Fed drops the pretense, buys bonds

The Federal Reserve continues its wildly aggressive monetary policy ways and the Fed is "far more rabid now" that it was when the financial system threatened to seize up back in 2008. Now, not only is the Fed replacing Operation Twist with $45 billion of outright bond purchases, it plans to do so until the unemployment rate hits 6.5%.

By Bill Fleckenstein
Mon 11:25 AM
MSN Money

Our redoubtable Federal Reserve was front and center last week as it continued its wildly aggressive monetary policy ways. It is ironic that the Fed is far more rabid now when it comes to conjuring dollars out of thin air than it was when the financial system threatened to seize up in late 2008, but that is what central planning committees do. They eventually overreact when they don't get the response they want.

That is not to say that the Fed won't get even more forceful, but it is following a time-honored, though inadvertent, tradition. The net of Wednesday's statement is that, not only is the Fed replacing its Operation Twist stimulus program (search on Bing for details) with $45 billion of outright bond purchases, it plans to do so until the unemployment rate hits 6.5%.

Fed fire sale still TBD

That is a wild concept by itself, but when you consider what a lagging indicator job growth is, one can only imagine how much excess paper money will have been printed before we get to the targeted level (assuming we do). I would guess if we do get close to that number, it will take several months -- not just one -- of low levels to be deemed "enough."

The amount of confetti that the Fed is printing is staggering, but that is only part of the mosaic, because the Swiss National Bank, the European Central Bank (after a fashion), the Bank of England and the Bank of Japan are printing massive amounts of money as well.

And after this weekend's election in Japan, the Bank of Japan is liable to print even more yen. I suspect that at some point it will take a page out of the Fed's playbook and target inflation, unemployment or some variation on that theme.

I also noticed that the Fed sneaked into its communiqué the "fact" that inflation is below the Fed's 2% "objective." I did not know that 2% was the Fed's magic number, so perhaps I missed that, but it is yet another wrinkle that shows how warped the world is. The prices of so many goods and services are rising, yet the Fed is not happy because, in general, they aren't rising fast enough.

Just imagine what will happen the Fed finally gets the citizens of the United States (and the rest of the world) to expect regularly rising prices. It will be impossible to put that genie back in the bottle. The Fed has been playing with gasoline in front of a blazing fire for a very long time, and it is impossible to know when the two will meet, but when they do, it is going to be an enormous mess.

Our bonds will be as good as their word

I am of course getting ahead of myself, as I am prone to do sometimes, so I might as well conclude by saying that at some point, after expectations for inflation finally are aligned with what the Fed wants (and then some), the bond market is going to be a train wreck.

I have noted recently that we now appear to be in an interlude between the deflation scare trade and worries about inflation, and I continue to believe that. But when inflation fears get the upper hand, it won't matter how many Treasury bonds the Fed buys, because those will be seen as the problem, not the solution. Then, all hell will break loose and we will head to the funding crisis, with the government unable to find buyers for its debt.

When that occurs -- and how quickly -- I cannot say. I know only that it lies in our future. But for now, money printing is perceived to be the answer to all our troubles, as opposed to the root of all evil.

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