Free Markets, Free People
“Inflation is Our Friend”
So, the Fed, for the first time since the 1960s, is buying back long-term bonds as part of it’s new policy, announced today, of buying back $1.2 trillion in securities to pump out cash into the economy.
With the country sinking deeper into recession, the Federal Reserve launched a bold $1.2 trillion effort Wednesday to lower rates on mortgages and other consumer debt, spur spending and revive the economy. To do so, the Fed will spend up to $300 billion to buy long-term government bonds and an additional $750 billion in mortgage-backed securities guaranteed by Fannie Mae and Freddie Mac.
On top of this, short-term interest rates are already at 0%. The fed has one monetary policy tool left–massive increases in the money supply–and they’re using it with a vengeance. This purchase of $300B in treasury bonds will be a signifigant increase in demand, pushing treasury prices up, and yields down. The 10-year note’s yield dropped to 2.5% in the aftermath of this announcement.
Our fundamental problem is still that the banking sector has their balance sheets all out of whack, and the Obama Adminsitration still has no apparent plan for clearing up bank balance sheets via recapitalization, or…well…anything else. Now, theoretically, that much new money being created would lower mortgage rates signifigantly. I wouldn’t be surprised to see 20-year fixed rates at 5% or less.
This action, however, opens the door for massive inflation. The inflationary implications of this move are so huge, that there’s simply no way the loans could be anything but a money-loser for the banks, because a 5% mortage rate may well be far below the rate of inflation. That will kill banks already weakened by their bad loan portfolios.
This is an extraordinary gamble of the Fed’s part. If this new money doesn’t stimulate a signifigant increase in demand for money, then we are going to have a huge pool of money chasing a very small pool of goods. The market knows it, too, and understands the inflationary implications. The dollar cratered in the FOREX market today, and analysts aren’t excited about the long-term implications:
Bernanke’s view that currency devaluation may be beneficial to economic growth speaks for itself,” writes Mr. Merk. “But even if there are no active efforts to debase the currency, we are cautious about the U.S. dollar. That’s because we simply do not see a viable exit strategy to all the money that is being thrown at the system.”
“[W]e simply do not see a viable exit strategy to all the money that is being thrown at the system” because there is no viable exit strategy. We are either going to have serious inflation, or the Fed will have to tighten up so severely at some point in the near future that it will kill economic growth anyway.
In “Texas Hold ‘Em” terms, this is the equivalent of the Fed going “all in”. We’ve essentially reached the limits of our monetary policy tools with this action.