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Where would we be without the Fed and its printing press? There's been a lot of debate about the appetite of foreign investors of our debt -- Treasury auctions continue to be strong, even as noises emanate from overseas about wanting to dump the dollar.
But here's a stark fact, via the Council on Foreign Relations: Only the Fed is buying agency debt. Foreign buyers, who once consumed it voraciously, have been net sellers so far this year.
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When the Fed prints the money and buys Agency Debt from foreigners and private investors. Then most of this money is used to buy US Treasury Bonds. And what used to be private debt become US government debt. And the Fed can quietly write off a lot of its Agency Debt as if it has never existed, when US mortgage borrowers default on their mortgages.
Everybody ends up being happy this way, at least for some time. But eventually US taxpayers will have to repay the increased US government debt to foreigners and private investors. And indirectly, all US taxpayers will pay for the mortgage defaults going on in USA now.
The only problem with this conversion of Agency Debt into US Treasury Bonds is that some of the money the Fed is using to buy Agency Debt is leaking into stock and commodity markets and is causing speculative price bubbles. Which will likely crash, once the Fed finishes purchasing Agency Debt and ends its purchases of US Treasuries.
And the Fed's purchases of US Treasury Bonds is just a roundabout way of increasing US debt to foreigners and private investors. Because when the Fed prints the money and buys US Treasury Bonds from investors. Then one way or another this money comes back into US Treasury Bonds, after changing hands several times through financial markets. And this means that the total amount of debt the US government owes to foreigners and private investors increases by the same amount that the Fed has paid for US Treasury Bonds.
This quantitative easing thing perhaps can help the economy temporarily. But it works by increasing the total amount of government debt. And it's unsustainable in the long run. Because there is a limit to how big government debt to foreigners and private investors can get.
But why does the US government even need to borrow from foreigner now? Why not just have the Fed print money, and buy government debt at 0% interest rate? The Fed can even conveniently forgive the debt. It's all funny money anyway, at this point.
Now, normally, this would cause crazy inflation. But since the total amount of money and credit in the system has dropped significantly, then even with all the money printing, the amount sloshing around out there is not higher. So we don't get inflation, at least until the velocity of money rises again.
I'm not advocating any of this. I think it sucks. But that seems to be what's happening, like it or not.
SM
The only way to avoid inflation is to remove from circulation the extra cash being printed by the Fed. And this the US government can do by selling US Treasury Bonds to investors and converting their cash into US government debt to them.
One way or another the US government has to borrow the same amount of money from investors that the Fed has printed and gave to the US government. Or else the amount of cash circulating in the economy will increase. Which will result in inflation even when the economy isn't doing well, as the Zimbabwean example has recently shown.
The Fed and the US Treasury can move the debts around from one set of books to another. They can convert Agency Debt into US Treasury Debt through trading in financial markets. And they can forgive their debts to each other.
But neither the Fed nor the US Treasury can print money and spend it in the economy without borrowing an equal amount of cash from investors in order to remove this extra cash from circulation. And neither the Fed nor the US Treasury can get investors to forgive and forget US government debt owed to them in the form of US Treasury Bonds.
The only way to avoid increasing the amount of cash in circulation and the resulting inflation is to have the US government borrow the money instead of just print and spend it.
Not quite incorrect but perhaps misleading in trying to imply there won't be a market for these, there certainly will be. The prices however will just as certainly be lower - the fact is it makes no sense whatsoever for anyone to buy these for as long as the Fed is. Almost by definition they are overpriced for as long as the Fed is a size buyer. Why would anyone try to compete with a buyer who is utterly price-insensitive?
I'm only surprised GS hasn't figured out how to short sell (futures maybe?) these to the Fed.