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The Fed Connection 2006

by K. Y. Leong. July 27, 2006

When the coalition tanks rolled into the Iraqi capital city of Baghdad on April 9, 2003, Saddam Hussein had to leave town in a hurry. He could not take much with him but he did manage to escape with a few truck loads of US dollar bills.

According to one CNN report

Saddam Hussein withdrew $2 billion from Iraqi banks last spring (2003), including a sizable withdrawal a week after the fall of Baghdad, according to a member of the Iraq Governing Council' Saddam admitted he invested stolen Iraqi money -- which the Iraq Governing Council estimates at $40 billion -- in Switzerland, Japan and Germany, among others, under fictitious company names.

More recently, and eight thousand miles away in the dense jungle of the Golden Triangle, where the notorious tribal warlord Khun Sha once ruled, more than one ton of drugs seized by Myanmarese narcotics agencies were destroyed in a burning ceremony to mark the International Day Against Drug Abuse and Illicit Trafficking.

As reported by the Associated Press (June 26, 2006):

"Drug enforcement officials said they torched 170 kilograms (374 pounds) of heroin, 691 kilograms (1,519 pounds) of opium, more than 20 million methamphetamine tablets, 102 kilograms (224 pounds) of crystallised methamphetamine, and chemicals used for making drugs" (with a street value) total of U$148.4 million. According to the US State Department's annual survey of worldwide drug production and trafficking, Myanmar "is the world's second largest producer of illicit opium, accounting for more than 90 per cent of Southeast Asian heroin."

While the world's financial markets sloshes around trillions of dollars in a frantic round-the-clock race to beat the constantly depreciating value of the greenback, billions of the same change hands between terrorists, drug lords and dictators in the vibrant "globalized" underground economy. Exactly how much of the Federal Reserve's printed dollar bills (the Fed's outstanding cash) circulating amongst the illicit and covert business world constitutes is anybody's guess. But judging from the above episodes, one can guess that the amounts involved would not be paltry.

Perhaps the professionals at the Fed can help?

The monetarist economists working in the Central Bank claim to have a clever way of correlating the total money supply, measured as M2 or M3 (depending on the flavor of the month), to the total value of transactions in the economy, i.e. the nominal GDP. Using the concept of the Velocity of Money, which is calculated as the ratio of the total value of goods and services produced in one year and the money supply, the Fed economists are able to determine the optimum size of the monetary base believed to be necessary for the economy to achieve its maximum output potential, and doing so without sparking off runaway inflation.

This means that, with this approach to macroeconomic management, all outputs (both legitimate/taxpaying and illicit/tax-evading transactions) must be accounted for so that the accuracy of the numbers, and hence the integrity, of this system of measurement is not compromised.

Granted that most Americans are honest taxpayers, the same cannot be said of arms dealers, heroin traffickers and corrupt government officials. Until diehard aggregators like Milton Friedman are dispatched to the dens of the drug lords and terrorists to consolidate these villains' books, the missing billions and the unknown but not-insignificant imaginary velocity of money (all cash) in the underground economy must render the monetarist's policy prescriptions suspect.

Moreover, if one were to subscribe to the monetarist's Quantity Theory of Money, which says that the Velocity of Money is constant over time, then one must also accept the suggestion that the greenback must be constantly supporting the covert transactions of the underground economy. Indeed, one can even argue for the case where any increase in the supply of US Dollar bills by Fed printing must also, in the long run, end up "equilibrating" a proportionate expansion in the illicit activities of the evil doers.

For example, one would not expect Kim Jong Il to ask Osama bin Laden if he would like to pay by "cash, check or charge?" Or the latter whipping out his plastic: "American Express?" The Rocket Man of North Korea will simply insist that:

"Brother, in Allah we trust, all others pay cash". Cold, hard Federal Reserve Notes, that is.

Similarly, one can safely say that the likes of Osama would not be making their purchases out of a checking account with say, the Citibank. This being the case, one can also expect that credit contraction by the Fed's open market operations would not curtail any "overheating" in the level of covert business activities in the underground economy, as all deals are strictly cash deals. In fact, Fed tightening of the money supply may even drive up the demand for cash and inadvertently boost the purchasing power of these scoundrels.

Indeed, as far as the sinister cash holders are concerned, increases in the quantity of FRNs by Fed printing can only flow forward into their illicit economy and help to further stimulate their sinister activities, but never backwards in a credit-tightening phase. Once the greenback is leaked into the hands of drug lords, tyrants and terrorists, it is beyond the monetary policy maneuvers of the Central Bank.

And Ben Bernanke can wax lyrical about narrowing the Output Gap or the need to optimize the NAIRU (non-accelerating-inflationary-rate-of-unemployment). The current Fed Chief will never understand that the followers of Osama are not out looking for a job – they are martyr-wannabes all.

Thus, the ever inflating greenback has become an ever expanding blood infusion into the organs of the globalized illicit economy. And the Fed's connection to all cash-wielding evil doers of the world cannot be denied.

But if it is impossible to drain off this all important life-sustaining liquidity from the bodies of the sinister organizations via the Fed's contractionary monetary operations, is there no way out this quandary? Yes, there is.

One approach would be for the Fed to continue to inflate the money supply exponentially by operating more FRN presses, running them much faster and getting its Chairman to work overtime. This will quickly drive the purchasing power of the greenback down to zero, rendering its value to no more than the basic commodities from which it was created i.e. wood pulp and dye. That might deter the evil doers from ever holding it and using it again to grease the wheels of their sinister operations.

Now most sensible people would consider that strategy madness, much like trying to cure cancer by nuking the patient (and everybody else in the process). But think again! Isn't that exactly what the Fed has been doing to our money since its founding? According to some calculations, the US dollar has lost some 95% of its purchasing power since the establishment of the Central Bank in 1913.

Of course, such massive depreciation of a currency did not start out as a countermeasure to stop the proliferation of the greenback as the de facto medium of exchange in the underground economy. It was simply a very neat way for the biggest debtor in the world (the US Government) to steal itself out of its ballooning liabilities accumulated through the two world wars (and the Korean War, the Vietnam War, Afghanistan and now Iraq), and the Fed's maniacal policy of bailing out reckless financial institutions and political allies through the many financial storms of the past two decades.

The only reason why the greenback is still accepted as final payment for goods and services (both legitimate and illicit) around the world today is not because of any intrinsic value it possess, but the mere fact that it has printed on it "This note is legal tender for all debts, public and private" and is thereby, implicitly guaranteed by the military might of the United States.

Therein lies the all-important message to the FRN-wielding evil doers of the world – undermining the superpower status of the US of A can do serious damage to their financial health! Once the Americans are no longer perceived as the Policeman of the world, the illusion of the Dollar as the world's reserve currency will disappear into thin air, from where it truthfully originated.

And there is also a lesson here for the folks in Washington DC. The next time G.W. Bush et al goes to Congress to ask for another budget increase in the name of Homeland Security, someone should point out to the President that the Fed is an inadvertent part of the terrorist menace. And instead of looking to squander more taxpayer money in an exhausting attempt to wipe out the evil ones, maybe he should first recognize the problem as emanating from his own backyard – and get rid of the Fed?

© 2006 K. Y. Leong

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K. Y. Leong
Singapore
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