*tradebum, thats me, I want to reiterate what I have been clamoring for all along. The fix of this mess lies in a book written by Tom Clancy called Debt of Honor. Financial crisis was Japanese dumping US treasuries in retaliation over Hiroshima. So a Soros like figure, convinces everyone its not happening and everything goes back to normal.
So in March 2008, fed should have nationalized the banks, brought all parties of CDS to the table and pretended that the things didn't exist and then just wipe away all the bad assets from banks, pretend no one has credit card debt or housing problems and issue every american a new debit and credit card and we start all over.
But thats just my opinion. Read The Economist'
Greg Ip of The Economist provides details on the move.
Fed buys Treasury bonds
RAY SUAREZ: Help us understand what it means for the Fed to buy Treasury bonds. Isn't that like putting your hand in your left pocket and just shifting the money to your right pocket?
GREG IP: Well, step back a second and ask, what is a Treasury bond? It's essentially one of the ways that the government finances itself. When they want to provide us with services, whether it's Social Security checks or funding the Department of Defense, they can either raise taxes, they can borrow the money from households or from foreign investors, or they can ask the Fed to print it.
And when the Fed purchases bonds from the Treasury, they are basically printing money. They say, "We'll take that bond," and, hey, presto, we will create this money in an account for the government to spend.
RAY SUAREZ: So the Fed creates the money and then just lends it to the Treasury?
GREG IP: That's exactly what happens, and the Treasury goes out, and they spend the money. Now, in this case, they did not directly give the money to the Treasury. They actually will purchase the bonds on the open market. They will purchase them from people who previously bought them from the Treasury, but it is, essentially, printing money.
THE RISK to FED
And, indeed, there are two risks to the Federal Reserve in this action. The first is that they could, if they do too much -- they could create inflation, essentially, by printing so much money that it gets spent and it begins to exceed the ability of the economy to provide goods and services. Then you have too much money chasing not enough goods and service. That creates inflation.
I think we're a long way from there right now. The unemployment rate is very high. There is a lot of unused capacity.
The second risk is to the Fed's political independence. Essentially, when they are buying bonds, they might start to worry, are we just becoming an arm of the government? Will there be pressure on us to keep doing this because politicians don't have the courage to raise taxes or borrow the money via going into the public markets?
But I think that that, too, is not a risk that we should worry about too much right now. Essentially, the Fed has decided that those risks are for another day. Right now, the risk is the economy is in a deep recession. There's some risk of actual deflation, never mind inflation, and they have to basically do, in their words, anything in their power to help the economy.
Effects already noticeable
RAY SUAREZ: But by essentially creating a trillion dollars, if you hold dollar-denominated assets in the United States or anywhere else in the world, are they worth just a little less today because there are now so many more dollars around, as of this afternoon?
GREG IP: Not necessarily, because it actually happens -- it depends on what happens to the dollars that the Fed has created. For example, if they print money or create money, it can end up either as currency in your pocket or as money in bank deposits.
But if you don't actually go out and spend that money, it doesn't create any additional demand, it doesn't circulate through the economy, and the total size of the economy doesn't actually grow, so you don't actually end up with a lot more dollars in circulation. That's just another fancy way of saying you don't get a lot of inflation.
Moreover, in the short term, what the Fed has done is, by buying Treasury bonds, it has actually driven long-term interest rates down, and that's actually good for other assets, which actually look more attractive because, you know, the alternative returns are not so good.
RAY SUAREZ: Well, you mentioned the last couple rounds of shock and awe didn't work. Will we know whether this is the jump that will work soon?
GREG IP: It's already helping. I mean, today we saw long-term interest rates fall very sharply. Mortgage rates are down. More people will be able to refinance, but it's not enough. People sometimes can't qualify for mortgages. There's a lot of effort needed still by the Barack Obama administration, for example, on bank capitalization.
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