Oh Ben! Oh Ben! Where For Art Thou?

As the Japanese discovered, once you’ve taken interest rates to zero, and your economic success is questionable, then you must try another tact. Step two for the Japanese was a tactic called quantitative easing, something the United States Federal Reserve is instituting today. Simply put, this policy can be defined as throwing as much money at the problem as needed. Millions? No. Billions? Not even close. Let’s try trillions.

Several weeks ago, the Fed announced they would be the purchaser of treasuries issued by the Treasury Department at the periodic auctions. In other words, if the world doesn’t buy our long-term paper, we’ll buy it ourselves. Historically speaking, from Rome to Britain, (and that includes us), that type of action has been tried and results in two unintended consequences. The first is total devaluation of one’s currency, and second, an inflationary spiral that is almost impossible to control. (Think of the Nixon and Carter years.)

At an alarming rate, the bond market has recently seen a selling of treasury bonds, including both the ten-year and thirty-year duration. People, institutions, and countries, do not want to hold paper of a country that’s headed toward currency devaluation and hyper-inflation. Unfortunately, as treasuries are being sold, interest rates are rising (remember the see-saw example.) This throws a monkey wrench into the Obama administration’s recovery plans for housing. Long-term treasuries have a direct influence on mortgage rates. Rising mortgage rates are the last thing Obama needs to make his housing plan (also questionable) work.

This is where Ben Bernanke comes in. In order to keep interest rates low, there has to be an overly large buyer of treasuries to drive prices up, and interest rates down. The only player in that game is not China, not some quant or hedge fund, and not the general public. The only player is the U.S. government. Ben knows he has to step up, but he also knows this vicious cycle we’ve embarked upon, has only one ending. Can you say Zimbabwe? *(Zimbabwe’s inflation rate has entered a zone where it is simply impossible to calculate the price of goods hour to hour.)

However, buy he will, and buy he must. The rational will be that they can fix it later. Unfortunately, history has proven that later never comes.

Till next time,

Bill


* The Times (South Africa) February 4, 2009



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