Is the Federal Reserve Really Purchasing Over 60% of 2011’s Fiscal Deficit? In a Word, uh . . . Yeah.


The other day, in my post “The Lull Before the Storm”, I mentioned that for fiscal year 2011, the Federal Reserve would be purchasing over 60% of the Federal government deficit.

In other words, the Fed would be dancing the Monetization Waltz, just like Latin American countries used to back in the 1970’s: Proof positive that America is indeed a banana republic—only with nukes.

A lot of people didn’t believe me—or wanted me to check my figures. Or wanted to know if I was having an acid flashback from those aformentioned 1970’s. A lot of people couldn’t believe it.

Mark Twain said it best: There are lies, damned lies, and statistics. If you want to deceive your audience, you source your numbers from some shifty salesman with an ideological ax to grind, gussy it up with percentage signs and charts and graphs, and thereby “prove” any damned foolishness you like.

But deceit in this context serves no purpose: It’s in all of our best interests to know exactly what is going on, in fiscal year 2011. 

So in this brief post (yes I know—shocker), I’m gonna check the figures for my observation—but I’m gonna get ‘em right from the horse’s mouth: From the White House, and from the Federal Reserve. 
To begin—
White House FY 2011 Budget Deficit Projection
The 2011 fiscal year runs from October 1, 2010, to September 30, 2011. According to the White House’s budget, the budget defict for that period will be $1.267 trillion. Source is here, on the second page of the document (which is marked as page 146).

This does not include the extension of the Bush tax cuts.

Federal Reserve Treasury Bond Purchases via QE-lite and QE-2

According to the Federal Reserve in its August 10, 2010, announcement, the excedent from the mortgage backed securities and other assets that the Fed purchased as part of QE-1 back in 2008–‘09, started to be reinvested in Treasury bonds starting in August of 2010. This is what is known as QE-liteSource is here.

The Fed is notoriously shifty as to the exact composition of its balance sheet. Credible source estimate that QE-lite will be between $200 and $300 billion in the year starting in August 2010. Sources for this estimate are here, here and here. No one seriously doubts this range of figures.

QE-lite purchases would have totalled between $16.7 billion and $25 billion per month. Excluding the months of August and September 2010 (which are not part of FY 2011), total QE-lite from October 1, 2010, to August 30, 2011, when the policy by the Fed’s own announcement is supposed to end, will have been between $167 and $275 billion.

Please keep in mind what QE-lite is and is not: QE-lite is reinvestment of excedent—it is not money printing. But this money that can be reinvested originated in QE-1, since this was how the MBS were purchased by the Fed in the first place—and QE-1 was money printing.

So some people might reasonably argue that QE-lite in fact is monetization, while others could reasonably argue that it is not monetization.

All can agree, however, that QE-lite will help the Treasury Department finance the U.S. Federal government deficit, because that’s what the Federal Reserve is going to do with QE-lite—buy up Treasury bonds.

For this discussion, that’s all that matters.

Now with regards QE-2: According to the Federal Reserve’s own statement of November 2010, Quantitative Easing-2 will be $600 billion over eight months, starting in November 2010 and ending in June 2011—firmly in FY 2011. And unlike with QE-lite, the Fed outright said exactly how much it would purchase for QE-2—$600 billion over eight months. Source is here.

The language of the statement left the door open for further Treasury bond purchases by the Fed beyond its self-imposed $600 billion limit. But for the purposes of this discussion, let’s ignore that possibility, and simply take the Fed’s statement at face value: $600 billion, and no more.

Now, QE-2 is monetization—indisputably: It is the creation of fiat money out of thin air, in order to finance the government’s expenditures. It is the very definition of monetization.

Application of Basic Math
Taking the last first, QE-2 represents a direct monetization of just shy of half of the Federal government’s deficit for 2011. The math is: $600 billion divided by $1.267 trillion equals 0.4736.

In other words, 47.36% of the Federal government’s deficit for fiscal year 2011 will be financed through the creation of money by the Federal Reserve.

As to QE-lite, if you take the conservative figure of $200 billion for the total August 2010 to August 2011 period, and exclude the first two months (since they’re not part of the fiscal year 2011), you get $167 billion of total Treasury bond purchases by the Federal Reserve during fiscal year 2011, as part of QE-lite.

Again, basic math applied on the $1.267 trillion deficit gives us a percentage of 13.15%. If we use the $300 billion figure for QE-lite, exclude the months of August and September 2010 as before, and divide it by the $1.267 trillion deficit, we arrive at 19.73%.

So conservatively speaking, the Federal Reserve will directly finance no less than 60.51% of the U.S. Federal government’s deficit for fiscal year 2011. That figure might be as high as 67.09%, depending on the size of QE-lite.

These are the official numbers—as promised, none of these are dodgy numbers from the disreputable sources ax-grinders like to use. These numbers are straight from the horse’s mouth: The White House, and the Federal Reserve.

Verbose Conclusion
With a single market participant buying up at minimum 60% of new issuance, the conclusion is obvious: The Treasury bond market is Bernanke’s bitch. His pimp hand is all over that ho’—and she be doin’ whatever Benny the Pimp wants her to do, as often as he wants her to do it.

Therefore, since Treasury bond yields during FY 2011 will be whatever the Fed wants them to be, they are no longer a reliable indicator of anything.

Quite the contrary, the bond markets will mask problems of the underlying economy until they are insurmountable.

This shouldn’t be a controversial observation: A single market participant that is purchasing 60% or more of a market owns that market. So anything that that market ordinarily signaled—be it risk, instability, whatever—is now no longer the case. The only thing that market will reflect is whatever fixed idea the Market Pimp will want it to reflect.

Therefore, since any problem that the Treasury bond market might ordinarily reflect will be masked until the very last minute, watching that market for signs of the health of the wider economy will only distract from what is actually happening in the wider economy.

Succinct Conclusion

The Treasury bond market is like a concrete highway over a sinkhole: You won’t realize anything is amiss, until the road suddenly disappears.

Like this—