Bernanke's Dilemma: It's His Low Rates Funding Washington's Enormous Deficit

Yes, most economic numbers are getting better, and various Fed governors are starting to use more optimistic language, leading many to speculate that the central bank will imminently (but slowly) begin the process of easing us off 0% interest rates.

First it will start with a language change. That’s the first step.

But while traditional monetary rules (and increasing evidence of inflation) would probably suggest that Bernanke needs to raise, he has a problem.

It’s his low rates that are funding the gigantic deficit. Indirectly, of course.

chartBank ownership of government securities has gone parabolic

Photo: St. Louis Fed

Banks, as has been known for months, are making a mint playing the spread, borrowing cheap from the Fed on the short end, and lending to the Federal government at much higher rates. This is not just convenient for the banks, it’s crucial to Washington’s ability to borrow, especially as foreign demand begins to wane (supposedly).That is what’s likely to be on Bernanke’s mind over the next several weeks and months.

Sure, the real economy can withstand slightly higher rates. But can Washington stomach the end of bank bond buying?

Don’t miss: 14 facts about the deficit that will blow your mind >

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