William (aka Bill the Godfather)

William (aka Bill the Godfather)

Tuesday, September 21, 2010

Federal Reserve hints (strongly) at more money printing

WASHINGTON — Federal Reserve officials signaled for the first time on Tuesday that they are worried that the slow-moving recovery could be undermined by very low rates of inflation and hinted that they might resume buying vast amounts of government debt.

While the central bank’s Federal Open Market Committee did not take any new steps on interest rates, it communicated in unmistakable terms its concerns about the fragility of the economic recovery and the threat to stable prices.

It said inflation levels were “somewhat below those the committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.” And it said it was “prepared to provide additional accommodation if needed” to support the recovery and get inflation back to normal.

The Fed will continue to use money from its holdings of mortgage-related bonds to buy long-term Treasury debt, the tactic it announced on Aug. 10. That strategy was intended to prevent a slight tightening of monetary policy that would have occurred as the bonds held by the Fed were paid off and money was taken out of the economy.
Read the rest here.

Following the announcement the stock market is trading mixed and near flat. The bond market is rallying across the curve with Treasury yields dropping. Precious metals are up on renewed fears of inflation and currency debasement. Gold is currently trading at 1288.20 oz. (up $8.70), a new nominal record high. Silver is up more than 1.20% and is trading at a multi-year high of $21.00 oz.

3 comments:

The Archer of the Forest said...

Government buying up Government debt. I'm no economic genius, but does this seem bizarre to anyone else?

The Anti-Gnostic said...

Yes it's bizarre because it's really no different than the naive belief I had as a young child that writing a check was 'creating' money.

The government's account is overdrawn to the tune of hundreds of billions (now a trillion+) every year, but government obligations are always honored by its bank, the Federal Reserve. Presumably, for every check the Treasury writes, the Fed notes 'NSF' and makes a debit entry which is added to the national debt. But it's also true that there are loads of Treasury notes that get unsold at each auction. What happens then? I don't think the Fed's books would balance but what do I know.

I'm reminded of that other zombie entity General Motors. The fundamentals of GM showed worthless stock. There should have been no market for the shares. My hypothesis is the institutional shareholders were just trading the stock back and forth to avoid delisting. Nobody would cut and run because then they'd go down with the ship. Just bizarre.

John (Ad Orientem) said...

Archer,
Actually the role of the Federal Reserve (our country's central bank which in theory is supposed to be rigidly independent of the government) is to manage the money supply and to protect (please hold the laughter) the integrity of the dollar. When a central bank believes the money supply is falling too far and possibly creating deflation, they normally just lower the rate at which private banks can borrow money from the FED and in turn lend that money to the general public at a profit. The money is created electronically these days although we still usually call it "printing" money. Only a fraction of the "money supply" today is actually physically printed.

In an emergency situation the FED can move to inject money directly into the economy by "creating" more money and then using it to buy government bonds. The technical term for this is Quantitative Easing (QE for short). It is also often referred to as the "nuclear option" in economics since it can drastically increase the money supply in the economy very quickly.

The other time when a central bank might "print" money to buy the bonds of its own country is if confidence in the ability of the country to repay its debt starts to falter and people start demanding extremely high interest rates to compensate them for the increased risk or they simply refuse to buy the bonds altogether.

In this scenario the term usually employed is "debt monetization." When a central bank is "monetizing" the national debt it is seen as essentially printing the money needed to keep the government functioning and paying its creditors, at least on paper.

The problem with both QE and debt monetization (which at a certain level are the same thing) is that they both massively increase the amount of money. This means that the central bank is debasing the currency, and creating inflation.

Currency debasement is a time honored method by which nations default on their debt without doing so formally. On paper everyone who lent money (bought bonds) to the government gets repaid. But in reality they loose money since the purchasing power of the money they are repaid with is enormously reduced by inflation.

In extreme cases this can lead to very high inflation (double digit) or even worse if the general public begins to lose confidence in the nation's currency. Neither the US Dollar nor any other currency in the world today is backed by anything. We, and most of the rest of the world, abandoned gold as the basis of our currency in the early 1970's. That means our money is really just colored pieces of paper with numbers printed on them that can be mass produced at will. In short it is a confidence game. Fiat money (money that is worth something just because the government tells you it is) only works for as long as people believe it is worth what they are told. Once they start to question its value serious trouble is likely coming, and it can come very very fast.