Thursday, March 26, 2009

Has the Monetization Really Started?

Headlines on the Wall Street Journal website Thursday afternoon, “Treasurys Climb After Solid Auction.” (See


The issue Thursday was a seven-year note sale of $24 billion and this capped the issuance of $98 billion in Treasury offerings this week. The day before, Wednesday, the auction of five-year notes was “tepid” and the market was nervous at the beginning of the day.

But, something else happened on Wednesday. The Fed began its planned purchases of existing securities. In fact, the Fed bought securities that matured between February 29, 2016 and February 15, 2019. Gosh, that’s right in the range of the new issue that sold so well on Thursday. Imagine!

Primary dealers offered the Fed a total of $21.9 billion in Treasury securities that matured in this time period and the central bank bought back $7.5 billion of them. Apparently, this will be the procedure that the Fed will follow in upcoming weeks as the indication is that they will purchase outstanding securities on a regular basis.

The Fed is expected to buy roughly $12 billion of Treasury securities every week until they exhaust the planned $300 billion in purchases as announced last week. Friday, March 27, they are going to be purchasing at the short end of the yield curve with dates running from March 2011 to April 2012. Planned are three purchases next week, with some maturity dates expected to run from August 2026 through February 2039.

One of the prominent explanations for the intermediate-term purchases is that the Fed thinks it will help keep mortgage rates down since most 30-year mortgages have an average life of about seven years. If choosing this maturity just happens to provide liquidity to the market so that the Treasury has an easier time of placing its new issues, well so be it!

So, it looks as if we are on our way.


To the land of Oz?

We are starting to see the Fed get serious about monetizing the debt. The talking is over and the direct impact on the market is now under way. At $12 billion in purchases every week, this means that for the next 25 weeks or so, the Fed will be entering the Treasury market acquiring more securities. And, this doesn’t include the provision to purchase mortgage-backed securities in large dollar amounts.

On the other side, as we saw with the $98 billion in new issues this week, the “recovery program” will be providing plenty of additional debt to the market during this period of time. Relieving primary dealers of outstanding issues will certainly “grease the wheels” for the Treasury in terms of the additional debt issue that will need to be placed.

So now we are seeing the future. The Wizard is waving his magic hand. Monetizing the government debt! Providing a scheme whereby private interests can make tons of money buying up “legacy assets”! And, a new regulatory scheme to keep the “bad guys” under control! It is a wonder land with a whole new geography.

It’s ironic. Last September, I remember feeling as if the world had changed, shifted, and would not be the same again. The specific time—a Tuesday evening--when I learned that AIG was being nationalized. I just felt different.

I feel that way again. The rules have changed. Maybe better said, the old rules are no longer applicable and we really don’t know what the new rules are—but we know that they will be different.

Will all this work and restore the banking system and speed the economy on to recovery? No one really knows. I guess we are all waiting for a “tipping” point. But the tipping point can mean different things to different people. The administration sees the tipping point producing a recovery. Critics of the administration see the tipping point creating a whole new cycle of inflation.

And, what if no tipping point appears? Well, that will just mean that a greater effort will be put into the attempt to spur the financial system and the economy along.

The most specific thing going right now is what the Federal Reserve is doing. They are purchasing the debt of the government and they are going to continue to do it for a substantial period of time. For today, we see that this effort has helped the Treasury Department place $24 billion of that debt. And, the Fed’s actions will probably continue to ease the placement of the additional new debt in the future.

What we need to look for, in my estimation, is what happens to the value of the dollar in foreign exchange markets. When the Federal Reserve initially announced this program the value of the dollar fell. When this policy of regularly purchasing Treasury securities up to the $300 billion proposed becomes excessive in the minds of currency traders, the value of the dollar will begin to decline again. My guess is that this will happen sooner rather than later.

1 comment:

Brian said...

Under what scenario might we not see high inflation rates given this behavior?