A recent headline at CNN.com said “Fed bails out GMAC with $6 billion.” Since I had heard it was the Treasury department funding the GMAC giveaway, I had to check the story to make sure this wasn’t another $6 billion being thrown down the drain. Fortunately, CNN just got it wrong: it was the feds , not “the Fed,” engaged in this particular instance of kleptocracy.
CNN’s error, of course, is not surprising. After all, an easy majority of financial journalists in the mainstream media clearly do not know the difference between the discount rate and the fed funds rate, nor do they have any clue what the Federal Reserve is or what it does. But thinking about the Fed made me realize that CNN’s error was actually no error at all. It will be the Fed that ultimately bails out GMAC.
The Treasury, after all, doesn’t have $6 billion, and it’s not going to tax us to get it — that’s way too old school. Where will Hank Paulson get the money, then? By issuing new debt. And who will buy this debt? A substantial portion of it will be bought by the Fed, which can “monetize” any debt or asset (i.e., print money to pay for it and say the new money is “backed by the debt (or asset)” for which it was printed).
More importantly, it is the power of the printing press that leads everyone else (China, Saudi Arabia, etc.) to buy American debt. If these foreign bondholders thought that their interest and principal would have to be financed by taxation, they’d know there’d be a second American Revolution before they recouped their investments. Instead, they know their money is “safe” so long as the Fed can create it at will to make good on the government’s bonds.
But there’s a reason “safe” appears in scare quotes. The Fed is creating an unprecedented amount of money, and as Austrian economic theorist Peter Schiff pointed out in a recent Wall Street Journal editorial, “each additional dollar printed diminishes the value those already in circulation.” Foreign bondholders are currently putting up $1 million to receive $21,360 in annual interest. If the dollar’s decline in purchasing power merely maintains current ten-year trends, then the real value of the principal at the end of the ten-year maturity will be just $767,330. And is anyone deluded enough to think price inflation won’t be much higher over the next ten years than it has been over the past decade?
Apparently so — for now. But as soon as these creditors wise up to the fact that the U.S. is broke, be prepared for a massive devaluation of the dollar: it’s going to zero.