Is the Federal Reserve Destroying the Dollar?

from americanthinker.com
November 14, 2010

By Fred N. Sauer

 If you think our economy is in bad shape now, just wait. To be sure, economic prospects for jobs and growth already are bleak, and the Obama administration has increased the national debt in less than two years from over$10.632 trillion in January 2009 to $13.561 trillion in September 2010, resulting in a record 30% increase in public debt.

But fear not. Some of our brightest leaders have got the perfect solution to all these problems:

Charles Evans, president of the Federal Reserve Bank of Chicago, called for the Fed to do more to charge up the economy, including a new program of U.S. Treasury bond purchases and possibly a declaration that it wants inflation to rise for a time beyond its informal 2% target. ...

The Fed is now considering whether to add to its $2.3-trillion portfolio of securities and loans by ramping up purchases of U.S. Treasury bonds, in an effort to drive down long-term interest rates and boost growth. ...

The Fed also needs to push down "real" interest rates, nominal interest rates minus inflation, to induce households and businesses to part with savings and borrow and spend more, he said.

It is hard to accept that the head of the Chicago Federal Reserve Bank, or any other Federal Reserve Bank president, or Ben Bernanke, the head of the whole system, believes that by driving long-term interest rates lower than they already are (thirty-year U.S. Treasury Note near 4%), one can convince anyone, much less one half of Americans who did not go broke, to want to borrow enough money to accelerate this economy. It is a preposterous concept.

The most probable outcome will be to ignite inflation. The U.S. dollar is the top reserve currency in the world primarily because of its reliability for maintaining its value. When the Fed, the fiduciary custodian of the world's current top reserve currency, tells all the holders of the dollar that they are going to deliberately depreciate it at 2% to 4% a year, a whole lot of people are going to be listening very closely. It is a little like yelling "fire" in a movie theatre. You want to be first to get out of the door.

If you are holding a ten-year U.S. Treasury Note yielding 2% and the Fed assures you that inflation is going to increase by 2%, you have a potential problem. Any prospective buyer of your Treasury will want to make at least 4% to compensate him for the new inflation. Thus, he will not want to pay you as much for your ten-year U.S. Treasury Note as you paid for it. When you paid $1,000 for your ten-year U.S. Treasury Note, you got it with a 2% interest payment. Because your new buyer requires at least a 4% interest payment, he will pay you only $833 for your $1,000 bond. You will lose $167, or 16.7% on the transaction. If inflation increases by 4%, your bond will be worth only $696, and your loss will be $304, or 30.4%. 


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