How the Fed and ECB Monetize Debt, Jim Rogers on Greece Bankruptcy, and More Bank Bailouts Coming

Big day in terms of everyone's favorite method to pay down debt: central bank monetization!  Philipp Bagus has a wonderful article today at the Mises Institute explaining how the Federal Reserve and European Central Bank purchase government debt through the banking sector in layman terms:

By tradition, the Fed uses the produce-money-and-purchase approach (PMP). Normally, the Fed produces money in their computers and uses it to buy US Treasuries from the banking system. In exchange for the US Treasuries, the Fed creates money on the account that the selling bank holds at the Fed.

An huge portion of the Treasuries are bought by the banking system, not only because the US government is conceived as a solvent debtor, thanks to its capacity to use violence to appropriate resources, but also because the Fed buys Treasuries in its open-market operations. The Fed, thereby, monetizes the deficit in a way that does not hurt politicians.
But what about the interest paid on the Treasuries? The US government has to pay interest on the bonds to their new owner, the Fed. The Fed receives the interest, which increases the Fed's profit. Who receives the Fed's profit? The bulk of the Fed's profit is remitted back to the US government at the end of the year.

Bagus even provides some delightfully simple charts:

The ECB finances deficits in a more subtle way. Only in the sovereign-debt crisis did it start to buy government bonds outright. Normally, the ECB lends to banks against collateral. Banks buy government bonds because they know it is preferred collateral at the ECB. By pledging the bonds as collateral at the ECB, banks receive new reserves and can expand credit. As the government bonds are still owned by banks, governments have to pay interest to banks. Banks, in turn, pay interest on the loans they receive from the ECB, which remits its profits back to governments.
Thus, the system is similar to the Fed, with the difference that normally some of the interest payments leak out to the banking system that pays lower interest rates on its loans than it receives on the bonds. Another important difference is that there may be a redistribution between governments if eurozone governments run deficits of different sizes.

And here is the coup de grâce:

Imagine that the government has a deficit and issues government bonds. Part is bought by the banking system and used to get additional reserves from the central bank, which buys the bonds or grants new loans, accepting them as collateral. The banking system uses the new reserves to expand credit and grant loans to, for example, the construction industry. With the new loans, the construction industry buys factors of production and pays its workers. The workers use part of the new money to invest in funds. The investment funds then use the new money to acquire government bonds. Thus, there is an indirect monetization. Part of the money created by the fractional-reserve-banking system ends up buying government bonds because of their preferential treatment by the central bank, i.e., its direct monetization.

Though I had a pretty good idea on how this process worked previously, Bagus' explanation is great just because of the simplicity.  Of course the real step-by-step process is a bit more complicated, but Bagus covers the gist very well and provides the perfect primer for those unfamiliar with central bank monetization or, as it should be called, counterfeiting.

The market was all a flurry today on the widespread belief that Greece is actually going to default finally.  Disregard the fact that anyone with a brain saw this coming months ago.  Jim Rogers weighed in on the situation this afternoon:

Pisani: You're long commodities but short stocks. explain how this fits in with the global growth story. Is there a global growth story and why are you long commodities -- wouldn't you still be long some commodities stocks, for example?
Rogers: No. well, I have some left over from 15 years ago. No, if the world economy gets better i'm going to make money in commodities because of shortages that are developing. Especially in agriculture and precious metals. If the world economy doesn't get better, Bob, you're not going to make any money in Toyota or IBM but you might make money in commodities because they're going to print more money. It's the wrong thing to do but they will print money. Bernanke is already printing money again. You have to protect yourself. I'm short stocks but i don't expect the world economy to get better. Not much better anyway, if it does and I am long commodities as a protection.
he's already -- you said bernanke is already printing money. has a new program been announces? that brings us to the u.s. dollar, of course, jim, which today is stronger against the euro. i would assume, though, that your long-term forecast for the dollar is not a particularly positive one.

Bob: So you're bullish?
Rogers: Bob, to your point, Bernanke has been lying to us again. He announced in early august that he was going to keep interest rates at a very low rate for two years. Now, Bob, how is he going to do that? You can't just say the words. You have to go into the market and force interest rates down. Come on. What is this, you believe in the tooth fairy? He's in there. That's the only way he can do it. If you don't believe the theory of monetary policy works, get out the unadjusted numbers since the beginning of august and you will see they shot up starting at the beginning of august as soon as he said we're going keep interest rates down. So he's in the market. He may be lying to us, they usually do, But he's in there. Be prepared.

Bob's facial expression after the tooth fairy comment was priceless.  Rogers once again proves why he is one of the few that actually understands what is going on.  Here he is on the whether the newest money printing by the Swiss National Bank will work:

Rogers: No, of course it's not. No central bank in the world has ever been able to control its currency in the long run. Many countries have tried, but the market always has more. The british tried it 15 or 20 years ago. Everybody has tried it. In the end the market has more money. The swiss will have two things happen. One, they will drive their currency down so much that they will no longer be a financial center, or it will go up again and they will lose money on all the currencies they're buying. This is a terrible mistake. The way you sort things out is you let the market take its course, the cure for high prices is high prices. That's how you sort things out.

So are central banks going to keep printing money?  Well here is part of the release put out following today's meeting by the G7 Finance Ministers and Central Bank Heads:

Central Banks stand ready to provide liquidity to banks as required. We will take all necessary actions to ensure the resilience of banking systems and financial markets.

Translation:  We are gonna print till the cows come home.  And if they keep wandering out to pasture, we'll just keep printing because that's all we know how to do!  As Robert Wenzel pointed out, Bernanke has had the printing press on at a 15.6% annualized rate for three months through July.  Just to quote my all time favorite line from Gary North:  "like a dog to his vomit, Bernanke always goes back to money printing."
But it doesn't stop there, the unbreakable relationship between the big banks and the government was just reaffirmed by German Chancellor Merkel, via Bloomberg:

Chancellor Angela Merkel’s government is preparing plans to shore up German banks in the event that Greece fails to meet the terms of its aid package and defaults, three coalition officials said.

Not sure who plays the drunken stepfather and who plays the delusional 12 year old girl in the incestous connection but it hardly makes a difference anymore.

I will end with an image that is reminiscent of the piece I had recently published:

Update- To further prove my point, Robert Murphy captured this interesting news headline that I was unaware of:

Whatever Bernanke is seeking, $100 bucks it's something that rhymes with funny sprinting.