When the Federal Reserve Board decided to spend $85 billion monthly less than a year ago to fund the ongoing Treasury bond auctions, as well as buying into the huge accumulation of mortgage-based debentures festering on major banks’ balance sheets, the U.S. stock and bond markets took off like a shot. Interest rates tumbled to depression era levels, facilitating business and consumer loans; thereby reviving the housing and automotive markets, giving the false impression that the U.S. economy was in better shape than even optimists had hoped for earlier in the year.
But the “morning after” shock came on Wednesday, June 19, when Fed economic super chief Ben Bernanke warned that the central bank’s sugar pill insertion was not endless. He further indicated that the end might come sooner than expected, based on optimistic economic analyses from America’s 12 federally constituted reserve districts.
With Bernanke himself delivering the message in a post announcement press conference at mid-day, the New York Stock Exchange market floor erupted into sell orders that accelerated into a climax the following day, only slightly abating by week’s end. The fixed income instruments were not to be outdone. As bond and commodity traders replicated the dizzying downward movements by reversing months of upward pricing and lower yields, this moved the popular 10-year note, on which many commercial loans are based, from a midweek 2.15% to a 2.53%, when the U.S. markets closed mercifully as the week ended. Also, this coincided with the position squaring of “triple-witching” option termination.
Like all artificial stimuli, the beneficiaries delude themselves that these palliatives are endless. Therefore, they make little, if any fallback provisions. What only a few investors realized is that this Federal Reserve Bank largesse had driven their holdings of treasury bonds and bills, plus mortgage-based derivatives from a “pre-great recession” balance sheet of less than one trillion dollars to over $4 trillion in less than four years. While the U.S. central bank is independent, these purchases are paid for by dollars issued by the Fed, with the purchased “paper,” serving as collateral. Eventually, this process has to be reversed, with long-term inflation a yet distant, but inevitable reality.
But even worse is the sham that such monthly infusion (which will inevitably end) is based on a questionable 6.5% unemployment statistic based on the Labor Dept’s interpretation. Like all “mirages,” this dependence on the Federal Reserve’s printing presses will be followed by a jump in mortgage rates, commercial loans, and a “user tax” on practically all consumer and producer-based goods.
Most concerning could be the interest paid on the U.S. Treasury debt, nearing $17 trillion, which has been the beneficiary of low and intermediate term interest rates. A mix of these, which comprise most of America’s outstanding debt, has kept payments to creditors, at home and abroad, at one-half the traditional rate of 6% over the years. This could double the already huge annual debt interest bill by hundreds of billions of dollars.
As in all crises, the solution to which have been based on false premises, this sudden addition to the annual deficit, could inflate the 2014 shortfall even more drastically than the budget planners had been concerned about.
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