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The Fed surprised the market by extending its policy of
0 to 0.25% Fed funds rate to mid-2013. The way the Fed manages to drive rates
lower is to buy Treasuries with newly created money – driving the price
up and the rates down. The big question is whether the policy will have a
sizeable effect on markets. The chart below shows the historical jump in the
Fed’s combined policy tools that were used to lower rates and bail out
financial institutions through a variety of programs. These include the big
purchase of mortgage-backed securities (MBS) called QE1 and the large
purchase of Treasuries called QE2.
The point of the extrapolation in the chart is just to
guess how much more money the Fed might need to create to keep the rate
extremely low for another two years. By connecting a straight line from the
start of the unusual policy tool expansions in late 2008 to today’s
number, and then extending it to 2013, we can estimate that the policy might
require about $1.5 trillion in order to keep the rate low.
The Fed doesn’t calculate the amount of money
that might be required and probably doesn’t know for sure. They just
keep buying on the open market until the rate comes to its target. If there
were a loss of confidence in the dollar, the amount could become very large
– and in the extreme, printing more money contributes to that loss of
confidence, which in turn causes runaway inflation. We are not there yet. But
this kind of open-ended promise is a dangerous precedent because we
can’t be sure of the cost of the commitment.
However, we can say that the Fed policy is to let the
dollar fall and to support the bankers and politicians who want to stimulate
the economy.
[Many
analysts at Casey Research foresaw the problems that are playing out today
with US debt and the dropping value of the dollar. Join Bud, Doug Casey, other
Casey Research experts, and special guests including John Mauldin and Mike
Maloney in a free online event focusing on the American
debt crisis – including how you can protect yourself and your
wealth.]
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