Money Laundering on Steroids

By Sarel J. Oberholster

King Henry the VIII of England was a man of huge appetites. Yes, the one who had a tendency to chop off the heads of his wives, well only two of the six to be exact. Huge appetites require lots of money and Henry was always short. He even grabbed all the money of the Catholic Church of England but still could not make ends meet. This is the description from the Royal Mint.

“It is widely known that the lifestyle of Henry VIII was one of abundance, from his grand palaces to his generous banquets. Even after he had amassed the wealth and property of the Catholic Church during the dissolution of the monasteries, the king’s finances remained seriously depleted.”

Henry, however, had a scheme to help finance his appetites. He replaced most of the silver in silver coins with copper, with the help of the merchant class and “seigniorage”, (“the Crown's right to a percentage on bullion brought to a mint for coining” - silver is also bullion).

Further form the Royal mint.

“Henry VIII turned to debasing the coinage, which involved combining the precious-metal content of a coin with a more common ‘base’ metal, but the face value of the coin remaining the same. Essentially, this meant that more coins, albeit with reduced fineness, could be struck with the same amount of precious metal.”

Henry literally took all the silver and coined copper coins with a thin silver plating to disguise the scam. Everybody had to return the previous silver coins to the king to be replaced with silver plated coins. The merchant class got into the scheme and collected the silver coins, melted them down and brought the silver to the mint to be struck as silver-plated coins. The king would look the other way as long as he got his seigniorage.

The bottom line is that kings were money launderers, feeding off the precious metal content of coins constantly forcing lesser value coins onto the population. It was an inefficient and cumbersome process with a lot of leakage.

Governments hated the discipline of a precious metals money system which required them to create money with an intrinsic value. They schemed and manipulated the process until they succeeded in replacing the precious metals money system with a money system of worthless paper and worthless digital footprints money.

I explained how gold becomes money and how governments schemed to pervert the gold money into worthless fiat money in “ Why do governments hate gold as money?.

I also wrote about the fiat money system in “The Curse of Fiat Money Creation”.

Both these articles are essential background for this article which will look at the inner workings of this fiat money system.

Let me at least repeat the basic facts of fiat money relative to precious metals money and who gets the profits from laundering fiat money. Fiat money has no intrinsic value and is a nothing. Precious metals money has an intrinsic value equal to the precious metal content and as such is a “good” like any other good or service being traded in an economy.

How does a central bank launder fiat money into the goods and services economy?

I’ll answer the question by placing myself in the shoes of a central banker, running my own central bank.

My job will be the “real” job of all central banks.

1.      Fund Government.

2.      Create enough new fiat money to maintain a 2% inflation rate.

3.      Push liquidity into all durations of lending to manipulate and “set”, by central bank decree, interest rates as low as possible.

4.      Make a huge profit on money creation and distribute the profit to myself, government and the connected.

I will design tools, as do all central banks, to meet my objectives.

Let’s just take a step back about the do’s and don’ts of central banking.

Rule number 1: I work for government, even though I pretend to be independent, but may not simply create fiat money and give it to government to spend. Doing that will just be too obvious to everybody what we (the central bank and government) are doing, and the population may refuse to use our fiat money.

Rule number 2: I may also not just create the money, and then “lend” it to government to spend, which effectively is the same is Rule number 1 but a little bit disguised. Interestingly, this rule was broken in 2008, but under the umbrella of “extraordinary lending and monetary policies that it implemented to combat the financial crisis and support economic activity”.

My central bank will, in actual fact, create money and give it to government to spend but I will launder it through the use of my “tools” through the economy to disguise what I am doing.

1.      Paper money and coin.

It is the desire of governments that all paper money and coin should be removed from the economy and all money should become digital footprints which we move around. The government can then track and trace every digital penny and control all money transactions of the population. Cash is a problem and cannot be traced thus it must be phased out. It is a work in progress but for the time being I, as Central Bank, will create notes and coin and sell them to the banks for distribution. My objective here would be to create the notes and coin at a cost as low as possible without inviting falsification of the money. I will profit handsomely from this activity but creating digital money will always be more profitable as it literally costs nothing to create digital fiat.

Here is the funniest part of creating notes and coin, I will record notes as a liability (a debt) to the public on my balance sheet. I have no intention of ever paying the notes back and even if required to pay it back, will only exchange it for other note. Did you understand that? I give you a worthless piece of paper and will give you another worthless piece of paper in exchange, at you demand, and then pretend I have a liability. 

It makes more sense if referenced back to when money was a promise by the central bank to give any holder of a note, gold of equivalent value upon request. I then had a very real liability. Anybody could demand gold, which has an intrinsic value, from me. Central banks dropped that promise and without it I simply can’t have any liability, but to keep up the pretense, all central banks pretend to still have a liability. Professional accountants and auditors happily sign off on the financial statements confirming my non-existent liability.

