"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Saturday, February 5, 2011

Federal Reserve System Balances compared to Treasury holdings of China and Japan

I thought it might be helpful for us to grasp the enormity of what the Federal Reserve is doing with its Quantitative Easing program by examining the balance sheet of the Federal Reserve system and comparing that to the total Treasury Holdings of Japan and China.

IT is said that “a picture is worth a thousand words”. In this case it might be more apt to say that a picture is word a Trillion words because that is where the total Treasury holdings within the Federal Reserve Sstem have now climbed. The most current date as of this past Wednesday puts the Fed holding over $1.125 Trillion in Treasuries.

Compare that to China, our largest foreign Treasury holder as of November 2010, which officially holds $895.6 Billion of paper. Our next largest holder of Treasuries is the nation of Japan which comes in at $877.2 Billion.

Combined those two nations hold $1.772.8 Trillion in Treasuries.

When the Fed announced Quantitative Easing in November of last year, they stated that the amount of Treasury purchases anticipated under that program would be $600 billion. We will know better how things stand as we approach the supposed cut off date in June of this year but at the current rate, the Fed will hold nearly as many Treasuries as both China and Japan combined.

All of this is money creation that is being used to pump-prime the economy. As the velocity of this money begins to increase throughout the economy, inflationary pressures are going to begin pushing sharply higher. Being short nearly anything is going to be extremely tricky for all but the fleetest of traders.

It is for this reason that I expect the stock market to continue rallying (barring a deterioration in the middle East) until we get some sort of indication that the Fed which started the party, will take away the punch bowl. That of course all depends on the condition of the US labor markets.
One can understand the impact that this is going to have on the US Dollar, not to mention the bond market which is becoming increasingly fearful of the inflation genie.

You might notice on the chart that the Fed has recently begun selling some of the massive amounts of mortgage backed securities that it purchased in order to shore up the banking system when the credit crisis first erupted into the open back in the summer of 2008. Prior to that emergency action, the balance sheet held none of this particular paper.

However, all of the sales of MBS's have been completely replaced by its purchases of Treasuries, which as you can see by looking at the angle of ascent of that line, will easily surpass the peak of MBS's held within the next month.