Inflating the dollar

Swept up by widespread assertions that "something must be done," many Americans doubtless responded to Wednesday's announcement that the Federal Reserve Board would purchase up to $300 billion in long-term U.S. Treasury bonds with a relieved "Well, at least they're doing something."

The stated goal of Fed Chairman Ben Bernanke is to push down long-term interest rates, generally pegged to the interest paid on these Treasurys, thus driving down the cost of mortgages, car loans, et cetera.

The rates paid those loaning money to the government by buying 10-year government bonds did indeed drop Wednesday by about half a percentage point, from about 3 percent to about 2.5 percent, mimicking the behavior of the British bond market after the Bank of England announced a similar plan to buy U.K. "gilts" on March 5.

Giving the matter a bit more thought, however, some will surely ask, "How does that work? The government is buying the government's own bonds? Isn't that like saying you don't have to feed corn to the chickens, because they can just eat each other?"

Not quite. The Federal Reserve Board is not a government agency, but rather a corporate consortium of privately held banks to which the Congress since 1913 has delegated -- wisely or not -- some of its power to create money and set its value.

Where will the Fed get the money needed to buy all these Treasury bonds? Will it send men out to mine more gold and silver, coining the stuff into silver dollars and $20 gold pieces -- or at least wait until enough new factories have been built and filled with labor-multiplying machinery to create $300 billion in new wealth?

No. The common slang for what the Fed will do is simply "print more money." Though in this day and age, the magic of electronic transfers probably means these new "dollars" may not even have to be made of paper and ink. They'll be created electronically.

Wow. Kind of like magic. But if the Fed can do that without repercussions, why not end the recession right away by simply mailing every American a million dollars?

Because there are repercussions. When new money is created on this scale, those dollars eventually go out into the market and compete for a limited supply of goods and services, driving up prices.

That's one good reason silver prices shot up by $1.55 on Thursday, and the price of gold by a whopping $69 an ounce. Investors want to trade their dollars for something else.

The Fed's move means dollars -- like the ones in your bank account and paycheck -- and dollar-denominated securities -- like the stocks in your 401(k) plan -- will now be worth less.

How much less? Ask Mr. Bernanke.