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Thursday, September 23, 2010

Stealth Monetization

Zerohedge recently had a post called "Stealth Monitization" that explains how the Fed and the To Big To Fail ( or TBTF) Banks are monetizing debt, debasing the currency and propping up the Bond Market.  Lets run through this briefly using quotes from the article as Tyler Durden does this very well.
See, the TBTF banks get money for free from the Fed, and then they turn around and lend it to the Federal government by way of buying Treasury bonds. Treasury bonds are paying absurdly low yields, because they’ve been bid up so high by all those freshly minted dollars that the Fed printed up. But to the TBTF banks, it doesn’t matter how low the Treasury yields are—it’s still guaranteed profits. Lending money to the Federal government is totally safe.
Circle of Life

This is because the Fed lends the money it prints at 0.25% to the TBTF banks.  These Banks then can buy Treasury Bonds at a higher interest rate from the Treasury.  Banks get to keep the difference.
Over the past few months, we have seen two things occurring simultaneously: Treasury bond prices are rising (and therefore their yields are declining), and the dollar has been falling against all commodities and all other major currencies.  This is a contradiction. This cannot be happening simultaneously for any sustained length of time—unless there is some exterior factor making this contradictory situation happen. 
Treasury Bond Yields
Bond Money Flows

 For proof on the statement that the dollar has been falling against commodities and other major currencies see post titled "Gold Surges and Dollar Dives" to see charts.
It is a contradiction because, if over a sustained period of time the dollar is losing value against commodities and other major currencies, then it would not make sense for investors to be putting more money into Treasuries and bidding up their prices. Not when their yields are at such absurdly low levels.
 In the beginning of the article by Tyler Durdan, he makes a statement that fiat currencies have been stable for 40 years and works like a charm.  I think he is alluding to when a central bank and the Fed do not get together as he makes this statement toward the end.
Stealth monetization: That’s what’s bidding up Treasuries, even as the markets are losing faith in the dollar.
Faith in the dollar is all that really gives it its value and the fact (pointed out by Chris Martenson of the Crash Course) that the IRS only takes payment in dollars, which also gives it its value.  Faith though not only involves Americans to have faith in it (great sign me up), but Foreign countries as well (bummer).  I have really summarized his article for clarity, if you want a more in-depth read, please click here.

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