“Federal Reserve Accounting for Currency and Coin

Federal Reserve notes are liabilities on the Federal Reserve's balance sheet.”

FED website, Currency and Coin Services

I wrote this article over the weekend and got this on my news on Monday morning.

“Trump says he has instructed US Treasury to stop minting new pennies: 'This is so wasteful!'”

"For far too long, the United States has minted pennies which literally cost us more than 2 cents," Trump wrote on Truth Social. "This is so wasteful! I have instructed my Secretary of the US Treasury to stop producing new pennies."

The value of even a penny has become completely detached from its intrinsic value to result in this bizarre outcome where production cost for a penny exceeds the face value. Why spend money on minting coins when the inherent inflation in the economy has already gone passed the face value of the coin?

2.      General liquidity and Lender in last resort to the banks.

Banks game their own balance sheets. They borrow from the general public, then call it deposits. It’s not really deposits as banks do not hold on to it, they lend it out again. The objective is to borrow the money cheaper and lend it out dearer to profit. The biggest profit margin is to borrow money in the short term and pay the lowest interest rates while then lending the money out in the longer term and charging the highest interest rates.

Gaming short deposits against long lending is high risk. What happens if depositors ask for their money, but the money has been lent out? The bank can’t pay, and you get a run on the bank. The bank is placed in forced liquidation and closed. It happened a lot in the past and still happens when the money system experiences systemic liquidity stress (too many people asking for the return of their money).

This is one of the reasons given for creating central banks. The logic is that all banks will place money with the central bank and the central bank can then use that pool of money to assist any bank under stress with extra money (liquidity). Nice on paper but a run on a bank is not an isolated event, it’s a domino event. It starts with one run and very quickly expands to all banks. The pool of money or reserves is a straw man easily consumed by the fire of even a single bank run. So, the only way to stop it is if the central bank just create new, and as much as required, fiat money to supplement the “reserves” and calm the money demands.

Central banks will not just create money and give it to banks. Central banks want to be repaid any money they create and lend out, with interest. Banks must give central banks collateral. Here is where we circle back to job number one. (We will be circling back to the jobs a lot.) My absolute most important job by far is to sell government debt. So, banks, you will be required to pledge government debt (or sell and buy back – called repos, or any other legal form of giving collateral) as collateral to me if you want to borrow money from me in any pinch. 

That will be the first “tool”, you want emergency money, then bring you government debt as collateral. I will then create money to lend to you and help you out. I now have the banks in my pocket. They will buy and hold vast amounts of government debt, will put all their normal, contingency and emergency reserves in government debt. No government debt collateral, no liquidity rescue. I can dictate the interest rates at which I am lending to banks, and I can manage interest rates down for government given the captured demand that I have created.

I have further created an open channel to create money from nothing, lend it to banks for on-lending, feeding fiat into the economy, and earn interest on my newly created-form-nothing-money. I’m also addressing my jobs 2,3, and 4 in the process. I will use this channel to encourage banks to increase debt by providing them with limitless money as long as they have government debt to give as collateral.      

3.      System of risk weighting to push government debt onto the balance sheets of banks.

People still talk about fractional reserve banking as if it is still practiced. It was historically a rule that banks had to place a fraction of all deposits, for ease of explaining let’s say it was 10%, with the central bank. It limited the bank’s lending activity or was supposed to. It was discontinued. I deal with this old system and its fallacies in my book Central Bank Conmen, Economic Robbers and Bankrupters of Empires and will not dwell on it here.

Managing bank debt creation is now governed by a system of risk weightings. Its easy to understand. The system requires a bank to hold capital equal to a certain percentage of every loan it makes. It grades loans in risk categories ostensibly relative to the risk of default but its actually just arbitrary thumb sucks to allocate debt in levels of priority.

This is how it works in simplified terms:

A.      Risk weighting for all debt 10% (say). This means you, as a bank, must have $10 in capital to make a loan of $100.

B.      I now say that loans to the general public have the highest risk so you must hold the full 10% capital requirement against such debt. I say that corporate debt is a lower risk, so you need only hold say 50% of the 10% requirement (5% capital against a loan, i.e. $5 in capital for every $100 loan, only half the risk). I say mortgage risk is also a 50% risk. I want more lending to flow into corporate and mortgage debt. I say municipal and local government debt is even better risk quality rated at 10%, so there you only need to keep 1% capital against such debt as opposed to the full 10% for consumer debt. Last, I say that government debt has no risk, so you need not hold any capital against government risk. You can lend infinite amounts to government at a zero-capital risk weighting.

