Topic: Monetary Policy
A Trillion Here, A Trillion There Pretty soon, it starts to add up to monopoly money.by Walt Thiessen
(libertarian)
Wednesday, March 18, 2009
Today's announcement by the Federal Reserve that it intends to pour another $1.15 trillion into the economy in the form of $300 billion in FOMC treasury purchases and $850 billion in mortgage-related debt drove the precious metals markets crazy this afternoon, as they experienced tremendous volitility and heavy volume after the announcement.
Beyond that, the announcement really had very little effect. The New York Stock Exchange experienced a mild rally, but not much else. The lack of significant reaction from most of the markets shows just how quickly we've become accustomed to throwing around the word "trillions" in news articles over the past year.
News articles on the subject of the latest deluge of cash sometimes bordered on the absurd. The Wall Street Journal quoted financial house UBS as commenting, "The U.S. is not explicitly targeting the money supply, like the Bank of England decided to do. It is an important distinction which we think should fail to hurt the dollar on a sustained basis."
Not targeting the money supply explictly? What would be explicit enough...turning on printing presses to print the actual cash itself?
At some point, one has to ask...when does all this money turn into inflation? History tells us it can take 1-5 years for price inflation to follow monetary inflation, and it usually only shows up in certain segments of the economy. So, we can expect that this latest round will show up sometime between 2010 and 2014. Unfortunately, it will be hard to distinguish it from the other trillions added to the economy during the past nine months or so.
It's becoming clear that more money has been pumped into the economy than has actually been lost in the form of defaulted mortgages...so far. The Fed's willingness to throw huge sums of money around has shown remarkably little "positive" impact on the economy. This suggests to me that the ability of the Fed to "stimulate" the economy has definitely been overplayed. The markets simply aren't responding the way they previously had to much smaller stimulations over the past 10-15 years.
I think this suggests that the debt-based nature of fiat money is finally starting to show its bloat. Many people don't realize that fiat money is debt-based, that every new dollar created is distributed by creating a debt, usually on behalf of the U.S. government. Typically, the Fed "stimulates" the economy by creating more of it, while shunning anything that even hints at reducing money supply as much as possible, because such reductions tend to be recessionary. The mortgage crisis has led to significant deflationary pressures, which of course are what are driving the emotions of the markets and the business community as a whole these days. Yet, the overall effect of all the Fed's most vigorous stimulation hasn't even gotten the economy to get up off the couch and slouch into the kitchen for some junk food. Bloat indeed!
What is forgotten by most, however, is that all this stimulation, no matter how inept it is proving to be so far, ultimately leads to greater debt. Today, the national debt is more than $11 trillion. That's the same as 11 million times another million....11 million millions. It's a number so horribly large that the human mind literally can't conceive of it in terms of real things. Even the numerical representation is mind-bogglingly long...$11,000,000,000,000. The only thing we know for sure about it is that it's a debt that we can reasonably believe will never be paid off. That's actually a depressing thought, because the only way in a fiat money supply to grow the economy is to inflate it further, thereby creating even more debt. We are now long past the point of no return.
Even more importantly, UBS (and many other people apparently) are forgetting or else in denial that all that money inventually does lead to inflation, quite possibly hyperinflation at the rate they're going. The endgame approaches.
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Posted By: Paul Benedict
Date: 2009-03-19 18:51:40
Hi Walt,
This particular new story has had me baffled. I asked the AP Econ kids, and they have no clue either.
Can you explain what it means for the FED to spend 300 billion buying treasuries? Do they just print that money? What will the Fed do with the interest? Will they resell the bonds to banks? Why would any of this lower interest rates? Wouldn't there be fewer bonds available, hence higher rates.
Good article.. you are preaching to the choir with me.. one point though is that most fiat currencies will turn into monopoly money not just the Dollar, as Eurozone, UK, Asia also infuse more new money into their economies.
