Guest post by Kris Sayce
We look at the market this morning, and what do we see?
Oh mamma, we see trouble a-brewing!
Quite frankly we don’t get why others can’t see the same problems.
To us it seems obvious. But anyway, seeing as no-one else is game to show you, if we’ve got space today we’ll reveal all. If not, we’ll hold the rest of it over until tomorrow…
First let’s get the crazy stuff out of the way. The US Federal Reserve’s Federal Open Market Committee met this morning and decided to keep the US Fed Funds Rate on hold at 0%-0.25%.
No surprise there.
But there was something that did surprise us. Although it apparently didn’t surprise the folks on Wall Street.
We were surprised because – naively – we didn’t think it was possible for Dr. Ben Bernanke and his buddies to be any more stupid than they already are.
But they can. Here’s what caused your editor to apply the palm of our hand to our forehead in a slapping motion:
To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.
What it simply means is that all the money the Federal Reserve created at the press of a button last year and the year before isn’t going anywhere. It’s going to hang around like a bad economic smell.
The idea that the Fed would contract its balance sheet has gone up in smoke. Even though that was the unwritten promise the Fed and it’s mainstream cheerleaders said would happen.
“Don’t worry about the increased money supply, the Fed understands this and will start to take money back out of the system at the right time” was the general chorus. Yeah right.
Of course, we always suspected that the Fed would have no intentions of reducing the size of its balance sheet. Not while there was the prospect of price deflation still around.
And sure enough they’ve done what we feared they would do.
Here’s how it works. In order to bail out the banks and housing market, the Federal Reserve bought a whole bunch of securities. It bought them using money it just created from thin air.
The money didn’t come from savings, because there wasn’t any. It didn’t come from tax dollars, because tax receipts had fallen. And it didn’t come from selling bonds to investors, because the investors couldn’t afford it because they had invested in the very crap that the Fed now wanted to buy!
So, the Fed just clicked a button and voila! There’s a cool trillion or so dollars.
Well, naturally enough, when you buy securities that have a maturity date, more often than not they mature, and the holder of the bond – the Fed – gets to receive the face value of the bonds on maturity.
Which is roughly where we are today.
The money that it created from thin air and then paid out to the likes of Goldman Sachs and Citigroup, to take the bonds off them, has now found its way back to the Federal Reserve.
Now, this was the chance the Fed had to reduce its balance sheet. It could make all that phony money go away. All it needs to do is hit the ‘Delete’ key, and poof, the money it created would just disappear.
But no. That would be too sensible. And more worryingly for the Fed and the O’Bama administration, it would probably bring forward the inevitable economic depression.
“Not on our watch”, they’ve clearly said. “Some other sucker can wear that one. Hilary’s gonna run for President in five years right?”
So, rather than taking the hit now and allowing the economy to purge itself of all the crap that’s still poisoning it, the Fed opts for the easy way out – easy for them and their taxpayer-funded jobs that is. Tough for everyone else.
But in this instance it’s not the banks or the car firms or the insurance companies that are in line for a massive bailout. No, this time it’s the US Federal Government that will enjoy the lion’s share of the inflated dollars.
Look, this isn’t the first time the Fed has bailed out Uncle Sam. Last year when the Fed started its quantitative easing (QE), or money printing programme, it bought up a whole bunch of US treasury bonds.
But today’s announcement from the Fed has just made things a whole lot worse.
In effect, the Fed has crossed the Rubicon. How so?
Simply because this one statement has now institutionalised central bank money printing as a means to pay off government obligations.
We’re not just talking your common-old-garden fiat-currency and fractional-reserve banking type of money printing. That’s the kind of money printing that goes on under the cover of darkness.
No, in this case it’s brazen printing money from thin air without even the charade of backing it with anything.
This decision by the Fed has in effect done for money printing what the consumer price index (CPI) has done for price inflation.
You see, the creation of the CPI is probably the single biggest contributor to higher prices. The adoption of an inflation target by central banks such as the Reserve Bank of Australia has institutionalised rising prices.
The brainwashing has been so effective that economists, commentators and even the general public view rising prices as a good thing. Even during an economic downturn! They can no longer see the conflict of supporting price inflation while at the same time lamenting the rising cost of groceries.
Hats off to the Keynesians and the inflationists for successfully spreading their economic evil. The rats.
But that could all be nothing compared to today’s announcement by the Fed.
Take a look at the chart below that we’ve reproduced from the Federal Reserve Bank of Cleveland:
Click here to enlarge
Source: Federal Reserve Bank of Cleveland
You see the large brown area (that’s appropriate) that suddenly emerged in early 2009. That’s the Fed’s holding of agency debt and mortgage-backed securities.
Agency debt by the way is debt issued by, well, agencies of the US federal government – such as Fannie Mae and Freddie Mac and a bunch of other QUANGOs.
Also note the yellowish area that started to grow in the early months of 2009. That’s US government debt. Long term and short term government bonds.
Well, what the Fed has decided today is that the total size of its balance sheet – around USD$2.25 trillion according to this chart – will be maintained at the level. Only the composition of it will change.
In other words, as the Fed starts buying up longer term treasury bonds we can expect to see the yellow area expand and the brown area contract. And as it does so, more newly printed money will flow into the US and global economy, and the greater the impact it will have on monetary inflation.
The focus on longer dated treasuries is the key point. The Fed knows the government can’t pay back its obligations, that’s why it’s going to load the balance sheet up with longer term debt.
Debt that won’t need to be rolled over for ten years.
If the US economy manages to struggle on for that long, the Fed will do just what the government has done in the past. It will use the money it’s been “repaid” by the government in order to buy more debt, plus print more money to keep the balance sheet at an inflation adjusted level.
Soon enough the Fed balance sheet will balloon out of all proportion just as the US debt clock has.
And just as the US Congress votes to increase the debt ceiling just as it’s about to be hit, so will the Federal Reserve vote to increase the size of its balance sheet in order to fund that ever increasing US government debt.
As I say, if it gets that far. Odds are the final collapse into economic depression will happen before the ten years is up.
Either way, the printing presses will soon be working harder than they’ve ever worked before.
For Money Morning Australia