The federal reserve came out and updated a statement on the amount and type of treasuries they are purchasing. Moreover, this looks very similar to an admission that they are now engaging in yield curve control.
If you are not aware, the yield curve is simply a chart that shows you as an investor or more accurately as a lender, how much you will make an interest if you loan money to the United States government. So this picture shows the current yield curve, and as you can see it’s like an S shape.
This is a very steep yield curve, especially in light of the last couple of years. Now, again, this just shows the amount of interest that you’re going to make. If you lend your money to the United States government for a varying amount of time. So anywhere from one month to one year, you’re getting basically zero out one year, you’re getting 0.05% and even all the way up to three years, it’s only 0.3, 5%.
But from there, it moves up steeply to the end where we have a. 30 year at 2.3% now, generally, and historically the market determines the interest rates here. And here’s what I mean by that. The government goes out to the market and says, “we have an appetite to borrow”. We want to spend money, but we’ve already spent everything we made in taxes this year.
We want to spend more than that. And so we’d like to borrow from anybody who wants to lend to us. One more lender might come up and they say, ” I’m willing to lend you money for 4, for 10 years”. Then another lender comes up and says, I can do better than that. We’ll do 3% for 10 years. Another lender says 2% for two years.
And so obviously the government’s going to go to that one person that says I’ll lend you money for 2%, for 10 years. Cause that’s the best deal for the government. But what if that person can only lend a billion dollars, but the government wants to borrow $2 billion. Then they have to see if there’s anybody else willing to lend at that 2%.
Nobody is the next person in line 3% for 10 years. So they have to borrow at 3%. This dynamic is constantly taking place and in a free market, that’s exactly what would be happening. Now, one of the factors that would influence whether people were willing to lend a 2% or 10% is the inflation rate, because if the cost of living is going up by two or 3% every year, You wouldn’t be very smart if you loaned your money for that exact same amount, because that means you’re not actually making any money.
You’re just breaking even if you get a 1% raise. So your salary goes from a hundred thousand to 101,000, but that year inflation was 2%. And your cost of living went from 100,000 to 100, $2,000, right? You didn’t actually get a raise. You got a pay cut. It’s the same thing with lending. If you lend at 1%, but cost of living, if inflation is 2%, you’re losing money.
Even if the total number of dollars goes up, they don’t go as far as they did before. And so you might be thinking to yourself who in their right mind. Is lending to the United States government at 2.3% when we just got the blow-out inflation report for April of over 4%. That means in real terms, when you adjust for inflation, it’s a negative 2% yield.
They’re losing 2% every year to lend money to the government who in their right mind is that selfless. That’s a great question because it’s not somebody in their right mind. It’s somebody that doesn’t care about profitability whatsoever. It’s somebody that can make as many dollars as they want.
At the whim from the push of a button, you guessed it. It’s the federal reserve. If the federal reserve right now stopped buying treasuries, which is another way of saying lending money to the government. They have to go through the banking system, but that’s the end result. If they pulled back and stopped lending new money to the government interest rates would immediately spike.
There’s just not enough money out there willing to lend the government money at a negative, real interest rate. Now, the federal reserve has been very clear in the past that they are not monetizing the debt. They’re not engaging in treasury purchases in order to push down interest rates. They’re just doing it to maintain a smoothly operating treasury market.
And they say clearly that we’re not doing this to push down rates because, we’re mostly buying the short end of the curve. What are the interest rates of the short end of the curve? They’re basically zero. And recently over the last couple of months, we saw one of the fastest spikes in interest rates, on bonds in history, they started skyrocketing and now things have leveled out in interest rates have started to drop, right as the federal reserve is saying, “We’re going to adjust the way that we buy treasuries.”
And we’re probably going to start purchasing some longer data treasuries now as well. So why does the federal reserve care about interest rates going up? Quite honestly, it’s because corporate America and the federal government are both bankrupt. If interest rates get too high, both corporate America and the federal government are just rolling over all of their debt.
It’s like paying off your old credit card that had the zero-interest introductory APR. It’s like paying that off with a brand new credit card with a new zero-interest APR introductory period. They are just continuing to do that. Rolling it forward. That means if that option is no longer available, corporate America, federal government both has to pay their minimum payment and the additional interest from the new debt when they roll it over.
Which they can’t afford. And so in order to stop this from happening interest rates, can’t get too high. Now the side effect is that this expands the money supply because the federal reserve is basically creating this new money out of thin air that goes through the banking system to go to the government, that the money that the government is spending into the economy.
So it’s expansionary to the total supply of money, which when the total supply of money expands, the end result is price inflation. And when price inflation happens and interest rates don’t, that means interest rates go further negative, which means. People and individuals and institutions want to hold less and less of that debt, which means they’re going to sell that debt, which means the federal reserve has to buy even more of that debt than they were before.
Great system. But in the end we can’t control what the federal reserve does. We can’t control how much money the federal government spends, but we can control our investment portfolio and we can buy gold. We can buy silver, we can buy Bitcoin. We can sell things like bonds that are giving us a negative return on investment.
The best that they can do is give us less than inflation. That’s a bad deal in my book and we can hedge our positions just in case we see the federal reserve or the federal government decide they will take pain flops by letting everything collapse. You can hedge your portfolio and even earn some income along the way by taking out options or securing your financial future with non-correlated assets like gold, silver and Bitcoin.
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