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California State University East Bay

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California State University East Bay

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Federal Reserve to Buy More Treasury Bonds

The issue of debt is closely associated with college students and homeowners.

However, some of the most powerful nations in the world are also grappling with debt.

Last month, the United States Federal Reserve announced that it will buy $600 billion worth of U.S. Treasury notes and bonds by the end of June.

In a strategy known as “buying back debt,” the Federal Reserve will now dip into its excess reserves in order to create inflation in an attempt to drive down bank interest rates and hopefully decrease unemployment.

On Nov. 19, Federal Reserve Chairman Ben Bernanke defended the decision at a central banking conference in Frankfurt, Germany, stating, “A fiscal program that combines near-term measures to enhance growth with strong confidence-inducing steps to reduce longer-term structural deficits would be an important complement to the policies of the Federal Reserve.”

Bernanke believes that “near-term measures” such as stimulus programs and debt buying are necessary steps in getting the economy back on track.

Addressing international backlash, Bernanke said those who support “insufficiently supportive policies” will “undermine the recovery not only in those economies, but for the world as a whole.”

At a recent speech at the Kansas City Federal Reserve Symposium in Jackson Hole, Wyoming, Bernanke explained the rationale behind buying Treasury bonds, “reinvestment in Treasury securities might be more effective in reducing longer-term interest rates and improving financial conditions with less chance of adverse effects on market functioning.”

Critics of this strategy include German Chancellor Angela Merkel and former Vice Presidential candidate Sarah Palin, who called for Bernanke to “cease and desist” at a recent speech in Phoenix, Arizona.

The problems of America’s debt became highlighted during President Barack Obama’s recent trip to Asia. During a press conference with Obama, Indian Prime Minister Manmohan Singh voiced his support for U.S. economic policy, stating, “a strong, robust, fast-growing United States is in the interest of the world.”

The perception that the American economy is resilient enough to eventually repay its debt is its greatest strength at the moment.

There are signs that the Federal Reserve has been successful. The projected rates of return for 3- and 6-month Treasury bills or “T-bills” have gone up in the last few months. What this means is that a bill purchased for $9,996.50 today is expected to be worth $10,000 in three months. “T-bills” have historically appeared appealing to investors because they have the full backing of the U.S. government, which, at least for now, still means something.

If the Treasury is able to quickly generate revenue, it will be able to print more money, which intern will create inflation.

CSU East Bay Economics Professor Tony Lima is optimistic that the Federal Reserve may be on the right track.

“It seems clear to me that the Fed has pretty much succeeded,” said Lima. “Long-term yields are higher because the Fed has managed to increase inflation expectations.”

The main point of focus for Lima is that Bernanke is at least attempting to get the country out of its current economic predicament. “I don’t think it’s going to do any harm,” said Lima. “It might help.”

Across the pond, Ireland has been forced into more desperate measures to get itself out of debt. The country recently negotiated a 90 billion Euro bailout with the European Union. Members of the European Union are worried that economic interdependence will cause the economic collapse in Ireland to spread to Greece and Portugal, who are struggling with their own problems.

“A small sovereign nation like Ireland faced with an outsized problem that we have in our banking sector cannot on its own address all those problems,” said Irish Finance Minister Brian Lenihan.
However, the United States is by no means a small sovereign nation. In today’s global economy, countries across the globe are deeply tied in to the U.S. economy, most notably The People’s Republic of China.

Many people view the fact that China owns over $800 billion in U.S. Treasury securities as an economic bailout of sorts. China’s economy is dependent on exporting manufactured goods to the United States. If the U.S. dollar drops too low, then it will stop buying these goods.

This also means that if China decides to suddenly cash in or diversify their holding of U.S. bonds, the U.S. could find itself in a lot of trouble.

“Monetary policy remains very accommodative, and financial conditions have become more supportive of growth,” said Bernanke, doing his best to give an optimistic assessment of the U.S. economy. This is necessary because actions of the Federal Reserve are justified by the projection of economic recovery.

For now, Bernanke appears to be acting kind of like a college student signing up for a new credit card to pay off next quarter’s tuition, knowing that graduation will come soon. This will work for the U.S. because everybody knows that economic recovery, like graduation, is just over the horizon. Right?

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Federal Reserve to Buy More Treasury Bonds