Whispers from the Edge of the Rainforest: Monetizing the US Debt

For the past few weeks the blogosphere has been debating the 'real' purpose of QE2.

The underlying sentiment? That QE2 has nothing to do with stimulating the economy but is, in fact, a covert way for the US Federal Reserve to monetize the debt.

Of course... that line of thinking is just wack-o, tin foil hat wearing, blathering... right?

Well last night a stunning bit of information hit the blogosphere.

Richard W. Fisher, president and CEO of the Federal Reserve Bank of Dallas, posted a stunning commentary on it's website.

Titled Recent Decisions of the Federal Open Market Committee: A Bridge to Fiscal Sanity?, the Dallas Fed has publicly admitted that "The math of this new exercise is readily transparent: The Federal Reserve will buy $110 billion a month in Treasuries, an amount that, annualized, represents the projected deficit of the federal government for next year. For the next eight months, the nation’s central bank will be monetizing the federal debt."

This is a stunning admission.

Selected passages from Fisher's statement:

As is our tradition, I can only account for and speak for myself and the Dallas Fed, not for anybody else or any other Bank or for the Federal Reserve’s Board of Governors. Today, I will provide a précis of the analysis of the nation’s economic predicament I presented to the FOMC last week on behalf of the Dallas Fed, summarize the arguments I made with regard to the course of monetary policy, and then provide a personal perspective on the decision made by the committee as a whole.

In his speech in Jackson Hole, Wyo., in August, Chairman Bernanke had asked all of us to consider the costs and the benefits of further accommodation. My response was that I was skeptical about many of the presumed benefits of further asset purchases. I was more certain of some of the potential costs.

One cost is the risk of being perceived as embarking on the slippery slope of debt monetization. We know that once a central bank is perceived as targeting government debt yields at a time of persistent budget deficits, concern about debt monetization quickly arises.

also worry about the risk of our being perceived as using quantitative easing and buying copious amounts of financial assets above and beyond the ordinary bounds of the Federal Reserve’s System Open Market Account as “the new normal” for implementing monetary policy. Everything we know from monetary history tells us that in times of crisis, we should open the floodgates—this has been the practice of central bankers since the 19th century. This is what monetary theorists might call Bagehot 101, after the British patron saint of central banking, Walter Bagehot. We did it in 2008 and it worked to pull us from the maw of financial panic and economic ruin. But it did not seem to me last week to be a time of panic or crisis. I suggested that were we to act by throwing more money at the economy under these more benign circumstances, the markets might come to expect more, that quantitative easing could become like kudzu for market operators—expectations of continued Federal Reserve purchases of Treasury securities as normal operating procedure might grow and grow and be terribly difficult to trim once they take root in the minds of market operators.

I might understand the case for accommodation if serious deflation were a clear and present danger. As I pointed out by citing the trimmed mean and through my anecdotal reports, it is not. I would add for this audience here today that this is thanks to Ben Bernanke’s adroit leadership in engineering the liquidity measures implemented during the Panic of 2008-09 and by avoiding the policy errors of the 1930s. Because of what we did in staring down panic and its aftermath, neither M2 money growth nor inflation has fallen off the cliff.[2] And while nominal growth is less than desired and is very painful, nominal income is growing, however incrementally, not shrinking.

Then there is the issue of exit policy. The more we engage in a policy of asset purchases that moves us further out the yield curve—and the more we laden our balance sheet with price-sensitive assets—the greater the likelihood of realizing a loss on our holdings.

In sum, I asked that the FOMC consider that we might be prescribing the wrong medicine for the ailment from which our economy is suffering. Liquidity and abundant money are not the binding constraints on the economic activity we wish to see. The binding constraints are uncertainty about income and future aggregate demand, the disincentives fiscal and regulatory policy impose on ridding decisionmakers of that uncertainty, and the reluctance, given those disincentives, of those who have the power to create jobs for our people to invest in undertakings that would create them.

The remedy for what ails the economy is, in my view, in the hands of the fiscal and regulatory authorities, not the Fed. I could not state with conviction that purchasing another several hundred billion dollars of Treasuries—on top of the amount we were already committed to buy in order to compensate for the run-off in our $1.25 trillion portfolio of mortgage-backed securities—would lead to job creation and final-demand-spurring behavior. But I could envision such action would lead to a declining dollar, encourage further speculation, provoke commodity hoarding, accelerate the transfer of wealth from the deliberate saver and the unfortunate, and possibly place at risk the stature and independence of the Fed.

My perspective, as with those of all other members of the FOMC, was given a thoughtful and fair hearing at the table. After deliberation, the majority of the committee concluded that under current and foreseeable conditions, the better approach was to purchase $600 billion in Treasuries between now and the end of the second quarter of next year, on top of the amount projected to replace the paydown in mortgage backed-securities. The math of this new exercise is readily transparent: The Federal Reserve will buy $110 billion a month in Treasuries, an amount that, annualized, represents the projected deficit of the federal government for next year. For the next eight months, the nation’s central bank will be monetizing the federal debt.

As I said, a stunning admission.

One of the presidents of America's Federal Reserve Banks has just admitted that the United States Federal Reserve has set about to monetize next year's entire issuance of debt.

I will be stunned if the immediate response is not a gigantic spike in precious metals later today.

I have a feeling today is going to be one of those 'bookmark' days in history.

Do you smell that? Do you smell that?... QE2 son... Nothing else in the world smells like that. I love the smell of QE2 in the morning... The smell... you know, that gasoline smell... the whole economy. It smelled like... victory. Some day this recession is gonna end...