The Federal Reserve And You
In The Year 2011 The Federal Reserve (And Not Investors) Purchased 61% Of All Newly Issued US Federal Government Debt
The Federal Reserve is propping up the entire U.S. economy by buying 61 percent of the government debt issued by the Treasury Department, a trend that cannot last, Lawrence Goodman, a former Treasury official and current president of the Center for Financial Stability, writes in a Wall Street Journal opinion article published Wednesday.
"Last year the Fed purchased a stunning 61 percent of the total net Treasury issuance, up from negligible amounts prior to the 2008 financial crisis," Goodman writes.
Goodman also warns that U.S. economy and markets are “at risk for a sharp correction” if conditions aren’t “normalized.”
"This not only creates the false appearance of limitless demand for U.S. debt but also blunts any sense of urgency to reduce supersized budget deficits."
Read more: WSJ: Fed Buying 61 Percent of US Debt
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(A rebuttal of the above claims)
So why did the Federal Reserve end up with 61% of all the 2011 issuance of government debt? It is the effect of the much-talked-about “quantitative easing” program the central bank began in the wake of the financial crisis to suppress interest rates. By purchasing these bonds, the Fed drives up the price of government debt and drives down the interest rate the government pays on that debt. The purpose of this is not to “subsidize U.S. government spending” as Goodman suggests, but to drive down rates for the rest us and stimulate the economy.
Setting interest rates is a primary function of a central bank. And these bond purchases are merely an extension of that responsibility.
Does this artificially drive down the interest rates that the U.S. pays on its debt and therefore understate true budget deficits? Yes. But this is a collateral effect of the policy, and not its intended purpose.
Does it mean there isn’t demand for U.S. debt? Absolutely not. According to Lewis Alexander, Chief Economist at Nomura Securities, demand for Treasuries has been strong throughout the crisis and remains so today. “It’s hard to look at how the Treasury market has reacted really since 2008 without being impressed by the consistent demand for U.S. securities,” he says. Yes, the Federal Reserve is successfully keeping rates lower, but absent those actions, Alexander believes that interest rates on government debt would be somewhere between 0.5% to 1.0% higher than they are now. That’s a significant difference, but not one that indicates the global market is suspicious of America’s willingness or ability to pay its debts.
Read more: http://business.time.com/2012/04/05/does-the-world-believe-america-will-pay-its-debts/#ixzz1zT9jYQ4T |
An Investor's View Of US Debt
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USA Debt Is The Most Sound Place To Park Bond Investments Because So Many Other Places Are Even More Risky
Just as the USA grew into an industrial powerhouse as Europe & Japan was in ruins, the present influx of investor funding into US Treasuries is due to the fact that the alternatives prove to be even more risky.
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The United States Federal Reserve's recent announcement that it will extend Operation Twist by buying an extra $267bn (£171bn) of long-term Treasury bonds over the next six months – to reach a total of $667bn this year – had virtually no impact on either interest rates or equity prices. The market's lack of response was an important indicator that monetary easing is no longer a useful tool for increasing economic activity.
The Fed has repeatedly said that it will do whatever it can to stimulate growth. This led to a plan to keep short-term interest rates near zero until late 2014, as well as to massive quantitative easing, followed by Operation Twist, in which the Fed substitutes short-term Treasuries for long-term bonds.
These policies did succeed in lowering long-term interest rates. The yield on 10-year Treasuries is now 1.6%, down from 3.4% at the start of 2011. Although it is difficult to know how much of this decline reflected higher demand for Treasury bonds from risk-averse global investors, the Fed's policies undoubtedly deserve some of the credit. The lower long-term interest rates contributed to the small 4% rise in the S&P 500 share-price index over the same period.
The Fed is unlikely to be able to reduce long-term rates any further. Their level is now so low that many investors rightly fear that we are looking at a bubble in bond and stock prices. The result could be a substantial market-driven rise in long-term rates that the Fed would be unable to prevent. A shift in foreign investors' portfolio preferences away from long-term bonds could easily trigger such a runup in rates.
Moreover, while the Fed's actions have helped the owners of bonds and stocks, it is not clear that they have stimulated real economic activity. The US economy is still limping along with very slow growth and a high rate of unemployment. Although the economy has been expanding for three years, the level of GDP is still only 1% higher than it was nearly five years ago, when the recession began. The GDP growth rate was only 1.7% in 2011, and it is not significantly higher now. Indeed, recent data show falling real personal incomes, declining employment gains, and lower retail sales.
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This author argues that the presence of Treasury bond investors is evidence of "US Economic Growth". This is not true. This details the relative security of the US debt as compared with other alternatives. The USA is spending more than it takes in. This is triggering the issuance of more debt. This debt presently is offered at favorable rates to investors but the debt service (interest payments) continue to grow as a line item in the federal budget. The more this balance grows, the reduced amount of federal money is avaiable for other purposes. As 10 and 30 year bonds come due they need to be financed at rates that are attractive at the time. In other words the good rate of today's new debt may not be so good 10 years from now if there is a loss in investor confidence, the USA can 't pay off the debt represented by the bond and they are forced to offer an even higher interest rate to compel the investors to bite. |
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