The monetization of U.S. government debt, we’re watching and it’s bigger than you think

Didn’t Chairman Bernanke say, “The Federal Reserve will not monetize the debt.”

Yes he did, as clear as day to the House Budget Committee back on June 3, 2009. And yet 17 months later Bernanke gave us QE II, which not only means the Federal Reserve will be purchasing about $75 billion a month in assets for the next 8 months, but as it so happens, some $110 billion in Treasury Notes and Bonds too. That’s enough to finance the U.S. government’s projected fiscal deficit right up through June 2011, in full.

target="_blank">Grants Interest Rate Observer, has a way with words, so we will let him explain the how and the why…

…Consuming much more than it produces, this country (America) discharges its debts in dollars. Having no use for dollars, their recipients, America’s Asian creditors, sell them for local currency, which their local central banks duly print. The dollars, meanwhile, go winging their way back to America in exchange for Treasurys and agency securities. So far, so sweet: Everybody seems to win. Asian asset markets levitate, and Treasury yields collapse. But the sheer volume of dollars emitted, Treasurys purchased and Asian currencies printed should make even the most sanguine bond bull stop and stare.

Grants Interest Rate Observer, September 3, 2010. Vol. 28, No.17

As Grant opines, the benefit the Federal Reserve receives from the monetization activities of these foreign central banks appears to be a clear win for the Federal Reserve, the U.S. Dollar and the U.S. government bond market, for as long as these banks and their respective governments find it worth their while. The problem is the other side of this debt monetization partnership is a whole lot of monetary inflation, both in America and abroad, a situation which clearly can not last forever (that though is a subject for another day).

U.S. Government Debt Monetization, the Numbers

Let’s bring these concepts to life with some numbers…

Have a look at the monetization activities of the Federal Reserve and foreign central banks using the latest available statistics plucked from the Federal Reserve’s Balance Sheet and Flow of Funds Accounts:

The Federal Reserve not intervening, or actively trying to… make it easier for the government to issue debt? Seems the facts are saying something different. As of 2nd quarter June 2010, the Federal Reserve held 25.7% of the U.S. government’s public held debt outstanding, up from 15.1% 4th quarter 2000. And as for foreign central banks, they just love U.S. government debt, holding 37.1% of outstandings, up from 19.1% 4th quarter 2000. All told, as of 2nd quarter 2010, the monetization efforts of the Federal Reserve and foreign central banks stood at a combined 62.8% of public held debt outstanding, 1.8 times 4th quarter 2000. Not a bad deal if you’re the U.S. government with a want to run trillion dollar deficits. Nothing like being able to pay your bills via the printing press, right?

Zeroing in on the important role played by foreign central banks, take a look at running 12 month monetization flows, Federal Reserve vs. foreign central banks:

Clearly, foreign central banks have been the Federal Reserve’s best friend these past 10 years (actually the last 30 years). Not only have they been taking on a steadily increasing share of the U.S. government’s debt, but they have often been found filling the funding gaps left by the Federal Reserve. Indeed, witness the funding provided by foreign central banks during the housing bust turn credit crisis turn Great Recession, when the Federal Reserve liquidated a large part of its Treasury holdings to help finance its plethora of credit crisis loan programs. While it’s likely the Federal Reserve provided a portion of the monies that helped its central bank friends fill that particular gap (one can not help but wonder what deals were being struck at that time), fill that gap they did. In the final analysis, and for whatever reasons, foreign central banks have been monetizing a lot of U.S. government debt, for years, monetization responsibilities that would have been left largely to the Federal Reserve.

U.S. Government Debt Monetization, the Series

With these preliminaries dispensed, enter our new series – http://blogs.forbes.com/michaelpollaro/us-government-debt-monetization/" target="_blank">U.S. Government Debt Monetization, a concise monthly accounting of the debt monetization activities of the Federal Reserve and foreign central banks – latest available statistics plus detailed historical tables and charts.

To wet your appetite, here’s a sampling of what will be a monthly feature of the series, a recap of the monetization activities of the Federal Reserve and foreign central banks in total, by bank and by asset class:

U.S. Government Debt Monetization, October 2010