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America's
economy is in shambles. Fiscal policy is totally gridlocked between Democrats
who want to see some long term tax increases, and Republicans who only want
spending cuts. Worse yet, the Republicans view economic failure in America as
a good thing as they believe it will enhance their chances of recapturing the
White House. Because compromise on the budget seems to be off the table right
now, that leaves only the Federal Reserve policy to stimulate the economy.
So, judging from what's been reported in the financial press and on TV
lately, the Fed's policy is ringing loud and clear: Keep interest rates at
record lows, and devalue the currency.
Keeping long
term interest rates low is desired because the Obama Administration is
praying that loan and mortgage refinancing will put more money into the
pockets of corporations and individuals, giving them money to spend. A lower
dollar is also desired to help boost exports. Selling more abroad is, for
now, the only way to create more jobs. In other words, fiscal policy is
frozen like a deer in the headlights and easy money is the only policy our
government's got. There is just one big problem with a policy of low interest
rates and a weak currency.
Foreign
central banks, led by China, currently hold $3.5 trillion dollars invested in
US treasuries. China created goods that they sold to America for dollars but
now we want to pay them nothing in interest and devalue their savings held in
dollars. Indeed, it must be galling to the Chinese that we are treating them
this way. (It's ironic but we're treating our retired savers in our own country
this same way). Needless to say, China understands what's going on and it has
them more than a little pissed off. At some point, they could cut their
losses and swap their horrible investment in paper dollars for tangible
assets such as gold and other resources they need to employ, feed, clothe,
and house their 1.3 billion citizens.
Countries
holding US treasuries face a two pronged dilemma: First, if they dump longer
term treasury securities, they would suffer massive price declines because
selling long term notes and bonds pushes their prices down. Second, foreign
countries would suffer currency depreciation losses because selling dollars
pushes the dollar down. If China and other central banks all sold their
longer dated treasury notes and bonds, US treasuries would decline in price,
causing long term interest rates in America to soar. At this time in American
history when our economy is so fragile and weak, rising long term interest
rates could spell disaster for our economy. This is the Obama Administration's
greatest fear especially as we approach an election year, so they had to come
up with a plan so foreigners dumping their longer term US treasuries wouldn't
hurt us. Since monetary policy is all we've got, the Fed was called in to fix
the problem.
So what else
could the Fed possibly do to keep our economy moving in the right direction?
Why not go to the Chinese and promise to pay them a big fat premium on their
current long term treasuries (that were purchased at much higher interest
rates) and let them swap them into short term treasury bills and notes.
Indeed, looking at the prices of US Treasury notes and bonds, most are
trading at premiums of 10 to 15 percent for recent issues, and 50 percent or
more for those issued just a few years ago. By allowing other countries to
get out of longer term treasuries at a time of record low interest rates, it
will give them an extraordinarily large gift and potentially enormous profits
that can be used in several ways: China would likely use the profits to offset
currency losses when the Fed goes back to printing money in QE3 to fund our
deficit; and, in Europe, the profits could be used to help recapitalize their
banks which are loaded up with Greek, Irish, Italian, and Spanish debt.
When foreign
countries have fewer treasury notes and bonds left in their arsenal to sell,
when they do get around to selling their dollar holdings it'll push the
dollar down without pushing interest rates up. (Note: Short term treasuries
will not go down in price if sold. Indeed, they can only go down if the Fed
raises rates, and even then they quickly adjust back to a par price of 100.)
At that point, America can dare China to sell the dollar, because pushing the
dollar down is our policy.
So basically
now you know what the Fed's recent "Operation Twist" is all about
(a more appropriate name might be "Operation Payoff"). We are
paying a King's Ransom to pave the way to devalue the dollar in the next QE3
and beyond. Just remember the downside of a falling dollar will be higher
import prices and higher inflation.
If you would
like to participate in Operation Payoff, do what the Central Banks will be
doing: Sell your long term treasuries to the Fed and then brace for the next
round of dollar devaluation and inflation which will soon be on the way.
Richard Benson
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