Hi Bill, I have a question about the latest Fed plan to buy up long term Government bonds. Majority of the markets likes it because it will help keep many consumer and mortgage lending rates low and more affordable. However, one simple thought I have is that United States is using its own money to buying back its own debt. Wouldn't this not make too much sense if this continues? What can be the negative effect? And does this start showing the foreigners that we are losing faith in our Government bonds?
Thanks for the “Macro” question. Weve all been told again and again that we are generally in uncharted waters, flying by the seat of our pants, and there is nothing from the past to guide us. In our current scenario this action is meant to pump billions of dollars into the economy in an effort to get money moving. In many economic theories, it is the speed of the circulation of money that determines the value being produced rather than the quantity of money itself. Via this theorem and its corollaries the value of the dollar being produced is magnified in the economy according to the number of times, over time, the dollar exchanged hands between self-motivated buyers and sellers with their own self-interests for gain in mind. It is this economic measure of how frenetic or sluggish the economy is at the point of measurement that describes the “multiplier effect” which fast exchange of the dollar has on its “value.”
I believe it is this acceleration of the number of times the money injected changes hands that the Administration is trying to effect and to thereby increase the velocity, or acceleration of monetary value. The banks are largely not fulfilling their function of loaning money to small businesses necessary for them to survive, which results in increasing unemployment and further downward pressure on the economy. Many banks are hoarding the stimulus money provided for the purpose of stimulating credit because their own balance sheets are a financial disaster. Unfortunately, there is no other existing structure that can substitute for the lending function of banks. The stock market is just window dressing by comparison when speaking of means to raise capital for business functioning.
Why wont they cut loose with some of that bail-out stimulus money? The reason is, put directly, the Government would have to give them all the money to account for the free fall in value of all the property that they should not have accepted as collateral, but did. All of the mortgages where they should have done an acceptable full appraisal before taking any property as security, but accepted a “drive by” for a real inspection, all of the loans given without verification of income from the borrower and without questioning obvious inconsistencies on applications regarding net worth, all of the pre-approved credit cards issued to infants and pets or dead people, and so on. The American people will have to cover many of these massive liabilities and potential defaults, essentially bringing the balance sheets up to Zero, before the banks will voluntarily begin to lend again as once was usual, thereby flooding the economy with funds with real value and accelerating hand-to-hand exchanges, multiplying the value of the dollars with each exchange. This plan sounds like it would work, but in my opinion, the amount of money for this scenario to succeed would be many times the trillion already approved for the stimulus legislation.
The buying of government T-bills showed us how the Fed can inject cash without the banks participation. While it does generally inject cash into a cash starved economy, the dollars often have no direction and can provide no accelerator exchanges to multiply the value (multiplier) of the money. The most it can do is counter the tendency of deflation of the currency in the current economy where prices are falling because of lack of demand. It might do some good in a scenario where we are having a rapid, accelerating and uncontrolled deflationary spiral as during the Great Depression, but it would take such a massive expenditure to be effective that the risk of a sudden turn to malignant inflation would be real and, thus hardly worth the possible social risk. I think that the Fed might have been warning the banks that they better get to lending, since they are not indispensable (although I think that they are). Coupled with a government implementation of a lending structure as a facsimile for a banking system, the injected cash might gain the direction and multiplier otherwise lacking-but at an unknown cost to financial freedom and our society as a whole.
In direction to your specific questions, The US might be using its own money to buy the debt, but the US has no known limits to its money supply. This is because as the “last man standing” after WWII, we took the opportunity to establish the world economy, with ourselves as its head. There are trappings of equality among states, but thats why they are called “trappings.” We effectively became the only government that can, as some put it, “print gold.” Our T-bills have replaced gold as the means many governments use to back their currency. Unless there is a total collapse politically, culturally and demographically of the United States, our currency will continue to be the standard for value for most major economies.
Part of the reason people do not realize our elevated position is that when we are told that we are the worlds largest economy, it is rarely followed up with how really huge it is compared with the rest of the world. To illustrate, Japan is the worlds second largest economy, and China is often stated to be the new rival to the US with a huge and growing economy fueled by its population. Yet if you add the GDP of both countries, it is much less than half of the US GDP. Other countries really have no choice but to continue large investment in the U.S. economy; after all, they willingly invested their monetary reserves in US T-bills instead of physical gold. They each now have as much stake in the value of the U.S. economy as we do in our own prosperity. Our failure becomes their failure, and no one has offered a realistic alternative.
I hope that I have provided some insight into how, and why, this system works. Thanks for visiting Bills.com where we help you Find. Learn. Save.