How The Fed Is Monetizing the Debt

For some time I have been wondering why interest rates have not been rising in the U.S. Treasury market given the huge issuance of new debt. One would think that a drastic increase in supply would result in lower prices and higher yields. In a normal market that would be the case but there are no normal markets anymore.

Chris Martenson has a great article detailing how the Fed is monetizing (funding U.S. debt with printed money) using a "backdoor" method in an effort to cover up their actions. Buying Central Banks agency bonds (Fannie Mae & Freddie Mac) and enabling them to reinvest in U.S Treasurys is the same thing as the Fed just printing money and buying the bonds themselves.

The dollar is doomed.-Lou

From Chris Martensens "The Shell Game - How the Federal Reserve is Monetizing Debt":

The US government has record amounts of Treasuries to sell.

Foreign central banks, which have a big pile of agency bonds in their custody account, would like to help but want to keep things somewhat under the radar to avoid scaring the debt markets.

The Federal Reserve does not want to be seen directly buying US government debt at auctions (and in fact is not permitted to, but many rules have been 'bent' worse during this crisis), because that could upset the whole illusion that there is unlimited demand for US government paper, but it also desperately wants to avoid a failed auction.

For various reasons, the Federal Reserve cannot just up and start buying all the Treasury paper that becomes available in record amounts, week after week, month after month. Instead, it uses this three-step shell game to hide what it is doing under a layer of complexity:

Shell #1: Foreign central banks sell agency debt out of the custody account.

Shell #2: The Federal Reserve buys those agency bonds with money created out of thin air.

Shell #3: Foreign central banks use that very same money to buy Treasuries at the next government auction

The Federal Reserve has effectively been monetizing far more US government debt than has openly been revealed, by cleverly enabling foreign central banks to swap their agency debt for Treasury debt.

This is not a sign of strength and reveals a pattern of trading temporary relief for future difficulties.This is very nearly the same path that Zimbabwe took, resulting in the complete abandonment of the Zimbabwe dollar as a unit of currency. The difference is in the complexity of the game being played, not the substance of the actions themselves.

The shell game that the Fed is currently playing does not change the basic equation: Money is being printed out of thin air so that it can be used to buy US government debt.

When the full scope of this program is more widely recognized, ever more pressure will fall upon the dollar, as more and more private investors shun the dollar and all dollar-denominated instruments as stores of value and wealth. This will further burden the efforts of the various central banks around the world as they endeavor to meet the vast borrowing desires of the US government.

One possible result of the abandonment of these efforts is a wholesale flight out of the dollar and into other assets. To US residents, this will be experienced as rapidly rising import costs and increasing costs for all internationally-traded basic commodities, especially food items. For the rest of the world, the results will range from discomforting to disastrous, depending on their degree of dollar linkage

Here is the link to Chris Martensen's interesting article