Debt, QE3, and the Current Situation

 When President Obama took office in 2009, the national debt stood at roughly $10.5 trillion. at the end of his administration, it will be roughly $16 trillion. Of course, the first and possibly the second year of that debt is more a function of the Bush administration, but the purpose of this article is not to lay blame for the source of the debt, but rather to explain the current debt situation. We start at the beginning of the Obama administration because that is when the quantitiative easing policies began.

In March of 2009, the Federal Reserve Banks announced that they would be initiating a $300 billion purchase of US Treasury bonds over roughly six months coupled with roughly $1.25 trillion in mortgage backed securities purchases. This was known as QE or quantitative easing. In November of 2010, the Federal Reserve Banks again announced that they would starting a program to purchase roughly $600 billion in Treasury bonds at a pace of roughly $75 billion a year. This program was called QE2.

In September of 2011 the Fed announced a $400 billion program  to sell or redeem shorter-term Treasury securities and use the proceeds to buy longer-term Treasury securities. This program was to run to the end of June 2012. In June 2012, the Fed continued the program through the end of 2012, with an additional $267 billion in Treasury securities. This program was known as Operation Twist.

A few days ago, the Federal Reserve Banks announced QE3 - a program to purchase $40 billion a month in Treasuries without a limit in the amount to be purchased or an end date.

The chart below shows the amount of notes and bonds held by the Federal Reserve (green line) and the total amount of securities currently held by the Fed (blue line). What can be seen is that in almost ever case, as one program ends another begins. The increases in the bonds and notes can be seen to rise when the QE programs are enacted and the $1.25 trillion in mortgage backed assets adds to the total of securities.

 

Of the $5.5 trillion in debt accumulated by the Obama administration, roughly $1.1 trillion was purchased by the Fed. This means that at least 20% of the debt under Obama has been monetized. If you add to this the $667 billion in manipulation under Operation Twist, then you are up to over 30%. 

These operations, especially operation Twist, have been successful in accomplishing what appears to be the primary goal - moving the maturity date of the US debt out as far as possible. In 2009, 22% of the US debt matured within a year and 20% matured within 5 to 10 years. As of September of 2012, 0% expired within a year, and 48% expired in 5 to 10 years. The implementation of QE3 will further extend these maturity dates.  

 

The purpose of this movement is obvious. The Obama administration and the Federal Reserve are keeping the interest rates low and using these low rates to purchase as much debt as possible and locking these rates in for as long as possible. The hope is that the economy will turn around and lower the deficit soon so that interest rates can be allowed to rise back up so that someone other than the US government will be enticed to buy treasuries.

This is a very risky strategy. As long as interest rates remain this low, more and more debt will have to be purchased by the federal government. The plan in place depended upon moving all of our current debt into long term bonds at low rates and then raising interest rates to encourage the purchase of new debt from legitimate sources. However, the sheer amount of new debt has prevented the Fed from raising interest rates and the Fed has announced that this policy will remain in effect until at least the end of 2014.

If QE3 remains in place for 6 months, it will represent $240 billion or at least 20% of the new debt. If it becomes a permanent policy, the US will be monetizing up to 50% of its new debt. If that happens, inflation becomes a given and hyperinflation becomes a real possibility.