Thursday, October 9, 2008

The Debts of the Spenders: The Governments' Role in Money Creation

In the last post, I wrote about the private sector's role in money creation. Now, I will focus this post on the governments' role.

First, a quick review. The cost of credit is determined by factors such as trust and solvency. Trust and solvency lie at the heart of the TED spread, which is the gap between 3 month Treasuries and 3 Month Eurodollars. I already addressed the 3 month Eurodollar so now I turn our attention on 3 month Treasuries.

Treasury rates are set by regularly scheduled government auctions in the CBOT or Chicago Board of Trade. These are reverse auctions where traders compete against each other by offering HIGHER interest rate bids. Traditionally, the 3 Month treasury rates were at or near the fed funds rate.

The yield on the 3-month Treasury bill, seen by many as the safest place to put money in the short term, slipped to 0.63% from 0.69% late Tuesday, indicating investors are willing to take a very small return on their money. In the past 2 weeks, the 3-month bill skidded to a 68-year low around 0% as panicked investors fled stocks.

However, all that has changed.

The factor in TED now is T bills being very near 0.

Now, in the United States the Fed says it will buy commercial paper; that is, it will buy up loans made to U.S. companies...or even loan the money directly to troubled firms. And not just financial firms. Any companies can apply -industrials, tech, retailers, etc. - just as long as they meet the criteria of "too big to fail". Whatever that means.

In the EU, government ministers have pledged to lend UNLIMITED amounts of money to banks after yesterday's coordinated rate cut failed to have any meaningful effects. Really, they should not be using words like "lend". Those are taxpayer donations to help ailing banks that will in all likelihood disappear down the drain.

In the UK, the government has had a long history of socialist intervention. British taxpayers barely protested when the authorities nationalized Northern Rock and HBOS. Now, they are being forced to subsidize the losses of Icelandic bank depositors after the entire country failed.

And the natural result of all these government interventions? Massive inflation.


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