Tag: qe3

The Biggest Gamble in World History

The Federal Reserve just announced it would continue its program of buying up US bonds and mortgage backed securities to keep rates low. They plan to buy $85b per month until it’s not needed anymore. That’s $3b per day. Or $283 per month for every man woman and child in the US. Where does that money come from? Our taxes? Borrowing from the Chinese? No.

We just create it out of thin air. We tell people we have it, add some numbers to a spreadsheet and boom, we have $85bn in new dollars! What a great idea! Then we use it to buy debt issued by the United States. This keeps interest rates artificially low because there are fewer US bonds on the open market. People who want to buy bonds compete over the only remaining bonds and drive down interest rates. It works the same way for mortgage backed securities.

Get it? If not, here’s another example. Say I want to buy a $1m house but I don’t have any money. I meet with the seller and say “I have one million dollars in my bank account, give me the house.” The guy believes me and gives me the house. On the way home, by some magical power, I decide that I have $1m in my account and create it out of thin air. Then I transfer it to the seller. That’s what the Federal Reserve is doing.

So why don’t we just print $16 trillion and pay off all of our debt at once? We could do it. But here’s the problem. If we do it, everyone with government debt would be rich and everyone without it would be poor. We’d kill anyone without government paper. And everyone without their newfound wealth would buy up everything else. In otherwords, massive, overnight inflation.

Ok, so why not $8 trillion? Same problem. $4 trillion? Still too much. $1 trillion over a year? That sounds ok. And that’s what we’re doing. $85b*12 months=$1.02 trillion in new money created each year. So we’re just creating money out of thin air, keeping interest rates low and hoping we can slowly inflate our debt away. We’ll keep increasing our money printing until we hear complaints from the rest of the world or the bond market. If nobody complains, we’ll buy $150b/month of our bonds. Then $200b.

That, I believe, is Wall Street and Washington’s master plan to get out of debt. The increased taxes and spending cuts of the fiscal cliff are a mere sideshow to distract the citizens and our investors to make us think that we’re actually serious about reform. For a myraid of reasons, we’re not. So we’ll try to avoid pain and inflate ourselves out of the problem.

Sounds great, right? Don’t really raise taxes, don’t really cut spending and make our debt worthless. Inflation in combination with real reform could be good, but unfortunately this plan destroys certain groups of people:

The poor

The poor spend a huge percentage of their income on food, housing and basic needs. These basic needs go up when we print money. Public assistance payment cost of living increases don’t keep up with inflation. Food, gas, rent increase. Inflation squeezes the poor.

The middle class

The middle class gets hit by rising food and commodity prices, but they also have savings. If they have $10,000 in a CD earning 1%, but inflation is 3%, they’re actually losing 2% each year. Creating money out of thin air erodes their savings and purchasing power.

Anyone on a fixed income

People on social security, retirees, people on disability or welfare are destroyed by persistant inflation. Each time we create $85b out of thin air, that social security check purchases less.

Savers, retirees and pretty much anyone with a net worth of less than ~$50m

These savers planned on being able to live off of their savings. But what are your savings worth when the government can just create money each month? Less and less each month.

So if creating money out of thin air hurts all of these groups, why is it happening? Because we either have to make hard choices to cut benefits and raise taxes. People want to raise taxes on the rich, but when it comes to cutting spending, if they’re affected they scream. And our government appeases us.

Our government is gambling that it can create enough money to keep interest rates low without pissing off our foreign investors or the rich who could affect the bond market. This gamble works until our investors say it doesn’t anymore. At that point, interest rates go up. Potentially from today’s 1% to 7-10% really quickly. And then the US is in trouble.

Short of seriously cutting spending and increasing taxes, this is our only hope. And it’s the hope our  government has hitched it’s wagon to. At some point in the future, our investors will call us on our persistant inflation. But if we stop and just massively cut spending, we could go into deflation like Europe. If the gamble doesn’t pay off, we’ll have a bigger bubble than we’ve ever seen in this history of the world, this time in US debt. We need to hope it does. Our third option between printing money and austerity is not any more politically feasible than it was when I wrote about it in April.