In essence the Fed has been monetizing the federal debt. By not selling the securities to the public Treasury has made the Fed a major buyer of federal debt. Unlike other buyers when the Fed buys treasuries it makes magic money (not credit). The Fed has been taking advantage of the treasury buying by slowly cutting back on it's crap holdings, leftover from Bear Sterns, MBS, etc. However, the net effect has been to slowly increase it's balance sheet (make magic money).
The Fed last did this in the late seventies. Back then the bad side of money creation was inflation. This time the bad side of money creation is protectionism, which is increasing worldwide. If the Fed does not put the brakes on promptly the U.S. will be facing trade barriers and beggar-thy-neighbor with it's partners, deteriorating relations at all levels of their governments, and the potential loss of reserve currency status which would be devastating.
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Time to emigrate?
ReplyDeleteThat's a tough call to be sure. I love southeastern Arizona. No place like it anywhere else on the planet. But this country is going down a path politically that seems fraught with difficulty at best and downright scary at worst.
I for one am in favor of losing the reserve currency status. Its made us a giant target, and given us inflated egos that led to our accumulation of massive unreasonable responsibilities and debt.
ReplyDeleteI liked this contribution today at Zero Hedge:
http://www.zerohedge.com/article/project-weimar-why-qe2-could-be-more-inflationary-you-think
The author is explaining that the primary dealers don't hold enough treasury inventor to sell to the Fed at the QE amounts being discussed. The author is suggesting that this could lead to even greater absolute mayhem in overflow markets if the Fed starts to approach limits where the PDs don't have more inventory to turn over for monetization. The implication to me is what you are suggesting, i.e., that the Fed knows its bounds and can't be so stupid as to do what the cheerleaders on CNBC are calling for.
Sorry I've been quiet here Steve! Hope all is well.
Josh
Josh
ReplyDeleteReserve currency status is a matter of confidence. If the Fed and Treasury alienate central banks then our interest rates will rise dramatically or the Fed would be faced with buying all newly issued treasury debt, monetizing everything. America would then quickly become a banana republic. I believe that, contrary to the voting public which constantly elects idealogues or idiots, there are enough really intelligent people to prevent such an outcome.
Steve, I accept your fears, but would hold out for the third potential. We lose the automatic ability to freely issue debt and maybe it forces us to bring our debt issuance in line. Sort of what the Europeans are doing with Germany at the helm.
ReplyDeleteThe Fed might still need to help in monetizing some of the existing debt if the economy slowed and the debt service imposed too large of a burden on a newly-balancing economy. But mostly, it seems that the reservce currency status has only done temporary favors for a few generations in the U.S., while causing massive long term damage that will take many future generations to unwind.
Either option is not optimistic, but one would hopefully lead to restricting our ability to incur more damage in the future.
I'm with you in opposing the banana republic. Scary times we live in!
Josh