Tuesday, August 10, 2010

Fed Monetizes 10% of National Debt

"Helicopter Ben," as depicted on investletters.com.
...and almost no one noticed.

The Federal Reserve announced today that it would reinvest the proceeds of its $1.3 trillion in mortgage-backed security (MBS) purchases into long-term Treasuries. Here is the official announcement, as reported by CNBC:
To help support the economic recovery in a context of price stability, the committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.
Translation: we fear deflation, so we're going to combat it with inflation.

Here are the facts: the Fed purchased $1.2 trillion in mortgage-backed securities over the past two years to drive down mortgage interest rates. The idea was to increase home sales by making mortgages more affordable. Today, the Fed announced what it will do with the proceeds of those investments: use them to finance our national debt.

In other words, the Fed is printing money out of thin air to pay our national debt.

This really shouldn't be a surprise, either. Ben Bernanke infamously stated in 2002 that he would fight potential deflation at all costs, including a "'helicopter drop' of money" into our economy. Again: fighting deflation with inflation.

Moreover, our politicians have no plan for paying off the $13.3 trillion debt they have created. Their only solution is to print more money.

Enter "Helicopter Ben." By purchasing $1.3 trillion of our $13.3 trillion debt, the Fed is wiping out 10 percent of our national debt simply by printing more money.

This "easy out" may sound attractive, but it devalues—or inflates—our currency. The more you have of something, the less valuable it becomes. After all, there is a reason why a nickel no longer buys you a cup of coffee. Unfortunately, wages—especially blue collar wages—rise much slower than prices. Savers especially suffer because the purchasing power of their cash drops like a rock, and the Fed is always late in raising interest rates.

But, politicians are OK with this because this allows them to pay back our debt with less valuable dollars.

The takeaway: inflation is coming. Bernanke stated this is his plan, and our political spendthrifts agree. Don't sit on large piles of cash, because you'll get slaughtered. Invest in gold and other hard assets, including real estate.

[Disclosure: I am long DGP, a gold ETN. Dammit Jim, I'm a lawyer, not a financial planner, so do your homework and consider consulting with an investment professional before you take my advice. Whatever you do, please don't sue me. Thanks.]

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