This system of risk weighting is a fantastic “tool” to allocate the money creation to achieve the objectives of my jobs. I prefer government in absolute terms in all bank lending fulfilling my primary number one job to push government debt into the markets. I push corporate debt, for jobs, but not at the expense of government debt. I prevent excessive debt formation in consumer debt to channel money creation away from inflation (job 2). The extra demand and lower cost of holding government debt allows me to lower the interest rates on government debt (job 3). Government’s insatiable demand for spending, debt and deficits allow me to create a circularity of money creation channeled into government debt for even greater profitability of money creation (job 4). This risk weighting tool is done via BIS, an institution controlled by central banks.

Why does risk weighting matter and what does it achieve? Best to demonstrate. For the record, its an “allocation” or ratio and banks will still need deposits and central bank money to fund the making of the loan.

Let’s say we have $1,000 in capital. This is how much we can lend out in each category.

Consumer credit $10,000 (10% of $10,000 is $1,000 which means all our capital is allocated.)

Qualifying corporate debt $20,000 (5% of $20,000 is $1,000, fully allocated.)

Same for Mortgage debt.

Municipal and local government debt $100,000 (1% of $100,000 is $100, fully allocated)

Central Government debt ∞, yes, a bank can give government infinite credit, and the central banks will help fund that for them.

You simply cannot be a large bank without equally large lending to government. Banks will hold a mix of debt, but all banks will migrate towards holding probably a dominant portfolio of government debt. Data supports that development. 

4.      Additional “tools” to carry all that government debt when needed.

Just the bare bones of central bank infinite money creation liquidity together with risk weightings have transformed banks into essentially government lending entities. Most large banks now hold more than $2 (at times near $3) in government debt for every $1 in consumer debt. I compiled data from the Federal Reserve for the USA banks for a chart for my book Central Bank Conmen. The ratio was roughly 1:1 before the introduction of the risk weighting system.

Central Bank Conmen, Economic Robbers and Bankrupters of Empires, Chapter 14.

The banks are now all top-heavy with government debt. The principle of risk weighting is carried also in risk grading of debt with government debt always given the best risk gradings. It is irrational given that governments are relentless borrowers who seldom, if ever repay debt, who borrow to pay interest and who routinely partially default, forcing creditors to take haircuts on debt, but that is the design of the system. It follows that all short-term insurance contingency investments are top-heavy in government debt, all pension funds are top-heavy in government debt, same with medical aid schemes and other reserves of savings against future liabilities.

The problem with such a government debt saturated monetary system now shifts away from liquidity to repricing of government debt should interest rates increase.

Let me explain in simplified terms. Government debt mostly carries a fixed interest rate. The value of the debt falls should interest rates increase. Simplified, like this. I buy $100 of government debt paying an interest rate of 10% pa. Interest rates increase to 20%pa. Now, if I wish to sell that government debt, I must lower the price from $100 to a price where the buyer would earn an effective 20%pa interest rate. That will be a loss for me. Combine those losses over all government debt for all terms up to 50 years across all banks and investment pools and imagine the immense loss risk in the markets and economy if interest rates increase even by a tiny fraction.

Banks, pension funds and insurance company losses spiraled out of control recently when interest rates increased, and the central banks needed to step in and bail them out. The repricing losses essentially wiped out all or most of the capital of the banks. Central banks needed to step in to re-rig the market to remove this risk for not only would it wipe out the banks and fund managers it would also push all that government debt into the markets on a fire sale and push up interest rates on government debt. That will undermine the objectives of Job 1 and Job 3 which will not be tolerated. 

Another tool, now to eliminate repricing losses, needs to be designed. Here’s how we will do it. Bring your loss-making government debt to the central bank. We will take it as collateral at face value as if there is no loss.  We use pretend money, so we have no problem in pretending no loss occurred. We will then create new money and give you a loan to carry the government debt on your balance sheet until maturity, so you never have to show a loss. You may even walk away with a profit and more so if we can once again manipulate interest rates lower, as is our job. No need to sell at a loss or to even show a loss in your financial statements.

We need to have liquidity carry tools (liquidity loans against government debt as collateral) and loss-making carry tools (low-interest rate loans against overvalued government debt collateral).

We need one more tool, a recue tool for when a bank gets into trouble. Any one bank getting into trouble can topple this whole system. The go-to rescue tool is to create money and make a huge loan to the ailing bank with the requirement that the bank must invest all the loan proceeds in government debt (Job 1). We will set the interest rate on the loan slightly lower than the interest earned by the bank on the government debt. It will substantially boost the balance sheet of the bank, and the interest differential will create a profit stream to restore some capital. Our “support” for the bank will scare off predators and calm depositors. This is great for all jobs from 1-4 as we sell government debt, create money, earn interest on newly created money, prevent interest rates from increasing and all over profit from the rescue. We cannot lose even if the bank were to go under in time as the loan is fully covered on capital and interest by the government debt collateral. The important requirement is that the loan and government debt stay on the bank’s balance sheet and not move to the central bank’s balance sheet.     

