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MONEY & INVESTING

Federal Reserve’s money printing inspires reader comments
jeannetteSHOWALTER, CFA

Readers often call or send e-mail after reading my column; but never quite as much volume as was received after “Does the Federal Reserve print money?” column from the first week of October. Many of the questions were similar in nature, so each question is not marked with a particular person’s initials. Here are my answers.

Q: You wrote that the Federal Reserve (“Fed”) is printing money and yet Fed Chairman Bernanke insists that he is not monetizing the U.S. debt. How can you be right?

A: Yes, Fed Chairman Bernanke has stated that he is not monetizing the U.S. federal debt.

To be clear, monetizing debt means printing fiat money to pay interest and principal on federal debt. As the U.S. dollar is fiat (not having a hard currency backing it) and since the Fed is buying the debt of the U.S. government, the question is relevant.

Bernanke’s position is as follows: he is printing money electronically to pay for purchases of U.S. debt and mortgages and other assets until lower rates and Fed credit creation are no longer needed. As it is temporary, since he intends to stop doing so at some point in time, as this is nnt not to be a permanent practice, he does not acknowledge it as monetizing. (See transcript

Ei of Bernanke’s Oct. 1 speech to Economic Club of Indiana at www.creditwritedowns.com)

My answer is that the Fed can, and iis, printing money to buy all sorts of financial assets including $40 billion of mortgages bought monthly under QE3. The Fed is also printing money to buy the federal debt. Though he does not pronounce the printing as permanent (and who would ever expect him to make such an admission), the U.S. federal deficit is seemingly permanent and growing in size. So there is really no reason to believe that the Fed will stop showing up for Treasury auctions. So, to me, there is no reason to parse words. It sounds akin to someone claiming that he is not a drug addict because he is using drugs for four years but maintains that his usage will not be permanent.

Q: When the Fed buys mortgages to lower interest rates is it monetizing the U.S. Debt?

A: No, the Fed is not monetizing the U.S. debt when it buys other forms of debt. To the extent that the Fed is not paying cash for those mortgages and is crediting the reserve accounts of the banks from which the mortgages were bought, the Fed is again creating a liability which can be easily turned into paper currency. Electronic printing is tantamount to paper printing. Q: Why do you call electronic printing the same as paper money printing?

A: At any time, the commercial banks can request that the electronic money owed to them (booked on the Fed balance sheet as a liability owed to the banks and called “Bank Reserves”) be converted into paper money. The commercial banks request paper dollars and the Fed gets dollars printed. They then owe the dollars to the U.S. Treasury.

Q: Isn’t this inflationary?

A: Yes, no, maybe. Yes, printing money and monetizing debt is ultimately inflationary. But, it is not currently inflationary as the Fed is fighting deflation. In terms of MV = PQ, Money supply is increasing but Velocity (speed with which money is spent) has been decreasing so Price has not risen. The Fed would answer that when the economy starts to improve, it will sell its financial asset holdings and the Bank reserve liabilities will be decreased… thus capping runaway lending that banks are known to do in inflationary times. So maybe the Fed can reverse inflation caused by printed money.

Q: Does gold solve the problem?

A: Holding gold is one solution to very uncertain times and where fiat currencies are being trashed. But a return to a gold standard? I believe the answer is no… for an economy to grow it needs to expand money supply and that would entail additional gold purchases. The problem is not that we lack a hard currency but that we lack responsible governments. As long as governments issue debt (outside of war financing), the country will have problems. Our currency has declined for many reasons. The primary reason is that our government keeps issuing debt to finance out of control entitlement and social programs and pay for gross inefficiencies throughout the bureaucracy.

Q: Who is to blame?

A: The Fed is not knocking at Congress’ door and asking for more deficit spending so the Fed can be the buyer of such debts. Bernanke goes before Congress asking for a solution to runaway deficits. Yet, he continues to buy Treasury debt and finance the deficit. Citizens are to blame, as some don’t vote and some others vote their own wallets. Presidents, senators and congressmen and women collectively, need to create a bipartisan solution to end deficits. When people vote for their piece of the pie, they are ignoring the fact that deficits will continue to make the pie smaller… and, soon, there will be no pie left for our children. ¦

— There is a substantial risk of loss in trading futures and options on futures contracts. Past performance is not indicative of future results. This article is provided for informational purposes only. No statement in this article should be construed as a recommendation to buy/ sell a futures/ options contract or to provide investment advice.

— Jeannette Showalter, CFA is a commodities broker with Worldwide Futures Systems, 239- 571- 8896, showalter@wwfsystems.com.


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