The Federal Reserve Chairman, Ben Bernanke, made some statements on 19 June 2013 that sent shockwaves throughout the financial markets in the United States and Asia. There is no change in policy. This, Chairman Bernanke, emphatically stated several times at the 19 June 2013 press conference. So why did the markets react the way they did? This analysis will assist in understanding why the markets responded in the manner that they did to Chairman Bernanke's suggestion that the asset-purchasing program will “taper off” in late 2013 or in mid- to late-2014 although this possibility is clearly stated in the Federal Reserve's Open Market Committee's (FOMC's) 22 May 2013 statement.

1. In the Name of Allah, the Beneficent the Merciful
Report Completed: 07 August 2013
The Federal Reserve Chairman, Ben Bernanke, made some statements on 19 June 2013 that sent shockwaves
throughout the financial markets in the United States and Asia. There is no change in policy. This, Chairman Bernanke,
emphatically stated several times at the 19 June 2013 press conference. So why did the markets react the way they did?
This analysis will assist in understanding why the markets responded in the manner that they did to Chairman Bernanke's
suggestion that the asset-purchasing program will “taper off” in late 2013 or in mid- to late-2014 although this possibility
is clearly stated in the Federal Reserve's Open Market Committee's (FOMC's) 22 May 2013 statement.
Topic: Understanding the Fed's Latest Moves
FOMC Statement 19 June 2013
The first thing that must be done is to actually look at the Feds' actual policy statement on 19 June 2013.
According to the 19 June statement, the monetary policy has not changed. Mortgage-backed securities (MBS) will
continue to be purchased at the rate of US$40 billion per month and long-term Treasury bonds will continue to be
purchased at the rate of US$45 billion per month with the Fed Fund rate remaining at the range of 0%--1/4%.
Why did the markets react the way they did? What is the problem with “tapering off” the asset-purchasing program
at an early date that caused so much panic and volatility in the markets? To clearly comprehend the market's
response it would be best to examine the actual FOMC's April 30—May 01, 2013 meeting minutes and what will be
affected by the possible earlier-than-expected “tapering” of the asset-purchasing program.
FOMC's April 30-May 01 2013 Meeting Minutes
The minutes state on page 7, paragraph 3:
Most participants emphasized that it was important for
the Committee to be prepared to adjust the pace of its
purchases up or down as needed to align the degree of
policy accommodation with changes in the outlook for
the labor market and inflation as well as the extent of
progress toward the Committee’s economic objectives.
Regarding the composition of purchases, one participant
expressed the view that, in light of the substantial

2. improvement in the housing market and to avoid further
credit allocation across sectors of the economy,
the Committee should start to shift any asset purchases
away from MBS and toward Treasury securities.
With this being clearly expressed in the April 30-May 1 meeting minutes, the markets should not have been
surprised if the FOMC decided to pull back on their rate of MBS purchasing early or later. There were two main
conditional factors that must be satisfied in order for the FOMC to begin to change their rate of MBS purchasing.
According to page 9, paragraph 3:
When the Committee decides to begin to remove policy
accommodation, it will take a balanced approach consistent with its longer-run goals
of maximum employment and inflation of
2 percent.
The FOMC's maximum unemployment rate target is 6 .5%.
The current unemployment rate (March 2013) is 7.6%.
The FOMC's longer-run goal of inflation is at or above 2%.
Inflation currently runs under the 2% target rate according to the minutes.
Neither of these conditions were satisfied. So what caused the markets' panic of earlier-than-expected “tapering” of
the FOMC's asset-purchasing program?
The FOMC's Asset-purchasing Program
The Federal Reserve decided to purchase mortgage-backed securities (bonds) at a rate of $40 billion per
month and Treasury bonds at a rate of $45 billion per month. This is the current composition of the assets being
purchased through this program. This program was designed to create inflationary pressure in order to “stimulate”
the economy. The bank holding companies that own these mortgaged-backed bonds will be the direct recipients of
this asset-purchasing program. According to this 21 February 2008 Bloomberg report, these bank holding
companies positioned themselves to directly benefit from the asset-purchasing program.
Asset Composition
Treasury Bond Purchases
$45 billion per month is allocated towards the purchase of long-term Treasury bonds with maturities up to
30 years. Traditionally, the purchasing of Treasury bonds (T-Bonds) by the FOMC is utilized to create inflationary
pressure. However, at a rate of $45 billion per month is unprecedented! What makes T-bond purchases effective, is
that currency can be in circulation for up to 30 years. This has long-term inflationary effects on the economy. This is
vastly different from simply “printing dollars”.
Mortgage-backed Bond Purchases
$40 billion per month is allocated towards the purchase of mortgage-backed bonds from bank holding
companies in order to increase economic growth. The liquidity (cash flow) received is then allocated towards mainly
commercial and industrial interests such as commercial and industrial (C&I) loans and commercial real estate
(CRE) loans. Consumer-market loans have been prioritized in narrow allocation mainly towards asset-backed loans
such as subprime auto loans, home loans, and student loans.

