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Edited on Thu Sep-03-09 09:56 AM by jakeXT
The shell game
Have you ever seen a sidewalk magician run the shell game, where a pea under a shell is magically shuffled around - now you see it under this shell, now you see it under that shell, now it disappears completely - or does it? The more it moves around, the more confused you get. If you can only figure out which shell the pea is hidden under, you win! But where is the pea? The point of the game, from the perspective of the street hustler, is to use complexity of motion to confuse the mark.
These are the three critical points to remember as you read further:
1.The US government has record amounts of Treasuries to sell.
2.Foreign central banks, which have a big pile of agency bonds in their custody account, would like to help but want to keep things somewhat under the radar to avoid scaring the debt markets.
3.The Federal Reserve does not want to be seen directly buying US government debt at auctions (and in fact is not permitted to, but many rules have been 'bent' worse during this crisis), because that could upset the whole illusion that there is unlimited demand for US government paper, but it also desperately wants to avoid a failed auction.
For various reasons, the Federal Reserve cannot just up and start buying all the Treasury paper that becomes available in record amounts, week after week, month after month.
Instead, it uses this three-step shell game to hide what it is doing under a layer of complexity:
Shell #1: Foreign central banks sell agency debt out of the custody account.
Shell #2: The Federal Reserve buys those agency bonds with money created out of thin air.
Shell #3: Foreign central banks use that very same money to buy Treasuries at the next government auction. http://www.chrismartenson.com/blog/shell-game-how-federal-reserve-monetizing-debt/25806
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