China  has been the biggest buyer of U.S. Treasury securities due to their large trade surplus with the United States.  Now, Chinese officials have made it clear that they will not be buying as many U.S. Treasury bonds, agency bonds, and government securities of other nations, due to the fact that their trade surplus with the rest of the world is falling and their huge foreign exchange reserves have stopped growing rapidly.

Further, the Chinese have been spending more of their money purchasing raw materials as they continue to buy up base metals, oil, and other reserves to stoke their economic machine.  Chinese officials have made statements recently that their purchases of bonds will fall as their trade surplus falls.

This is the primary reason that the U.S. yesterday announced the purchase of $300 billion of U.S. Treasury bonds by the Federal Reserve over the next six months.  This is Quantitative Easing, or to put it more plainly, printing money.  The long term effect is highly inflationary.

We predict that this is only the first of many quantitative easing activities, and the U.S. will have to print more money to buy much of the $2 trillion in new bonds that are going to be issued in the coming year.  This will have large effects, including:

1. A decline in the value of the U.S. dollar.  (The decline began yesterday as soon as the announcement was made.)
2. Substantial inflationary pressures.
3. Long-term upward pressure on the prices of fixed assets, gold, commodities, real estate that produces steady income, stocks that can grow.
4. Serious negative effects on the economic future of coming generations of Americans (personally, I blame the U.S. political class for their unmitigated shortsightedness.)

The Financial Times
Federal Reserve plan stuns investors
By Krishna Guha in Washington
Published: March 18 2009

The Federal Reserve on Wednesday stunned investors by announcing plans to buy $300bn of US government debt, triggering a plunge in bond yields and the dollar.

In a further display of aggression, the US central bank also said it was more than doubling its purchases of securities issued by housing giants Fannie Mae and Freddie Mac to $1,450bn. It said it now expected to keep interest rates near zero for an “extended period” of time.

The yield on 10-year US Treasuries plummeted 50 basis points to 2.50 per cent, while private borrowing rates fell by roughly half as much. Equities bounced with big gains in troubled banks such as Citigroup and Bank of America. But the dollar fell 3.2 per cent against the Euro and 2.3 per cent against the yen.

Goldman Sachs said the Fed was throwing the “kitchen sink” at the problem. The plan to buy Treasuries caught investors off guard. “It appears that they wanted to give the market a jolt,” said Peter Hooper, an economist at Deutsche Bank.

The last time the central bank attempted to bring down yields on long-term securities through direct intervention came during the ill-fated Operation Twist in the 1960s. Recent comments by Ben Bernanke, Federal Reserve chairman, and William Dudley, New York Fed president, did not suggest that Treasury purchases were imminent.

But the deterioration in the US outlook, problems rolling out the US financial rescue plan and the Bank of England’s success in buying UK government gilts seem to have persuaded the Fed to act.

Alan Ruskin, a strategist at RBS, said it was a “flip-flop” that “could be cast as a sign of desperation” but “confirmed that Bernanke will do whatever it takes to get some hold of the problem”.

The Fed said it would concentrate on Treasuries with maturities of two to 10 years. It said its objective was to “improve conditions in private credit markets” – not to help the government finance its mounting deficits. The Bank of Japan said it was stepping up its purchases of Japanese government debt by about a third to Y1,800bn a month.

Wednesday’s Fed announcement will increase the size of its balance sheet by another $1,150bn to about $3,000bn even before the roll-out of a $1,000bn scheme to finance credit markets. Once this scheme is fully implemented, its balance sheet could approach $4,000bn – nearly a third the size of the US economy.

A swollen Fed balance sheet runs the risk that the US central bank may find it difficult to manage down the money supply when the economy turns, raising the possibility of inflation.

Gold surged in response to the Fed’s announcement, rocketing from a session low of $884.10 a troy ounce to a high of $942.90, a jump of 6.6 per cent.


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