If you haven’t been following the Fed meetings like it’s the NCAA championship you might have missed the announcement yesterday that the Federal Reserve (led by Bernanke) will start buying Treasury bonds as a matter to combat deflation.  That alone doesn’t sound so bad.  The big worry at the latest meeting is that we face a downward spiral of deflation of prices, which could ruin the economy further.

However it is the method they are implementing to combat deflation that should have you as a saver looking for you torch and pitchfork.  What the government is essentially doing here is printing money.  You’ve heard that term “printing money” plenty of times and the TV news networks have probably convinced you that is exactly when they’re doing.  No the government doesn’t actually print money and hand it out, they buy Treasuries.

By buying Treasuries, the Fed is essentially introducing new money into the financial system.  You see they aren’t actually allowed to by the debt directly from the Treasury Department.  The Treasury Department will auction off the bonds to investors, and then the investors will turn around and sell them to the Fed.  The Fed will hold them and collect interest from their partners down the road at the Treasury (the interest is paid with tax revenue).

Those investors from before now have money instead of the Treasury bond and can go use that money for something else.  In many cases, they go invest it or loan it.  This is how more cash gets into the financial system.  It could come in the form of a bank having an extra $100 million to lend to small businesses and home-buyers, or maybe invested in the stock market.  The net effect is that there is more cash in our system.

Sounds great right?  Not really.  With more money in the system cash is “cheaper” to obtain.  That is to say interest rates are lower and more cash is available.  More cash available means more people will be buying things with that cash.  More people buying items will cause the prices of those items to go up, inflation.  By creating some inflation, the Fed essentially combats deflation, which was their original concern.

But how does that piss of savers and the Chinese?  By “creating” inflation, the Fed is making it harder for you to save your money.  Right now ING Direct rates are at 1.65%.  If inflation is at 3%, the money in your account is worth 1.35% less every year it sits there.  It doesn’t matter how much you put in there, if inflation is higher than the rate of return on savings, you are losing value.  As someone trying to be safe and saving your cash, you can interpret this as the government punishing you for saving.

To add insult to injury, this increase in money supply hurts the American dollar as well.  The value of our currency compared to other countries in the world took a nice dive on this news.  This is because everyone expects to see inflation result from this, and they don’t want to see their money grow weaker.

It may not be all bad though.  Perhaps this is short-sighted though.  Come back this afternoon for the conclusion.

Photo: alexadralee

By The Weakonomist

The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics.

categories: economics, government