M O M U S S P E A K S

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MARKET MANIPULATIONS
 The Big Fix

The Federal Reserve’s Shuffle: Central Bank Liquidity Swaps, and the Missing Half
Trillion

Back in July 2009, Federal Reserve Chairman Ben Bernanke went before the
House Financial Services Committee and had an extraordinary exchange with Repre-
sentative Alan Grayson concerning the use of central bank liquidity swaps. Grayson
raised the issue and highlighted the fact that from the 4th quarter of 2007 on into the
fourth quarter of 2008, the Federal Reserve had issued $553 billion in central bank li-
quidity swaps. You can view their dialogue at the following link:
http://www.youtube.com/watch?v=n0NYBTkE1yQ&feature=player_embedded.

The swaps work as follows: the Federal Reserve buys up foreign currencies from
other central banks, and those in turn buy up U.S. dollars. The currency rates and inter-
est are locked in, but the value of the currencies in question can fluctuate. That last part
is the key issue, because over the time frame of the swaps in question, the dollar appre-
ciated by 20%, as the U.S. dollar nominal exchange rate reveals. This would mean that
the foreign banks would be holding dollars that were worth north of $100 billion more
than they were at the beginning of the swap, and the Federal Reserve would be holding
currency that was worth 20% less. Someone lost over $100 billion.

Where did the $553 billion go? Don’t ask Ben Bernanke, because he doesn’t
know. However, there’s one reasonable explanation that stands out, and that is the pur-

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chase of U.S. Treasuries. Treasury bonds and bills are used to finance deficit spending,
and there would a great deal of such spending occurring both during and after the eco-
nomic crisis. In order to maintain investor confidence, you’d need to make Treasuries
look like a good buy. One way to accomplish this would be to funnel money around the
world through central banks with the understanding that the money would be used to
buy Treasuries.

The banks would benefit in two ways. First, they’d reap over 20% in profit on the
exchange as the value of their dollar holdings rose. That’s roughly $110.6 billion in
profit just off of the fluctuation in currency value alone. Second, they’d have safe hold-
ings in U.S. Treasuries which would return a further payout to them.

There were 14 central banks who received the money in question. Divvy up
$110.6 billion in profit, and you have an average windfall of $7.9 billion per central
bank. Of course, not every bank received an equal amount. New Zealand received $9
billion, which would leave it with a paltry $1.8 billion in profits to divvy up among its
member banks and investors.

Bernanke’s explanation for the program was that it acted as a hedge against vola-
tility in our own markets. By preventing private banks from seeking dollars here, he’d
allayed a serious threat to the dollar’s value. However, if that’s the case, why did he
need to give New Zealand $9 billion in U.S. dollars?

Can we really be expected to believe that New Zealand was $9 billion short in
dollars, and that there was a tremendous demand within New Zealand’s banking com-
munity for a dollar amount that equaled out to over $3,000 for ever man, woman, and
child in New Zealand? The simple truth is that New Zealand’s private banks would not
have sought $9 billion in U.S. dollars for their own purposes. In 2008, New Zealand’s
gross domestic product was $131 billion. It’s implausible to suggest that over less than
four quarters, in a global economic climate that was imploding, New Zealand’s member
banks required $9 billion in U.S. dollars on their own, especially considering the dollar
amount of central bank liquidity swaps in the first three quarters of 2007: zero. That’s

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right, prior to the final quarter of 2007, there was no demand for such swaps to provide
dollars to foreign banks through their central banks.

Simply put, this was a small glimpse into a much larger fix. By funneling dollars
to fourteen central banks in foreign countries, the Fed manipulated market perception
and investor demand for U.S. Treasuries and in doing so bolstered the idea that rising
U.S. deficits and an exploding national debt were of no concern to private investors in
the know. Of course, when you consider that those private investors were essentially
being bribed to the tune of $110.6 billion in profits off of the currency swaps, you can
see that they had no real reason not to go along.

The more chilling revelation came in an interview Grayson did after his memo-
rable duel with Bernanke. The Federal Reserve’s balance sheet revealed liabilities that
exceeded capital by 40 times. To give you an idea of how severe this picture is, Bear
Stearns imploded under an over leveraging of 33 times liabilities to assets, and Bear did
not come anywhere close to the Federal Reserve in its bets.