To try to answer Paul's question: Yes the Fed will essentially print $300M and the buy bonds with it. Buying bonds will push the price of a bond up.. when u buy a lot of anything the price goes up. When the price of a bond goes up, its yield (% rate) goes down. So yes the price of a bond will rise but the rate go down.
Posted By: Paul Benedict
Date: 2009-03-20 17:58:47
Thanks Adam-- Hence, "fiat" currency? Monetary policy is loosened by "fiat"? Gold and oil don't know whether to go up as a hedge against infationary pressures or go down against apparently weak demand?
The interest goes down because interest goes up to increase demand if long term bonds are not sold?
Are there any non-fiat currencies today? Is buying bonds the ususal way to loosen monetary policy?
Good stuff. "Millions and Millions" have become "Billions and Billions" and will eventually become "Trillions and Trillions" as the number become so large it is indeed hard to rationalize them. Eventually we will start lopping off zeroes.
One of the many suggestions Ron Paul has made that made sense was to stop minting pennies - hundredths of a dollar have basically no purchasing power these days. I was reminded of this yesterday when I was conned into accepting a 0.01 Yuan chinese coin instead of a 0.1 Yuan piece of change. The 0.01 yuan coins have been out of practical circulation for a few years.
Dear Paul Benedict -
All government issued currencies are fiat. The Swiss franc was the last to go over to the dark side, and nowadays I wouldn't touch this currency with a 10-foot pole, it appears badly mismanaged to me.
Physical gold is a currency as well as money. Most people are blissfully unaware that an average of $60 billion in gold-denominated contracts are traded (most privately) every day on the London exchange.
As far as the FED money creation via creating bonds goes, I recommend giving this article I wrote a while back a shot [link edited for length]
Posted By: Walt Thiessen
Date: 2009-03-22 05:01:32
Paul: Good questions. Some of them have been answered by others here. Let me take a crack at them too.
(Q1) Do they just print that money?
(A) Sometimes yes, but not usually. The one thing they always do is simply decide that a certain amount of money needs to be created and then enter that amount on their ledger. Poof! Instant money. Once it's on their ledger, they loan it out, usually to the U.S. government or to their list of "master dealers," although in theory any large institution or investor can "borrow" it. (I put the word "borrow" in quotes because I think it's silly to talk about borrowing something that didn't exist five minutes ago and only exists now because a monopoly authority says it exists. Of course, that's ultimately how our entire money supply is created, so while it's silly, it's also a public menace IMHO.) One way to loan it out is to print currency to represent it...and then loan the currency out. They can also make the newly created funds available to a member commercial bank, so that bank can loan it out.
(Q2) What will the Fed do with the interest?
(A) Earnings are paid out according to the Fed's rules. Unless the rules have been changed lately, I believe the current split is that 90% of all Fed profits go to the U.S. government, and 10% are divided among the member banks.
(Q3) Will they resell the bonds to banks?
(A) Ultimately, yes, to banks and other large institutions and investors.
(Q4) Why would any of this lower interest rates?
It doesn't, directly. The two factors that influence interest rates are the Federal Funds rate and the Discount rate. The two are very similar. Read about them at Wikipedia to learn more. However, the Discount Rate in particular depends upon creation of new money like this in order to be useful. Without it, changing the Discount Rate accomplishes very little.
(Q4) Wouldn't there be fewer bonds available, hence higher rates?
I'm not sure why you think there might be fewer bonds available, particularly since one form of a Treasury is called a Treasury Bond, and ultimately even Treasury Bills (one year or less) and Treasury Notes (2-10 years) are really just shorter term bonds. Creating new money requires the creation of additional bonds, not removal of bonds from the market.
Posted By: Walt Thiessen
Date: 2009-03-22 05:54:06
Paul: I just realized why you thought there'd be fewer bonds. You're thinking of the Fed's "bond buying program." This is actually a case of "new rags for old," since they'll raise the money to buy these bonds by issuing more new bonds.
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