from Fortune.com:
WASHINGTON -- When stock markets plumbed new lows in March, the Federal Reserve responded with nearly every tool in its box. It announced it would create new money to buy $1.25 trillion in mortgages and $300 billion in government debt.
That purchase of government debt looked particularly ominous. Creating new money to buy government debt is the sort of strategy that's known to destroy economies--just ask Zimbabwe, which suffered so much hyperinflation that it destroyed its currency. The Zimbabwe central bank printed bills in the denomination of 100 trillion Zimbabwean dollars, then found they had value only as a novelty item on eBay. Eventually, Zimbabwe was forced to abandon its currency altogether.
But the difference between the U.S. Federal Reserve and the Reserve Bank of Zimbabwe (one would hope) is that the Federal Reserve will stop before it wrecks the dollar.
The first major test of the differences between Zimbabwe and the U.S. is rapidly approaching. An indication could come as soon as the Fed releases a policy statement Wednesday afternoon. The Fed is not expected to announce a major change of course (see "All Quiet On The FOMC Front"), but the present course calls for current programs to unwind.
The first program to end is the purchasing of government debt. In its March 18 meeting, the Federal Reserve announced that "to help improve conditions in private credit markets" it would purchase $300 billion of government debt. The Fed wanted markets to believe it was purchasing these Treasuries for the purpose of lowering interest rates. Since much borrowing is ultimately benchmarked against the yield on Treasuries, if the Fed purchases Treasury debt, it should make borrowing easier throughout the economy.
The Fed stated it would make these purchases for six months. As of Aug. 5, according to the Federal Reserve Bank of Atlanta, it has purchased $236 billion of government debt. By the time the Federal Reserve meets again in September, it is likely to have spent all $300 billion, and the six months will be over.
It is a tricky moment for the Fed. If it continues buying government debt, it may help keep interest rates low, but it would raise concerns that the country is inching ever closer to Zimbabwe (and, of course, if enough people believe we're headed down the Zimbabwean road, it would eventually become a self-fulfilling prophecy).
The Treasury purchases are only the first program the Federal Reserve is on course to close. Its plan to purchase $1.25 trillion in mortgage-backed securities is only supposed to last through the end of the year. The Federal Reserve has purchased $702 billion and this program is also on course to run out the clock in four months. Eventually, the Fed will have to indicate a change for its target interest rate which, since December, has been floored between 0% and 0.25%.
Since the announcement in March of its programs to purchase mortgages and Treasuries, the Federal Reserve has been able to sit back at each meeting and simply say the programs would continue apace. In recent meetings the Fed has fiddled with its language about the pace of recovery and their expectations for inflation, but announced no other changes.
Summer is nearing an end, and the economy may already be recovering. The most recent GDP data show an economy headed for growth in the third quarter (see "The Recovery Question.") A report from Macroeconomic Advisers says GDP for the third quarter is on course to grow 3.1%. Even key indexes for manufacturing are poised for a turnaround (see "A Manufacturing Recovery?")
If the Fed is confident about the recovery, it may announce Wednesday the timing of its plans to take the economy off life support. But the Federal Reserve is more concerned with employment--the Fed has a mandate to seek full employment and price stability. Most people certainly care more about having a job than about a measure like the GDP expanding. On the job front, there is still a lot of concern: Last week, "only" 247,000 jobs were lost in the U.S. That's better than a loss of more than 600,000, like we saw earlier in the year, but not even close to the Fed's goal of full employment. (See "Bad News: Unemployment Falls To 9.4%.")
Since March, the strategy has been to wait and see. When summer is over, that will no longer be an option.
