Latest Federal Reserve Board Action Caps Runaway U.S. Treasury Debt Interest Payments

Although some pundits, financial observers, and various Federal Reserve Board analysts, etc. have questioned the Fed’s action in extending its long-standing Quantitative Easing, the results of these guessing games may have failed to determine the real objective. Opinions have ranged from the unlikely conclusion that the excess of monthly multi-billions will regenerate economic viability, accelerate hiring, and revitalize “small business” to forestalling a new, global-driven recession.

Others see a political twist in the timing of the purchase of worthless mortgage-backed securities festering un-priced in the vaults of most major banks, to accelerate financial institutions’ lending to potential home buyers and re-financing candidates.

There are even charges of potential “reflation,” in face of sagging prices, as consumer demand factors barely provide forward motion in America’s global-leading gross domestic product of $15.5 trillion.

However, the real answer may lie in the Feds’ plans to sell the short end of the yield curve, and use the funds to buy the long end up to 30 year bonds. This would, in effect, cushion the yield increase in U.S. treasury debt that is inevitable as inflation comes creeping back. But it also would keep the 10-year note— on which mortgages and most commercial loans are based— from surging if foreign investors stall. This will become critical in the economic recovery period ahead, as the interest on the nation’s $17 trillion Treasury debt continues to grow by leaps and bounds.

Since the bulk of our national debt is currently financed at the low 2% rate, this means that such payments could double in only a few years through a combination of principal growth, as well as ongoing debt-servicing. Such a circumstance would place these payments just behind entitlements, and on a par with Defense expenditures, even before any budget cutbacks in the military.

Be that as it may, the Federal Reserve Bank will likely be loaded up with mortgage-backed securities, which will relieve banks, and sticks the Fed with trillions of dollars worth of derivatives. This will have the effect of establishing a market value by virtue of buying them out of U.S. bank vaults and placing them on the U.S. Central Bank’s balance sheets.

In the long run, this will leave the Fed with trillions of dollars of obligations on their balance sheet, which will eventually drift back to financial institutions, as they are sold when coming back to maturity at an established price.

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