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Treasury's Money Supply

Written by A Forex View From Afar on Thursday, February 12, 2009

The latest reports show that the Fed is preparing to add four new primary dealers, as the Treasury is set to auction up to $2.5 billion this year, in order to raise cash for the much needed stimulus programs.

Primary dealers are the main bidders for U.S. debt, issued periodically by the U.S. Treasury. Currently, there are 16 primary dealers, including all the big names from the Wall Street, the lowest number on record, preparing to bid for what will probably be the biggest amount of treasuries ever sold. From the primary dealers, treasuries pass into the secondary markets and become marketable. In other words, primary dealers are the main market makers for U.S. debt.

By adding four new dealers, the Fed will try to reduce the spreads in the primary market, as some traders have complained lately that the market has become rather illiquid, with relatively small volumes. An illiquid market means the government would have to pay more at its auctions, and this is not too good when you are preparing to sell a record amount of debt.

The Treasury is preparing to borrow up to $2.5 billion of debt this year, almost four times more than the amount of debt issued in 2008. This means that for every basis point, the government will have to pay $250 million per year in interest, or $70,000 per day.

The huge amount of debt issued might be another reason the Fed wants to start buying longer-term debt. This way, it will reduce even further the yields on the Treasury bonds, helping the government pay less in annual interest, and at the same time sending the mortgage and commercial paper lower (in theory, that is).

All this debt come at a huge cost, and most likely, the dollar will be sacrificed. Having the Fed buy U.S. bonds, the printing press will once again start working day and night, increasing the money supply at a strong pace. From economics 101, when the supply surpasses the demand side, the price has to fall somewhat lower until a new equilibrium point is met.

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