Posted: 03/19/09

Updated 3/20/09

Federal Reserve Spends $1.15 Trillion to Buy Back Obligations... Now We're Printing Money

It was reported this week that Ben Bernanke, Chairman of the Federal Reserve would spend $1.15T to "buy back" Treasury bonds and mortgage obligations in an attempt to help reduce interest rates to consumers and encourage banks to start lending.


The bank rate (bank-to-bank) currently stands at zero to 0.25%. Basically, free. However, blocking our economic recovery is the unwillingness of many banks to lend, and the rate charged to consumers who actually meet the stricter lending standards. So, Dr. Bernanke's plan appears to be "print money." He will need to in order to "buy back" Treasury obligations so he can force long-term interest rates down. This in turn will lower consumer interest rates on things like mortgages. In addition, buying back $1.15T in obligations from the Treasury provides the additional money it needs to help free banks of "bad assets," thereby, making them more willing to lend. Will it work?


Well, given where our economy currently stands Dr. Bernanke's plan may be the only choice left. But, in my humble opinion the cure could be worse than the illness. We may be spiraling toward incredible inflation... and that's not all.


Please understand, I have the greatest respect for Dr. Bernanke. He has been thrown into a situation beyond any my years have seen and he is a student of the Great Depression. But if this is where we are, we must evaluate the potential results and anticipate our own course of action as consumers and investors.


First of all, going out into the open market and "buying back" obligations versus simply buying new issues directly from the Treasury Department are in my estimation two very different strategies. Let me explain.


Scenario One: Buying back Treasury bonds from those who purchased the bonds with pre-inflated dollars (before we printed the $1.15 trillion) means we are repaying debt with dollars worth less than those the buyer lent to us when they (in the case of a country... like China) originally purchased the bonds. This could tick them off in that we have control over the money supply and can devalue their investment at will. Not a thought that really encourages investors.


Secondly, printing money runs the risk of increasing interest rates through an inflationary spiral. This could really backfire if interest rates increase on The United States' debt, making our current deficit much larger. And, nearly impossible to pay. The United States of American would be in a position of potential default. At that point, pack your tent and head for the hills. It's all over.


Scenario Two: If Chairman Bernanke's plan is to purchase newly issued Treasury bonds with newly printed money, then all it appears we have done is add to the money in circulation (money supply) and devalued the dollar. The idea is we would decrease the T-bonds supply resulting in greater demand and raising the price of the bond above "par value." This would then reduce the interest the Treasury would have to pay on new long term instruments (bonds) and produce Chairman Bernanke's desired result... lower long term interest rates for consumers. The key piece? Will greater demand for the Treasury bonds actually be created by reducing their supply (buying our own issues)? It remains to be seen. Some experts say the world has nowhere else to put its money. Pray they're right. One last thought. Some say the only reason a country prints money is because no one will lend to them.


Should the increased demand anticipated for Treasury bonds not materialize, interest rates would soar but for a different more ominous reason. Our inflated dollar will have reduced the perceived value of our Treasury instruments, and we won't be able to sell our debt obligations on the open market. I don't want to even think about what that really means.


If I am wrong... please let me know. I really hope I'm wrong.













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