"We're not going to monetize the debt. It is very, very important for Congress and administration to come to some kind of program, some kind of plan that will credibly show how the United States government is going to bring itself back to a sustainable position."
His concern, according to The Washington Times, was that " the impasse in Congress over tough spending cuts and tax increases needed to bring down deficits will eventually force the Fed to accommodate deficits by printing money and buying Treasury bonds."
That impasse crystallized on November 3, 2010, when Republicans swept the House. There would be no raising of taxes on the rich, and the gridlock in Congress meant there would be no budget cuts either. Compounding the problem was that over the last six months, China has stopped buying U.S. debt, reducing inflows by about $50 billion per month.
QE2 Is Not QE1
In QE1, the Fed bought $1.2 trillion in toxic mortgage-backed securities off the books of the banks. QE1 mirrored TARP, the government's Troubled Asset Relief Program, except that TARP was funded by the government with $700 billion in taxpayer money. QE1 was funded by the Federal Reserve with computer keystrokes , simply by crediting the banks' reserve accounts at the Fed.
Pundits were predicting that QE2 would be more of the same, but it turned out to be something quite different. Immediately after the election, Bernanke announced that the Fed would be using its power to purchase assets to buy federal securities on the secondary market -- from banks, bond investors and hedge funds. (In the EU, the European Central Bank began a similar policy when it bought Greek bonds on the secondary market.) The bond dealers would then be likely to use the money to buy more Treasuries, increasing overall Treasury sales.
The bankers who applauded QE1 were generally critical of QE2, probably because they would get nothing out of it. They would have to give up their interest-bearing bonds for additional cash reserves, something they already have more of than they can use. Unlike QE1, QE2 was designed, not to help the banks, but to relieve the pressure on the federal budget.
Bernanke said the Fed would buy $600 billion in long-term government bonds at the rate of $75 billion per month, filling the hole left by China. A n estimated $275 billion would also be rolled over into Treasuries from the mortgage-backed securities the Fed bought during QE1, which are now reaching maturity. More QE was possible, he said, if unemployment stayed high and inflation stayed low (measured by the core Consumer Price Index).
Addison Wiggin noted in his November 4 Five Minute Forecast that this essentially meant the Fed planned to monetize the whole deficit for the next eight months. He quoted Agora Financial's Bill Bonner:
"If this were Greece or Ireland, the government would be forced to cut back. With quantitative easing ready, there is no need to face the music."
That was meant as a criticism, but you could also see it as a very good deal. Why pay interest to foreign central banks when you can get the money nearly interest-free from your own central bank? In eight months, the Fed will own more Treasuries than China and Japan combined , making it the largest holder of government securities outside the government itself.
The Overrated Hazard of Inflation
The objection of the deficit hawks, of course, is that this will be massively inflationary, diluting the value of the dollar; but a close look at the data indicates that these fears are unfounded.
A dding money to the money supply is obviously not hazardous when the money supply is shrinking, and it is shrinking now. Financial commentator Charles Hugh Smith estimates that the economy faces $15 trillion in writedowns in collateral and credit, based on projections from the latest Fed Flow of Funds. The Fed's $2 trillion in new credit/liquidity is therefore insufficient to trigger either inflation or another speculative bubble.
In any case, Chairman Bernanke maintains that QE involves no printing of new money. It is just an asset swap on the balance sheets of the bondholders. The bondholders are no richer than before and have no more money to spend than before.
Professor Warren Mosler explains that the bondholders hold the bonds in accounts at the Fed. He says, "U.S. Treasury securities are accounted much like savings accounts at a normal commercial bank." They pay interest and are considered part of the federal debt. When the debt is "paid" by repurchasing the bonds, all that happens is that the sums are moved from the bondholder's savings account into its checking account at the Fed, where the entries are no longer considered part of the national debt. The chief difference is that one account bears interest and the other doesn't.
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