We don’t know the true picture of the Federal Reserve’s losses on this or any
other speculative moves it has engaged in because the Fed retains its independence
from government oversight. But what we do know, in the form of the balance sheets
which reveal liabilities which outstrip capital 40 times over, is damning enough. The
Fed is insolvent. The fact that it has the power to print up dollars and funnel them
around the world to manipulate economic perceptions and realities cannot obscure the
basic truth contained within its balance sheets. Short of taking a $110 billion loss on a
currency swap in order to bolster Treasuries, the Fed can’t really do much to salvage a
country that is overextended financially.

Anyone can get an investor to buy Treasury debt if you a.) give him the money to
buy the debt with, b.) promise him a 20% profit for going along, c.) take a 20% loss
yourself in order to accomplish your goal of convincing the world that Treasuries are a
sound investment. This doesn’t make Bernanke’s strategy sound or even smart. I’ll
make it simple enough to understand with the following analogy: let’s say you’ve been
knocked overboard on a cruise, and you don’t know how to swim. As you bob in the
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waves, screaming for help, you see deckhand peer over the side. He throws you a life
preserver, and you feel as though you’re saved. You go to grab the life preserver in or-
der to save yourself, but much to your surprise, you realize that the life preserver is
made of lead and is therefore not buoyant. Would you feel better about your chances of
survival? Therein lies the problem with Bernanke’s approach: the solution is as bad or
worse than the original problem, and the result is the same: insolvency.

What do you expect from Keynesians? Let’s take a look at what they believe, ex-
cerpted from Keynes’s General Theory of Employment, Interest, and Money:

“If the Treasury were to fill old bottles with banknotes, bury them at suitable
depths in disused coalmines which are then filled up to the surface with town rubbish,
and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes
up again (the right to do so being obtained, of course, by tendering for leases of the
note-bearing territory), there need be no more unemployment and, with the help of the
repercussions, the real income of the community, and its capital wealth also, would
probably become a good deal greater than it actually is. It would, indeed, be more sen-
sible to build houses and the like; but if there are political and practical difficulties in the
way of this, the above would be better than nothing [emphasis added].”

I might venture to be cruel and ask a proponent of such asinine ideology what,
exactly, constituted a “suitable depth,” but there is no reason to be that vicious in these
times. For that matter, I might point out that Keynes actually goes to advocate “leaving
it to private enterprise on well-tried principles of laissez-faire to dig the notes up again”
in order to highlight utter vacuousness of such reasoning, but you get the point. The
advocates of such nonsense are full fledged fans of losing $110.6 billion in order to ac-
complish the delay of the inevitable and the necessary; namely a reckoning for their
failed policies of spending more than incoming tax revenues permit. In doing so, they
only make matters more severe for the future. As Keynes put it, and Bernanke imple-
mented it, “if there are political and practical difficulties in the way of this” (this being
in the current day the more sensible way, which in our current situation would be an
honest accounting of our fiscal house and a full fledged effort to set matters right), en-

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gaging in such insipid fixes is better than doing nothing. There’s only one problem:
who said that you had to do nothing to begin with? So what if there are political diffi-
culties in the way? The job of public servants is to do what is in the best interest of the
nation as a whole. It is to make decisions not based on polls which reflect short-term
fluctuations in moods and attitudes, but to take an eye towards the long-term survival
of our republic in order to ensure that it can still stand with strength and freedom in the
future. In short, the job of elected officials occasionally entails doing what is necessary
even if it isn’t particularly popular.

Would it were that our government had the capacity for an act of greatness. As
much as one has to admire Alan Grayson for challenging Ben Bernanke and calling at-
tention to his shenanigans and utter incompetence, one also has to note that Grayson’s
problem wasn’t with the half trillion being shuffled around at a $100 billion loss. It was
that the half trillion went to foreign banks rather than U.S. citizens. He’d like the credit
to go here, thank you very much, even if the credit is bankrupt and functions to do
nothing more than spur inflation. At the end of the day, Grayson, despite his growing
reputation as someone who speaks truth to power, is a Keynesian who advocates doing
something in the place of nothing even if the something is utterly stupid. Consequently,
we have a dearth of leadership that is likely to be terminal on some level.

M o m u s S p e a k s Market Manipulations