Since last November the Fed set out on a plan to stimulate the economy by buying a hundred billion dollars worth of treasury bonds per month using money created out of thin air. To understand how enormous this is and what a distorting effect it is having on our economy I'd like to put this in terms of how many people it would take to duplicate this effort.
To keep the numbers simple I'm going to use 5% as the amount the average person saves each month. The number varies from month to month but 5% is right in the middle of the typical range for the US savings rate. In order for real people to match the amount of money being pumped into the financial system by the Federal Reserve using only 5% of what they make it would take a combined income of two trillion dollars. Remember, this is per month, not per year.
How many real people would it take at an average income of $60,000 per year, or $5,000 per month to be able to purchase one hundred billion dollars worth of treasury bonds every month using only 5% of their income? If you take the two trillion number and divide it by five thousand you end up with the staggering number of four hundred million. Considering that the entire US population is just above three hundred million and the labor force is around one hundred and thirty million this number should make it clear that what the Fed is doing is totally outside the realm of reality. Imagine that they are pumping more than three times the entire collective savings effort of every working American into treasury bond purchases and despite that the price of treasury bonds has steadily dropped.
With the addition of four hundred million workers it should come as no surprise that the stock market and commodities markets are all shooting up. With the Fed effectively taking over the entire treasury bond market the real people out their are left looking for somewhere to invest their savings. You can't just leave your money sitting in a bank account earning less than 1% interest as inflation will make your money worthless in no time. This phantom savings of four hundred million imaginary souls is forcing the real investor to choose extremely risky investments in order to have a chance of beating inflation. The price of everything is being artificially boosted by this massive injection of Fed money along with the Fed's zero interest rate policy making safe investments a losing proposition.
What should be of utmost concern is the fact that at some point later this year the Fed will completely stop buying treasuries and the markets will have to adjust to life without the four hundred million phantom savers. The government is still going to need to issue over one hundred billion in new treasuries each month but now the Fed won't be there to buy them all so it will be up to real investors to pick up the slack. Assuming that four hundred million new people and jobs aren't created all at once later this year that money will have to come from the savings of real people worldwide and that money will not be available to buy stocks and other investments.
It may end up that as the end of this bond buying program draws near the Fed may have no choice but to continue its purchasing given the immense quantity of these bonds it owns. If the price of these bonds were allowed to plummet the Fed would be stuck with hundreds of billions in losses that it would end up passing on to the treasury. The problem though is that if it continues to create new money to keep on purchasing treasuries inflation will begin to reach dangerous levels. If anyone has lived through or read about the inflation of the 1970s you know what a destructive effect is has on everyone's life. Stagflation, as it has become known is the combination of high inflation with no economic or wage growth. This is the story of the 1970s, rising prices without a raise in pay. It took the use of incredibly high interest rates in the 1980s to eventually kill inflation and start economic growth. With our massive debt of over fourteen trillion much of which is financed in very short term bonds, high interest rates would be impossible to deal with. Even having to pay 5% interest on our debt would make the payment much too high handle.
Many people are right now being sucked in to the stock market by the constant reports of "experts" claiming the economy is recovering and stocks will keep heading higher. Hopefully you now understand that all of the "prosperity effect" being felt right now will end or inflation will take over. There really is no painless way out of this mess and the more money we spend inflating this prosperity bubble the worse off we will be when it inevitably pops.