Bernanke The Bond Salesman

All jokes aside this is what's called Quantitative Easing (QE), one of several important policy tools the Fed can use after monetary policy has failed to stimulate aggregate demand which Bernanke outlined in his 2002 deflation speech, and one the Fed has actually already begun pursuing in terms of commercial paper and now agency paper. The goal here is to bring down longer term interest rates by purchasing credit instruments thereby stimulating the creation of additional credit and said demand, which means QE acts as a huge open market operation that injects money into the system. It's a policy that is bound to meet with limited success at this time (in terms of stimulating aggregate demand) because the U.S. consumer is absolutely up to there in debt already and with a weakening job market is in no mood to add to his burden.  Still, whatever benefit can be achieved here is worth the effort but it's just one approach among several which Bernanke outlined back in 2002.

Bringing down the cost of credit is obviously important for a government which intends to leverage up in order to spend who knows how many trillions on an economic stimulus over the next several years. All that money sitting on the sidelines needs to find a nice safe home and what could be safer than when the Federal Reserve is monetizing the debt of the U.S. government? We know that is one debt which is going to be paid.

To paraphrase an old saying when you're looking for money you go to where the money is and there's plenty of money sitting in the coffers of the U.A.E.'s Abu Dhabi Investment Authority ($875B), Saudi Arabia's SAMA Foreign Holdings ($433B), Singapore's Government of Singapore Investment Corporation ($330B), China's SAFE Investment Company ($311B) and Norway's Government Pension Fund ($301B). Nations like China are probably especially interested in purchasing U.S. debt at this time because although weakened, China still wants to grab as much business as it can from U.S. consumers and the best way to do that is to devalue the Yuan, which is exactly what's happening now (the Chinese stopped letting the Yuan appreciate in mid-July). Purchasing Treasuries is an important way China manipulates its currency downwards.

Of course, there's a drawback to this. With all of China's supposed "slowing" their reserves will still top $2T by the end of the year and the IMF is estimating the coffers will swell by another $700B to $900B in 2009. The facts are that the U.S. will desperately need the Yuan to appreciate at some point in the future in order to boost our exports to China but for now, thanks to the greed of our financial movers and shakers, the U.S. needs to borrow and we're stuck with the situation as it is. So we rather doubt that Mr. Paulson is on his way to China for a lecture on the virtues of Yuan appreciation. More than likely he's bringing a sample bag chock full of U.S. paper, his order book and a pen.

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