Wednesday, February 23, 2011

The Federal Reserve Blows Past China in the US Treasury Market

It’s official!  Within the past couple of weeks, news was released that the Federal Reserve has surpassed China as the largest holder of US Treasury bonds, more commonly known as governmental debt. The Federal Reserve now holds around $1.1 trillion in United States debt, while China holds around $891 billion. If you don’t think the Federal Reserve’s recent increase in purchases of government bonds is anything to be worried about, think again.
In early November, 2010, the Federal Reserve announced they would purchase $600 billion in US Treasury bonds over an 8 month span in a program called QE2. Federal Reserve chairman Ben Bernanke stated this program was a necessary form of economic stimulus to help speed up the recovery for the US economy. Although many critics and inflation hawks (such as myself) immediately challenged the proposal of QE2, stating it would spark inflation and prolong the recession, many Keynesians and inflation doves such as Bernanke took action in following through with this plan while ignoring their critic’s concerns.
The purchasing plan for QE2 was for the Federal Reserve to buy US Treasury bonds at a rate of $75 billion per month. Considering this program started in mid-November, the Fed is almost at the halfway point of its $600 billion planned purchase. This means the Fed still plans to purchase $300 billion more in US Treasuries over the next 4 months. Such an action will further strengthen the Federal Reserve’s new standing as the number one holder of US debt.
For those who don’t know, the Federal Reserve is the central bank of the United States. The main duty and obligation of a central bank is to regulate the nation’s currency by increasing or contracting the money supply. In doing this, their main objective is to hold the value of the currency stable and minimize the risk of inflation and deflation. When the Federal Reserve purchases US Treasuries as they are with QE2, they do so by simply printing the money out of thin air and adding it to the United States’ money supply. As the money supply increases at a rapid rate, inflation starts to rise, and the value of the US dollar declines in value against foreign currencies. Both foreign and domestic goods increase in price as inflation starts to rise, and it becomes tougher for the US to pay back its debts to foreign nations. Once this point hits, foreign nations become less likely to lend money to the US government, and the only way the US can continue to borrow is by going to its own central bank and ask them to crank up the printing presses.
The Federal Reserve acting as the top bond holder of US debt is a very bad policy, and it will inevitably slow down the recovery instead of speed up the process. As the federal government continues to spend and foreign nations become less interested in funding such habits, the Federal Reserve will continue to increase its purchases of US debt in an attempt to be seen as an economic stimulator and savior of the US economy. In reality, they will prove themselves to be the exact opposite.  If the Federal Reserve does not immediately slow down their holdings of US debt, it will take a longer time period for the US to pull out of recession.

- Liberty_Mike

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