Craig Steiner, u.s. Common Sense American Conservatism |
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I wondered over a month ago where we were going to borrow enough money to pay for the mammoth deficit spending that has been proposed in the last two months. I pointed out that nobody in the world has $1.7 trillion to lend us so that we could borrow and spend it. So my conclusion was that "the Federal Reserve will start buying Treasury's" which would mean "we're going to borrow the money we can borrow... and print the rest." I was absolutely correct. The Federal Reserve held a key interest rate steady near zero Wednesday, and added that it will start buying long-term government bonds, opening a new front in its battle to lift the country out of recession. When the Federal Reserve purchases these securities and holds them (rather than turning around and selling them) it means we're essentially printing money--which means we're subject to all the inflationary risk that printing money entails (see Zimbabwe's inflationary crisis and what has often happened in third world countries). Money is being created out of thin air by the Federal Reserve and being dumped into the economy to purchase these instruments. Interestingly, the spin put out by the media is: Doing so could help the economy because many kinds of debt -- from mortgages to corporate bonds -- are linked to Treasury rates. Fed purchases would boost Treasury prices and drive down their rates. That would ripple through and lower rates on other kinds of debt. True... when the Federal Reserve buys U.S. securities, it drives prices up which forces interest rates down. So it won't be surprising to see mortgage rates drop. For now. But there are two problems:
So my conclusion from last month was 100% accurate: That probably means the Federal Reserve will start buying Treasury's--something it has indicated it would do to keep the Treasury market from being flooded and driving up interest rates. But that means we're essentially going to be printing money rather than borrowing it. Or, actually, we're going to borrow the money we can borrow... and print the rest. Indeed, we're borrowing everything we can from the world and from U.S. citizens and then the Federal Reserve is printing the rest. Also note that this is just an announcement of what the Federal Reserve intends to do over the next six months. In order to continue funding the deficit spending, it's a pretty safe assumption that the Federal Reserve will end up printing some more money after that. $300 billion isn't enough to make up the shortfall for the proposed $1.7 trillion deficit. So in six months (or sooner, if the government ramps up spending faster) expect to see a similar announcement whereby the Federal Reserve will buy additional U.S. Government securities. When you don't have enough money to cover expenses, that means you have to borrow from someone else and you're officially living beyond your means. But once you reach a point that you need so much money that nobody even has enough to lend you, and you have to print money, that means you're officially living beyond everyone's means. We've started down a dangerous road. I guess we'll just have to see where it takes us. Update An Hour Later: The move to purchase U.S. Treasuries seemed pretty obvious to me a month ago, but apparently the decision caught some people by surprise. Many Fed watchers had expected officials to raise the size of the mortgage programs. However, the decision to buy Treasury securities came as a surprise since the Fed had sent no signal it intended to move so soon on that idea, first floated by Mr Bernanke in December. This actually kind of confirms what I wrote above... that the impact on the market is more spin than the real motive. I think the real motive is, in fact, to make sure the U.S. Government can borrow all the money it needs. In the last month the U.S. has been going to great lengths to convince China that loaning money to the U.S. is still safe and a good idea. But China remained cautious and, even if it weren't, there simply isn't enough money for the U.S. to borrow. So I think the main justification behind buying $300 billion in U.S. Treasuries is to make sure the U.S. Government can borrow all the money it needs. Any other impacts, such as lower interest rates, are at best desirable side-effects. But a headline such as "Not Enough Money in the World for the U.S. to Borrow" certainly would've shocked worldwide markets. So, instead, they're just printing some more. Update About an Hour Later: For anyone that doubts we're just printing money, here's some additional supporting information: But in a surprise, it dramatically increased the amount of money it will create out of thin air to thaw out the still-frozen credit markets that have cramped lending to consumers and businesses alike.... The second two paragraphs seem to further confirm my speculation as to the motive: Making sure the government could borrow all the money it needed. The information available as far back as at least a month ago made it clear that there wasn't going to be enough money for the government to borrow. I'm not sure why this move was so surprising to so many people. Update same evening: Not unexpectedly, the dollar dropped against major currencies in response to this. When you print more money, the value of the money drops so it becomes weaker against other currencies. The dollar traded near the lowest in two months against the euro after the Federal Reserve said it will buy $300 billion of longer-term Treasuries, spurring