The Shell Game - How the Federal Reserve is Monetizing Debt

Lori Smith has emailed a research report by Chris Martenson that details some of the methods being used by the Fed to keep the Treasury market auctions looking strong.

Here's Martenson's Executive Summary (My comments in italics):

•The Federal Reserve and the federal government are attempting to "plug the gap" caused by a slowdown of private credit/debt creation.

Rather than calling this plugging the gap. I would say the Treasury by its borrowings are crowding out the private sector. Further, any Fed purchases of gvt debt are distorting away from (and robbing) the private sector.

•Non-US demand for the dollar must remain high, or the dollar will fall.

Can't argue here. This is pretty close to a tautology.

•Demand for US assets is in negative territory for 2009.

True.

•The TIC report and Federal Reserve Custody Account are reviewed and compared.

This is an important comparison by Martenson. Growth in TIC (for 12 months ending May '09) shows plus $50 billion, BUT the Fed custody account (where the securities are held) shows growth of $277 billion. Why the difference? His conclusion: interest on securities held by foreign central banks must have been $135 billion.

•The Federal Reserve has effectively been monetizing US government debt by cleverly enabling foreign central banks to swap their Agency debt for Treasury debt.

Here he shows that the Fed is buying up gvt agency paper being sold by foreign countries, where the foreign countries then move into Treasury securities.

•The shell game that the Fed is currently playing obscures the fact that money is being printed out of thin air and used to buy US government debt.

By buying agency securities the Fed can report less Treasury securities that it is printing up new money for. But in actuality the agency paper it is buying is also being monetized with the money in the hands of foreign countries, who then by the Treasury securities.

An even more significant point is that rather than buying huge new net amounts of U.S. gvt securities, Martenson's report shows that foreign countries have been simply doing swaps (from agency to Treasury paper). Bottom line: Treasury security buying from non-Federal Reserve sources is much weaker than it appears, because of this shell game. Once the foreign countries run out of paper to swap, the amount of paper the Fed is actually buying will become more obvious.

The full Martenson Report is here.