The Monetization of U.S. Government Debt, We're Watching and It's Bigger Than You Think

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Didn’t
Chairman Bernanke say, “The Federal Reserve will not monetize
the debt.”

Yes he did,
as clear as day to the House Budget Committee back on June 3, 2009.
And yet 17 months later Bernanke gave us QE II, which not only means
the Federal Reserve will be purchasing about $75 billion a month
in assets for the next 8 months, but as it so happens, some $110
billion in Treasury Notes and Bonds too. That’s enough to finance
the U.S. government’s projected fiscal deficit right up through
June 2011, in full.

THE
CONTRARIAN TAKE
says, what gives!

Echoing his
June 3rd testimony, said Bernanke to Congressman Ron Paul and the
House Financial Services Committee on July 21, 2009, “We
are not intervening, or actively trying to… make it easier
for the government to issue debt.” Well, QE II may or may
not be aimed at “monetizing the debt’ but monetizing the
debt, and in robust fashion, it nevertheless is.

We here at
THE CONTRARIAN TAKE love to crunch numbers. So we asked the question,
just how big are these debt monetization activities in the light
of historical precedence? Given the impact these activities have
on the currency and bond markets, we’re thinking its something
we all want to know. What we found is that these activities are
a whole lot bigger and a whole lot more pervasive than even we thought.

Before we show
you just how big and pervasive, some preliminaries…

Intro to
U.S. Government Debt Monetization, Our Take

The traditional
take on U.S. government debt monetization activities is centered
on U.S. Treasury debt and the Federal Reserve. To wit, the Federal
Reserve purchases or monetizes Treasury debt by issuing checks
on itself, in effect printing the money with which to purchase the
debt. Certainly true, but in our minds, too narrow a view for two
reasons:

  • Treasury
    debt is not the only government debt.
  • The Federal
    Reserve is not the only central bank actively monetizing government
    debt.

Treasury
Debt, Not the Only Government Debt

What other
government debt is there, you ask? The obligations of the government-sponsored
enterprises (Agencies) Fannie Mae and Freddie Mac.

On December
24th 2009, recognizing the dire state of the housing market, a market
that just so happens to be dominated by the Agencies, the U.S. government
gave the Agencies, already in conservatorship and under government
control, unlimited access to the U.S. Treasury, effectively making
them divisions of the U.S. government and their mounting losses
the government’s own. On that date, the long standing implicit
guarantee bestowed on Agency debt by the U.S. Treasury was turned
lock, stock and barrel into and an explicit one, making Agency debt
obligations the defacto debt of the U.S. government.

In our minds,
that means that when the Federal Reserve buys Agency debt, in a
very real way, it is monetizing the debt of the U.S. government.

Read
the rest of the article

December
6, 2010

Michael
Pollaro [send him mail]
is a retired Investment Banking professional, most recently Chief
Operating Officer for the Bank’s Cash Equity Trading Division. He
is a passionate free market economist in the Austrian School tradition,
a great admirer of the US founding fathers Thomas Jefferson and
James Madison and a private investor. He is a columnist for True/Slant
magazine.

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