The beginning of the end

Make note of this date – March 18th, 2009.   100 years from now, historians will point to it as the day the United States of America sealed its’ fate.

Today the United States shifted from a long slow decline into high gear – and nailed the accelerator pedal to the floor.  There are several other dates which may be picked as well, such as the AIG bailout on September 16th, 2008, or even the Bear Stearns bailout on March 14th, 2008, but today is the one that should be remembered.

It should be remembered as the beginning of the end, because today, for the first time, the Federal Reserve announced that it is going to directly purchase US Treasuries.  $300 billion worth – and that’s in addition to $1 trillion in mortgages.  The full text of the Fed announcement is here.

Here’s an important part:  To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. [Emphasis mine]

The term “increase the size of the Federal Reserve’s balance sheet” is a euphemism for “create money of out thin air” – or as it’s more commonly known – printing money.

It’s time for a refresher in basic economics – although this isn’t in Econ 101 – but it should be.  In the past, the Federal Reserve served simply as a clearing house for banks.  They would lend money to banks, but they effectively “held the mortgage” on whatever collateral the banks put up.  The collateral was commonly US Treasuries, although it could be almost any asset.  So the Federal Reserve might do something like take $100 million in US Treasuries from Bank of America and in return the Federal Reserve would give the Bank of America $100 million in US dollars. (Hypothetical situation)

They printed up $100 million to loan out, but they received $100 million in assets, so the net effect on the balance sheet of the Federal Reserve was zero.  This is important – please re-read that if you don’t understand the process.  No money was created that didn’t already exist.  In the hypothetical example above, the Bank of America gave the Federal Reserve $100 million in the form of US Treasury bills, and the Federal Reserve gave them $100 million in cash in return.  The Bank of America can now loan out that $100 million to others – something they couldn’t do with a Treasury note.

But the net effect on the balance sheet is zero.  No new money was created.  It all existed in some form before the transaction, so the net effect is zero.  You can’t give the local grocer a US Treasury bill for a loaf of bread – you can give him dollars.  That’s what the Federal Reserve effectively did – they provided a liquid form of money (dollars) in exchange for illiquid money in the form of Treasury notes.

Got it?  Ok, read on….

Another part of the announcement says Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

You really need to understand that the Federal Reserve doesn’t actually have any money, so when they “purchase” something – as opposed to normal lending – with what do they  purchase it?  The answer is really simple – they make up money.  They create it out of thin air.  Unlike the example above, this money isn’t backed by anything.  Nodda.  Zilch. Zip.

They simply make a few keystrokes and “create” more US dollars.  This is the electronic way to debase the currency.  The Romans did this by alloying other metals such as lead into their gold coins.  The end result is the same.  Inflation.

When you make each coin (or dollar) worth less, you are expanding the supply of money.  The amount of goods in the economy hasn’t changed at all.  If you read through an earlier post of mine, you’ll see that money is simply a way to facilitate transactions – but all money needs to represent actual goods produced that have not yet been consumed.

When the Federal Reserve buys US Treasuries, they are doing the same thing that the Romans did – causing inflation by debasing the currency.  It’s the law of supply and demand.  The Federal Reserve announcement today directly expanded the money supply by $300 billion.  That’s why gold soared today at the exact time of the announcement.

US Treasuries also soared on the news, but that will prove to be short lived.  It will be short lived because traders will realize Treasuries soared because the Chinese have dramatically slowed down their purchases of US debt – and their initial joy that someone is going to purchase the treasuries will fade when they realize that the purchases are being made with funny money.  The Chinese have made it clear that they won’t sit by idly and watch the value of their investments be debased by US policy.

Here’s a link to a NY Times article with a few different takes on the news.  It’s good, read it.  A few choice quotes are copied here:

  • Although the notion of quantitative easing has been much discussed in the past few months, the policy clearly took effect today. Many thought it would never come to pass. In many ways this is a tragedy that could have been avoided. (Joseph Brusuelas, Moody’s
  • Today’s announcement that the Fed is committed to purchase more than $1 trillion in Treasury and agency debt is great news for current holders of those instruments looking to bail out, but horrific news for just about everyone else, particularly long-term holders of U.S. dollars-based assets. (Peter Schiff, Euro Pacific Capital)
  • But by being the buyer, not just the lender, of last resort, the Fed has laid in a course that can only lead to ruin for the U.S. dollar. (Peter Schiff, Euro Pacific Capital)
  • Adding up these programs puts the Fed’s balance sheet somewhere around $4½ trillion before the end of this year… We think the Treasury rally will be short lived and see these purchases as negative for the dollar against foreign currencies and gold. (John Ryding and Conrad DeQuadros, RDQ Economics)

If you’ve read this far I congratulate you.  If you read through this looking for advice on what to do with your money, or what the stock market will do, here’s my take.  This advice is free and worth every newly debased penny.  Go long on anything that’s sold in dollars, because as each dollar becomes worth less and less, the value of those items is more and more when measured in dollars.

Buy gold.  Buy silver.  Buy oil. Buy the Euro, the Brazilian Real, the Chinese Yuan – and short the dollar.  The dollar is officially toast.

I’ll end with a note that I REALLY hope I’m wrong.  I hope that the US isn’t headed down the path to inflationary ruin.  But that’s just hope.  My head says that this is the beginning of the end of this brief experiment, and that the United States as we know it will cease to exist at some point in the next 10 to 20 years.  Damn I hope I’m wrong….


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