Wednesday, March 18, 2009

Fed Pledges To Inflate More

Even as the consumer price index increased for a second month in a row (for a total of 0.7%, or 4.2% at an annual rate), the Fed now says it will accelerate inflation. The FOMC Statement specifically pledges to:

"The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months."

$1.25 trillion + $200 billion + $300 billion. That adds up to $1.75 trillion in Fed asset purchases.

Financial markets reacted immediately, with stocks, Treasuries, foreign currencies ,gold and commodities in general all soaring in value. $300 billion of purchases won't really make that much difference considering that the deficit this year will be well over $1.5 trillion. However, combined with the massive purchases of mortgage-backed securities and agency debt, and the possibility that they might later decide to purchase even more, the massive increase in liquidity will certainly result in Treasury yields dropping significantly, which is what we saw today.

However, considering the inflation that this will unleash, Treasuries are not the place to be right now. The only safe place is in real assets, such as gold.

3 Comments:

Blogger Wille said...

...I'm considering adding conserves, gold coins, a safe and a gun to my previous investment in gold..

12:06 AM  
Blogger Samewise said...

Stefan,
Is the Feds decision to buy $300 billion in Treasury notes an acknowledgment that the rest of the world can't or won't lend these sums to the US or is it simply an attempt to inflate?

7:23 PM  
Blogger stefankarlsson said...

It is more an attempt to inflate.

The U.S. government won't have any problem borrowing. The question is rather what price it will have to pay. If the Fed hadn't started to buy these Treasuries, the large deficit would have pushed up yields, something which in turn would have pushed up the yield on for example mortgage backed securities as more investors would prefer Treasuries to them if yields go up.

Higher yields in turn would have had a deflationary effect which would have cancelled out the inflationary effect of higher government spending. So, the purpose is to create inflation.

8:58 PM  

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