed’s website called “Lender of More Than Last Resort,” David Fettig noted that 13(b) allowed Federal Reserve banks to make loans directly to any established businesses in their districts, and to share in loans with private lending institutions if the latter assumed 20 percent of the risk. No limitation was placed on the amount of a single loan.
Fettig wrote that “the Fed was still less than 20 years old and many likely remembered the arguments put forth during the System’s founding, when some advocated that the discount window should be open to all comers, not just member banks.” In Australia and other countries, the central bank was then assuming commercial as well as central bank functions.
Section 13(b) was eventually repealed, but the Federal Reserve Act retained enough vestiges of it in 2008 to allow the Fed to intervene to save a variety of non-bank entities from bankruptcy. The problem was that the tool was applied selectively. The recipients were major corporate players, not local businesses or local governments. Fettig wrote:
Section 13(b) may be a memory, . . . but Section 13 paragraph 3 . . . is alive and well in the Federal Reserve Act. . . . [T]his amendment allows, “in unusual and exigent circumstances,” a Reserve bank to advance credit to individuals, partnerships and corporations that are not depository institutions.
In 2008, the Fed bailed out investment company Bear Stearns and insurer AIG, neither of which was a bank. Bear Stearns got almost $1 trillion in short-term loans, with interest rates as low as 0.5%. The Fed also made loans to other corporations, including GE, McDonald’s, and Verizon.
In 2010, Section 13(3) was modified by the Dodd-Frank bill, which replaced the phrase “individuals, partnerships and corporations” with the vaguer phrase “any program or facility with broad-based eligibility.” As explained in the notes to the bill:
Only Broad-Based Facilities Permitted. Section 13(3) is modified to remove the authority to extend credit to specific individuals, partnerships and corporations. Instead, the Board may authorize credit under section 13(3) only under a program or facility with “broad-based eligibility.”
What programs have “broad-based eligibility” is not clear from a reading of the Section, but it isn’t individuals or local businesses. It also isn’t state and local governments.
No Others Need Apply
In 2009, President Obama proposed that the Fed extend its largess to the cash-strapped cities and states battered by the banking crisis. “Small businesses and state and local governments are having serious difficulty obtaining necessary financing from debt markets,” Obama said. He proposed that the Fed buy municipal bonds to cut their rising borrowing costs.
The proposed municipal bond facility would have been based on the Fed program to buy commercial paper, which had almost single-handedly propped up the market for short-term corporate borrowing. Investors welcomed the muni bond proposal as a first step toward supporting the market.
But Bernanke rejected the proposal. Why? It could hardly be argued that the Fed didn’t have the money. The collective budget deficit of the states for 2011 was projected at $140 billion, a drop in the bucket compared to the sums the Fed had managed to come up with to bail out the banks. According to data released in 2011, the central bank had provided roughly $3.3 trillion in liquidity and $9 trillion in short-term loans and other financial arrangements to banks, multinational corporations, and foreign financial institutions following the credit crisis of 2008. Later revelations pushed the sum up to $16 trillion or more.
Bernanke’s reasoning in saying no to the muni bond facility was that he lacked the statutory tools.. The Fed is limited by statute to buying municipal government debt with maturities of six months or less that is directly backed by tax or other assured revenue, a form of debt that makes up less than 2% of the overall muni market.
The Federal Reserve Act was drafted by bankers to create a banker’s bank that would serve their interests. It is their own private club, and its legal structure keeps all non-members out. A century after the Fed’s creation, a sober look at its history leads to the conclusion that it is a privately controlled institution whose corporate owners use it to direct our entire economy for their own ends, without democratic influence or accountability. Substantial changes are needed to transform the Fed, and these will only come with massive public pressure.
Congress has the power to amend the Fed – just as it did in 1934, 1958 and 2010. For the central bank to satisfy its mandate to promote full employment and to become an institution that serves all the people, not just the 1%, the Fed needs fundamental reform.
Ellen Brown is an attorney, president of the Public Banking Institute, and author of twelve books, including the best-selling Web of Debt. In The Public Bank Solution, her latest book, she explores successful public banking models historically and globally. Her blog articles are at EllenBrown.com.
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