by Oakley » Tue 28 Jun 2011, 12:47:49
There is a big difference between buying federal debt with the proceeds of existing maturing debt and buying newly issued debt with newly issued money.
The current monetary system allows the creation of money out of thin air by banks to loan into existence, such as when the FED buys new federal government debt. But this has an inverse. When the federal government repays maturing debt, the money supply contracts, as the federal governments checking account balance goes down by the amount repaid the FED; repayment of debt to banks deflates the money supply. So if the money expands by the FED buying federal government debt and this debt is just to replace maturing debt, then there is zero effect on the money supply, and on the monetary base; the money supply goes up by the FED buying debt to replace the maturing debt and goes down by the repayment of the maturing debt. It is like breathing in and out.
Were the FED to not buy new debt to replace the maturing debt the effect would be highly deflationary. The current plan is neutral. The QE's were inflationary because new money and new debt were created.
All the while the federal government was going deeper and deeper into debt and the FED was buying his debt, the private economy was doing the opposite. Individuals and businesses were repaying debts to banks, which is deflationary. The battle between inflationary and deflationary forces it looks to me is being won by deflation. I know that prices of some commodities have increased, but there are other factors beside monetary inflation that have contributed to these price increase, and other sectors like real estate continue to experience price decreases.
I expect interest rates on the benchmark 10 year treasury to increase over the next two years, almost tripling. The effect of this interest rate increase, related to increased risk, will be highly deflationary. The interest rate on the 10 year treasury effect the value of all assets. For example, if farmland produces $10,000 in annual rent when the interest rate is 3%, the capitalized value of the land is no more than $333,333 ($10,000 / .03). If the interest rate increases to 9% then the capitalized value of farmland producing $10,000 in annual rent drops to $111,111 ($10,000 / .09). All assets are effected including non-income producing property like residential real estate. The assets of banks will be significantly effected because existing loans they have made will likewise fall in value.
"The deepest sin against the human mind is to believe things without evidence" Thomas H Huxley