Interest rates and QE2

The Federal Reserve has been printing money to buy treasuries for a number of months under the second part of its program of quantitative easing or "QE2" as it is commonly known. Under the normal reules of economics, all of that extra cash chasing the securities issued by the US Treasury should have increased the price of those bonds and lowered the resulting interest rates. Indeed, the Fed has pumped hundreds of billions of dollars of cash into the treasury market over just the last few months, so the impact of so much money in such a short time ought to be quite large. So what has happened? Just the opposite! Interest rates for onger term treasuries have been rising and the value of such bonds falling.

So how can this be? Did the Fed's actions scare off foreign (and domestic) buyers of treasury bonds? Are those in the market dumping the bonds they already hold, thereby transfering the bonds to smaller holders who can be left literally holding the bag? Is there some other factor at work here that is more powerful than the buying program of the Fed?

It seems that the proper answer is "all of the above". Obviously, there had to be excess selling in order to drive the price of the bonds down even with all that extra buying by the Fed. It stands to reason that much of the selling came from foreign holders who were alarmed by the Fed's action. Big domestic holders also have to be selling as well.

With the Fed, in essence, monetizing the debt, it is no wonder that holders of that debt are running for cover. Why hold bonds that pay a low return when the value of the currency in which the bonds are demoninated is likely to decline? What good are bonds that pay 3 or 4 percent if the inflation rate goes to 5 or 6 percent (or higher)?

Maybe it is time for the Fed to stop playing its games with the monetary supply of the USA. The old model of the Chicago School was to strive for stead growth of the money supply at a rate sufficient to support expansion (lie 2 to 3 percent per year). Over the last two years, the Fed has increased the money supply by a rate that is extremely high. (like 30 times higher than the goal.) The Fed assures us that if inflation gets out of control, they can bring it back down with just a little tinkering with the system. Seeing the total lack of success with QE2, one has to wonder whether the Fed will have any success with anything they do in the nature of "tinkering". The sad thing is that they are betting the US economy on their moves.