09.30.2010 0

The Futility of Printing Money

  • On: 10/07/2010 18:17:41
  • In: Monetary Policy
  • By Bill Wilson

    With sideways economic growth and persistently high unemployment, the Federal Reserve and other Keynesian economists have been obsessed with 1930’s-style “deflation.” Since the end of 2008, and in the wake of the financial crisis, the nation’s central bank has been engaged in so-called “quantitative easing” (QE) to allegedly prevent a second Great Depression.

    In lay terms, the Fed has been printing money and injecting it into the financial system and government coffers.

    First, the Fed reduced the federal funds rate to near-zero in December 2008, where it has kept it ever since. Then, it announced it would purchase some $1.25 trillion in mortgage-backed securities (MBS) plus $175 billion of Fannie Mae and Freddie Mac debt. It also said it would buy $300 billion of U.S. treasuries.

    Where did they get the money? They printed it. That was in March 2009. Keeping its word, the Fed went ahead and made the purchases, raising its share of treasuries from $474 billion to $776 billion by the end of March 2010. Still not satisfied, however, in August of this year, it announced that it would then be selling its MBS holdings, and then use the money to buy yet more treasuries.

    Now, the central bank owns over $808 billion in treasuries. And it still has over $1.086 trillion of MBS in its portfolio left to sell. Since the middle of August, the Fed has been buying about $4.35 billion of treasuries a week, a pace that will add another $226 billion to the Fed’s share of the national debt, bringing it up to over $1 trillion by August 2011.

    That would be more than either China or Japan hold, and make the Fed the top holder of the national debt in the whole world.

    It is in this context that there is now widespread advocacy for the Fed to once again step in and buy even more treasuries. How much more? Nobody knows for certain, but it has already been dubbed “QE2,” and Wall Street is all but certain it will happen. Investor’s Business Daily speculates that it could be as much as another $1 trillion.

    Why might the Fed do this?

    The Fed says that “measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.” This represents a strong signal they may actually be preparing to go through with it. The Fed says it “is prepared to provide additional accommodation if needed to support the economic recovery”.

    Inflation is too low, they say, and unemployment too high. Some more monopoly money should do the trick, they say.

    But we’re the ones who will pay. Apparently, $85 for a barrel of oil and $1,300 for an ounce of gold is not high enough for the central bankers. As noted by Investor’s Business Daily, since March 2009, “gold has surged 46 percent and oil is up even more, by 73 percent.” Who knows what 2011 will hold?

    Ostensibly, the justification for printing more money is to help the economy. But what if that was not the real reason? What if “QE2” was just a front, an excuse for the Fed to buy the national debt?

    According to Strategas Research Partners’ Jason Desena Trennert: “$5.2 trillion of U.S debt comes due in the next three years…” In addition, the White House Office of Management and Budget projects that in the next three fiscal years, the national debt will grow by $3.6 trillion to $17.453 trillion.

    That means in the next three years, the Treasury will have to sell $8.8 trillion more treasuries: $5.2 trillion to roll over the existing debt, and another $3.6 trillion for budget deficits and interest owed on the debt. That means each year it will have to sell $2.93 trillion of more debt.

    So, what if the reason for “QE2” had nothing to do with helping the economy? According to Bloomberg News, IHS Global Insight, Moody’s Analytics, and Macroeconomic Advisors say it won’t help that much anyway. “The firms estimate that the unemployment rate will remain around 9 percent or higher next year whether the Fed buys $500 billion or $2 trillion of U.S. Treasuries in a second round of unconventional stimulus,” Bloomberg reports.

    It will only add 0.1 percent to growth and do nothing to create jobs. Therefore, what if the real reason to print the money was because the Treasury didn’t think it could sell that much debt without the Fed helping? Fiscal Year 2010 was already a record year for expanding the debt, when the Treasury sold $2.3 trillion worth of treasuries.

    What if the Fed is buying the national debt because we’re broke? Because principal on the debt can no longer be paid on the debt by simply rolling it over? Because the only way to pay the principal due is to simply pull a Weimar Republic and print it?

    Assuming the actual demand for treasuries remains consistent from 2010, there will be about a $630 billion shortfall to pay the debt every year for the next three years. With China slowly declining its share of the national debt, the only way to pay the bills will either be for the Treasury to find new buyers, or for the Federal Reserve to print another $630 billion every year (or conversely speed up its sales of the MBS).

    The Treasury had better hope it can either find new buyers of the debt, or that Congress balances the budget next year. The alternative is that the Fed will run up its share of the debt to $1.6 trillion in 2011, more than $2 trillion in 2012, and perhaps as much as $3 trillion in 2013.

    That’s assuming there would not be a terrible, horrible, no good, very bad impact on the demand for those treasuries on account of us papering over the debt. Who will want to be paid back with monopoly money? Will foreign owners of the debt even accept payment in dollars any more?

    France and Britain ultimately rejected the Weimar Republic’s attempts to pay its war debts with printed money after World War I. The result was hyperinflation in Germany and double-digit unemployment, which eventually spread throughout the continent and helped cause the first Great Depression.

    Meanwhile, China is the primary beneficiary of these developments. Every year, it takes the trade deficit and converts it into treasuries and earns a modest return. But it is also using the money to stockpile gold, buy real assets like ports in Greece and factories in Brazil, modernize its navy and other armed forces, and build real infrastructure in its mainland.

    In short, the American people are paying the Chinese an exorbitant tax, with which they are buying the world. They are sucking us dry. This is equivalent of Dutch traders buying Manhattan for beads, blankets, and seashells, except this time it is cheap furniture, plastic toys, and electronics we really don’t need.

    This is worse than the Great Depression.

    Bill Wilson is the President of Americans for Limited Government.


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