5.      Asset backed facilities to carry government debt even for non-banks.

All these tools are good and well for banks but with investment managers in insurance, medical aid and pension funds also top-heavy on government debt, we need extra tools to also help them out so they do not start selling government debt and undermine our jobs 1-4. We’ll just stay with the same recipe, which we know works. Create money, provide a carry loan, interest can be subsidized to encourage further investment in government debt or even be slightly higher to generate greater profitability for us, but nothing must undermine the objective to encourage buying of government debt. This tool will allow us to assist holders of longer-term government debt to carry a lot more longer duration government debt and support our sales efforts to get longer term government debt absorbed into the markets.

6.      When all fails, as in 2008, drop the pretense and simply create money to directly buy government debt.

All the money creation prior to 2008 culminated into asset bubbles as money creation is deliberately channeled into asset inflation to avoid goods and services inflation. The most dangerous asset bubble developed in residential mortgages. Too much money was pumped into mortgage loans causing massive, fixed property inflation together with lending to just about any Tom, Dick or Harry with little regard for the ability to repay loans. See also the lower risk weighting on mortgages to encourage this type of lending. Everything crashed when the property bubble burst, and all the substandard mortgages rolled over.

Then the pretense of Rule number 2, as discussed above, was dropped and the central banks simply created money and bought the government debt directly. It was supposed to be temporary but continued right up to COVID. The vast majority is still on the central banks’ balance sheets even today, 17 years later. COVID, another “crisis” but then the bond buying went wild, far exceeding the direct bond buying of 2008. It was just too much, and inflation popped out of the 2% constraint. Central banks were forced to increase interest rates and, as discussed in 4. above, bonds lost value and triggered a repricing crisis. That crisis was quickly solved with the new carry tools as also discussed in 4 above.

The Bank of England has made this a permanent tool and its not just for banks but also for managers of large investment pools stuffed to the brim with government debt. “The Contingent Non-Bank Financial Institution Repo (CNRF) allows companies to borrow cash from the BoE using gilts they own as collateral.”

The FED is literally going to make losses for a number of years given how it gorged itself on money creation to buy government debt onto its own balance sheet. It will fail Job 4 for a while but will be back.

Federal Reserve profitability (Job 4 – the FED is usually very good at this job, too bad about that repricing risk).

The FED will no doubt with the help of generous new money creation be back in no time to handing money creation profits to central government.

Federal Reserve Act

Section 7. Division of Earnings

(3. B) “Any amounts of the surplus funds of the Federal reserve banks that exceed, or would exceed, the limitation under subparagraph (A) shall be transferred to the Board of Governors of the Federal Reserve System for transfer to the Secretary of the Treasury for deposit in the general fund of the Treasury.

Section 7 says, pay a small, defined and limited, dividend to pretend shareholders, keep a bit as a contingency fund but pay all the rest across to government. Profitability will remain at risk while the FED carry government bonds on its balance sheet. Thus the bonds must go.

The FED has been moving some of that excess government debt off its balance sheet though it looks as if it is slowing down. The importance of job 1 remains but the debt and the losses must not become visible ever again. All the new tools will ensure that the government debt goes to and stays on the balance sheets of those beholden to the central banks for rescue when the system wobbles. It does not mean that the central banks have stopped funding all that government debt. It will just be structured to stay off the balance sheet of the central banks. Losses, similarly, must stay off the balance sheet of the central banks which will require structuring the “tools” in a manner which will absorb the losses into money creation, easily achieved, though it simply passes the loss to the population.

https://www.FEDeralreserve.gov/monetarypolicy/bst_recenttrends.htm

What does it all mean?

It means that the central banks are creating money in a system designed to dynamically favor deploying that money creation to government debt. It further means that structuring is used to keep government debt off the balance sheets of the central banks even though all or most of the funding for holding that debt will continue to be sourced from the central banks. It is systemically designed to hide the fact that the central banks are just creating money for on-lending to governments to spend (Job 1).  Governments are just perpetually rolling the debt, not repaying it. Governments even borrow to pay the interest on the debt which is usually viewed as debt delinquency. Tax income after government spending is insufficient to pay interest and nothing is available to repay any capital portion of the debt. The net result is that Rule 2 above is yet another farce. The debt will never be repaid.

Central banks are creating valueless fiat money and handing it to governments to spend, in the most comprehensive money laundering system ever witnessed, to disguise what they are doing.

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