You have certainly heard the references to Bernacke over the last couple of years as “helicopter Ben” because of the allusion that he would simply fly over America and dump money out of a helicopter to stimulate the economy. Of course we are too well aware that the trillions of dollars dumped into the economy was not that evenly spread. Perhaps all that stimulus money would have done more good if it had been dumped from the helicopter rather than the methods employed by the Fed in reality. Of course the Fed was not directly involved in the TARP funding, that was a Treasury action, but they made if possible by printing more money for Treasury to buy those bank stocks rather than the “toxic assets” they said they were going to buy. Again, we probably would have been better off it they had bought all those bad mortgages. After all the government, us, owns over 90% of all the mortgages out there through Fannie, Freddie and the FHA anyway.
Then the Fed bought over a trillion dollars worth of bonds, mortgages and Treasuries in ’09 to facilitate the government’s “Stimulus” bill rammed through by the Democrats. On top of that there was the Obama budget with its built-in 1.3 trillion dollar deficit which had to be funded somehow and yes, it was with more debt. That was mostly through the sale of Treasury bills and notes which were primarily bought by the banks and foreign entities, can you say Chinese? The banks got their money to buy these Treasuries, from you guessed it the Fed. Now the Fed is actively talking about doing another round of quantitive easing, that is buying more Treasuries to the tune of a trillion dollars in the near future.
Most people don’t realize how that actually works. What will happen usually is that the Fed will go to individual banks and buy Treasuries from them at a profit. Remember that the banks bought these in the first place with TARP or discount window money and almost zero interest rates and were making a profit without having to administer anything. These Treasuries will be sold at a profit to the banks. That is how the Fed gets more money into the economy. From a technical stand point that makes sense as the banks are the conduit for the flow of money into the economy. But the rub is that where does the Fed get the money to buy all those additional treasuries? They are the only entity that can create money from nothing. They simply print up more money to give to the banks. There is no inherent worth behind those new dollars they are merely pulled out of the Fed hat like the white pigeon from the magician’s bag of tricks. That is inflationary. One day you had x number of dollars in the economy and the next you have x plus y but without any increase in real economic output or activity.
All of which brings us to the interest rate on the Treasuries at the moment. The 10 year note which is the more or less the bench mark pays a yield of about 2.40 at least as of last Friday. So you invest say 10K and you get only $240 a year in interest. I know it is not a true interest payment but for illustration purposes it is accurate. Interest rates and returns on investment are always related to the amount of risk involved in the investment whatever type it may be–stocks, bonds, Money Market accounts, Treasury bills or whatever. I completely understand the arguments about safety and that many investors and investment funds are seeking security and a high degree of safety with their money. This is especially true since Obama was elected with all the uncertainty about taxes, regulations already on the way and the promise of even more to come if the powers that be in Washington remain in p0wer. This is exacerbated by the hostile rhetoric spewing out of Washington like a steady drum beat for the last couple of years.
Why would anyone accept such a low rate of return? I think those who are only thinking of safety are myopic. What good will the safety do them if inflation takes off again and the dollars they receive years from now on their investment won’t pay for cab fare? The uncertain future of the value of the dollar is reflected many believe in the recent rise in the value of oil, gold and silver and other commodities. That is probably true to some extent. But why are billions of the Treasuries still be sold at such depressed interest rates? The Chinese will continue to buy for a while because they need our consumers and our markets for their products. But someday it will be a revelation when many investors realize all at one time that the Emperor is not wearing any clothes. After all several nations have defaulted on their debts in the past; many European and a few Latin nations are near default again and have only avoided it with help from the IMF or the European Central Bank. We have no guaranty that our debt is sacrosanct.
When the day of revelation comes everyone will still be willing to buy the Treasuries, especially the big banks since they are regulated by the seller, but collectively the market will demand much higher rates of interest. The risk is high of either default, partial default or inflation that devalues the investment and interest rates will zoom. It can happen quickly. Just like a street crowd when one person starts looking up, then another, then another, within seconds everyone is checking out the scene. Watch the interest rates on those Treasuries for the early warning test for our future economic well-being. The increase in interest rates will make our deficits and debt explode. It will have an exponential effect.
At least with the gold standard governments could not manipulate the currencies or fiscal policies. It has its drawbacks but also has its advantages. www.olcranky.wordpress.com