speculation the central bank is debasing the currency. This is potentially the start of a vicious cycle. As I wrote above, the Federal Reserve probably is printing money in large part to make up the shortfall between what the government wants to borrow and what the world is willing to loan. The problem is that this has already caused the value of the dollar to drop. All the money that China and the world has invested in the U.S. just lost value today. So they'll be less likely to invest more money in the U.S. in the future which means the shortfall between what the government wants to borrow and what the world is willing to loan it will increase... which means the Federal Reserve will need to print more money to make up the difference, which will further decrease the value of the dollar, which will lead to the world lending even less money to the government, and so forth. The world will loan the U.S. government less and less money as we print more and more money which is worth less and less. In addition, a decreasing value in the dollar will lead to imports being more expensive. Anything that's imported--computers, television, oil, etc.--will become more expensive for us to buy. This leads to inflation. The only way this has a happy ending is if the policy succeeds in reactivating the economy real quick so the cycle above can be broken--but it will only be broken if we reign in deficit spending which Obama's budget proposals don't plan to do anytime in the next decade. Otherwise, the vicious cycle described above is looking extremely likely. This is a potentially risky move by the Federal Reserve. We all have to hope it works, because the consequences of failure could be severe. Further update this evening: Forbes confirms what I wrote earlier. For anyone asking how the government is going to pay for the $787 billion stimulus and the $700 billion bank rescue, ask no more. The Federal Reserve will simply print new dollars. That was the word from the Federal Reserve today.... Another update evening of 3/18/09: Additional reports seem to support everything I've written here today. The central bank, effectively, will print more money to pay for the purchases. Combined with the billions already deployed by the Fed, the new money dwarfs even the biggest government bailouts of financial companies... This article was quite explicit in its agreement with what I've written about the purpose being to finance the deficit spending. It also adds an ominous warning about the future of the dollar: 'The Fed is basically financing our deficit by buying the debt issued by the Treasury,' she said. 'If the Obama administration pushes through another stimulus package, the dollar is done.' And another article was also pretty direct: Bernanke's economic strategy: Trillions now, worry later This comes back to what I wrote back in December--we're living in economic denial. Everyone--including the president--has criticized businesses for not having a long-term perspective, at looking only at the next quarterly results. Yet the Federal Reserve, effectively forced by Obama's massive spending, is doing the exact same thing. They're trying to obtain immediate economic satisfaction and put off the hard decisions for tomorrow. But the whole idea of printing money should have risen a whole bunch of red flags. We need to start thinking about the future today and stop putting off the hard decisions. It's not acceptable to say, "The situation today is so bad that we can't afford to think about future consequences." We can't afford not to. The Federal Reserve could have prevented the U.S. Government from engaging in the destructive massive deficit spending that it is currently planning. That would have caused some short-term pain for the long-term good. Instead, both the Obama administration and the Federal Reserve have opted for some short-term relief at the expense of long-term pain. That is precisely the short-sighted type of thinking we need to stop. President Obama and Federal Reserve Chairman Bernake are basically betting the future of the world's economy on this. Update 3/19/2009: More confirmations that this is something to be worried about: Even though the central bank may have some initial success in depressing rates, analysts worry that monetary policy has passed a point of no return with the printing of money. Update 3/23/2009: Putin has weighed in with a warning against printing money: The government should tackle the deficit 'by using the reserves that have been accumulated in recent years, or if necessary by borrowing under market conditions,' Putin told the Cabinet in Moscow today, adding that Russia doesn't yet need to borrow and won't seek loans abroad. 'Resorting to a printing press would be unwise and extremely dangerous.' Update 4/8/2009: Weeks later, the bond market is apparently still curious as to why the Federal Reserve started buying government debt when it did. Bond strategists had said they were interested in why the Fed opted to surprise markets after the March 18 meeting by saying, months before most expected, it would buy $300 billion in Treasurys in the next six months. The Fed noted a worsening economic outlook forcing their hand. The "worsening economic outlook" is a throwaway excuse. Everyone (including bond strategists) know the economic outlook, yet they're still curious why the Federal Reserve did what it did when it did it. Is it still not obvious? It wasn't about the market or economic conditions. It was about ensuring that the government could borrow everything it wanted/needed. Go to the article list |