Tuesday, January 14, 2014
Dangerous to back your currency with the future value of your currency
One of my many explanations of hyperinflation is the Backing View or Real Bills Doctrine. This says that the central bank has to have assets that it can use to withdraw the notes it issues to support the value of those notes. It also warns any bonds should be short term, like 60 days or less.
The Fed owns 40% of all treasuries over 5 years in maturity. About $3 trillion of the $4 trillion in assets the Fed owns are more than 5 years. This means that the Fed is using long term bonds, against the advice of the Real Bills Doctrine. The reason this is a problem is that it ends up backing the current value of the notes with the future value of the notes. If interest rates are going up the value of the bonds will go down and so the backing of the current notes becomes worth less and less. But the more the value of the current notes drops, the less the long term bonds will be worth also. This can spiral out of control.
The Fed is backing the dollar with the future value of the dollar. If this starts to go bad it can go really bad.