Thursday, March 19, 2009

The Fed, buybacks, and currency (stock, economy)

Yesterday, the Fed announced a bold plan, including purchasing up to $300 billion in government bonds. My first reaction was one of confusion. The US Treasury creates money by issuing these bonds but the Fed is also printing money to buy them? As my friend explained to me, they're not necessarily going to buy newly issued ones, but ones that are already in the marketplace. My next reaction was that it sounds kind of like a stock buyback. Oh boy, that's not good.

I am very much against stock buybacks. I feel that it is a short-term manipulation that doesn't really help long term investors. Have you noticed how many companies were buying back loads of stock as the market went up, but that few of them are buying at these much lower prices? As I mentioned in a previous post, Trading vs. Investing 2, the open market is not a way to invest money directly into a company. Similarly, a corporation cannot invest in itself. It makes no sense to me why a company buys back shares at an open market price while raising cash at a discount to the open market price. It may boost numbers on paper and market metrics, but it weakens the company. Here is an interesting essay I found online about the fallacies of buybacks:

So will this plan be detrimental to us longterm? The aforementioned friend thinks so. In a battle against deflation, it's also very easy to set yourself up for hyperinflation. Noone can predict the future, but this move by the Fed will help some aspects of the economy in the near term, just like buybacks will boost a stock's price short term. This move should increase reserves in the banking system, which I feel is still the one thing the Fed is most worried about failing. The Fed doesn't really print money, as explained here:

This reminded me of a research paper I wrote back in senior year of college. It was about the cost of change, ie. lower denomination currency. It was a teaser of observations about the inefficiencies and limits of physical currency. Some points include:

People often would prefer to get rid of pennies instead of keeping them, yet the government continues to spend money to make them.

How people would feel if their employers suddenly decided to pay them their monthly salary in quarters.

Some denominations that some people feel are inefficient, such as the $10 bill and the fact that the largest US denomination is $100 (although I think that's for anti-smuggling purposes, considering that you're supposed to declare cash in excess of $10,000 through customs).

In the end, my conclusion was that it makes sense for us to move toward a cashless society. With the Fed and Treasury continuing to "create" large amounts of money by writing zeroes on a balance sheet, maybe this is a good time to move in that direction?

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