3. Compositional Effects of Asset Purchases
Treasury Bond Purchases
The $45 billion per month allocated towards the purchase of “long-term Treasury securities” (T-Bonds) is
strategically implemented to induce inflationary pressure. This strategically-induced inflationary pressure is the
direct cause of upward price movements in the world's markets. The current rate of T-Bond purchases positions the
US dollar to risk currency devaluations. The current Fed Fund rate—the rate in which subordinate banks can
borrow from the US central bank—is between 0.00% and 0.25%. The currency devaluation risk, as previously
mentioned, positions the subordinate banks to receive inflationary dollars at near-zero interest. This discourages
consumer lending practices due to the lack of volume required to sustain credit issuance under such monetary
conditions. Issuance of loans with inflationary dollars at near-zero interest put subordinate banks at risk of
accumulating negative balances over the long-term. Commercial and industrial (C&I) credit markets are not as
vulnerable to the effects of this “accommodative” monetary policy due to the amount of volume C&I markets
produce. The volume in reference is cash flow or revenue. Under these monetary conditions, consumer credit
markets are riskier than C&I credit markets due to the limited revenue-generation components that make up the
consumer market which significantly affects the frequency and sustainability of repayment on loans. Most
consumers are dependent on wages or salaries that do not necessarily increase when the cost of living increases.
Most consumers face employment-loss risks due to economic and market factors beyond their control. Therefore,
the risk of loan defaults and infrequent repayment on loans are much higher in the consumer credit markets than in
C&I credit markets under current monetary conditions. This is what discourages consumer lending. The C&I
credit markets are not as vulnerable to these monetary conditions, but they are vulnerable nonetheless. C&I
markets are not limited by their revenue-generation components and are capable of generating massive volumes of
revenue at a much higher frequency than consumer markets. The volume of revenue-generation and revenue-
generation frequency significantly reduces the credit risk of C&I markets under current monetary conditions.
However, the ultimate risk of sustained inflationary pressure is that eventually costs catches up with revenue. When
this occurs, profit margins are reduced. Production costs increase at a rate that current price levels become
unsustainable. Maintenance of profit margins imposes price incrementation (increases). Price incrementation
eventually slows down demand. Demand reduction results in decreased production and downward pressure on
prices. This ultimately results in lower revenue-generation. This is commonly known as the law of diminishing
returns. This will continue until either production levels decrease to the point where satisfactory profit margins are
restored and/or demand increases at the lower price level. With lower revenue-generation, debts are more difficult
to repay. As common general business practice, debts are always paid first before distribution of profits. Debts are
not only in the form of direct loans, but are commonly issued through corporate bonds. Therefore, the lower
revenue-generation directly affects a company's bond rating—determining its ability to pay back its creditors.
Sustained lower revenue-generation can also affect a company's ability to retain its equity value which can result in
significant capital-loss. Under sustained inflationary pressure, lending institutions would normally be reluctant to
issue credit to C&I entities without raising interest rates to reflect the compensation required for receiving devalued
currency. Even more so, yields on corporate bonds would rise—reflecting a company's ability to pay back its
creditors--under sustained inflationary conditions. Current monetary conditions do not reflect sustained inflationary
pressure, but ever-increasing or incremental inflationary pressure. The near-zero interest rate would make it very
difficult for a lending institution to engage in credit issuance at any level under such monetary conditions ...unless
certain accommodations were implemented to offset the natural effects precipitating from these monetary conditions.
Mortgage-backed Bond Purchases
The $40 billion/month allocated towards the purchase of mortgaged-backed securities (MBS) is strategically
implemented to induce economic growth under the current monetary conditions. Due to the current financial
regulations and the accelerated merger and acquisitions of banking institutions , qualified bank holding companies
are in position to benefit from the central bank's asset purchasing program. The $40 billion will go towards
purchasing MBS directly from qualified bank holding companies on a monthly schedule. This enables credit issuance
to C&I interests. The proceeds from the direct MBS purchases enable subordinate banks to issue loans and other
forms of credit and capital to C&I borrowers. C&I borrowers are then able to sustain their corporate bond ratings
and credit ratings with the acquired capital. The acquired capital enables C&I market expansion. Hence, economic
growth can continue under current monetary conditions, albeit with short-term sustainability. The additional $40
billion/month does not contribute to additional inflationary pressure. The additional $40 billion/month is strategically
implemented to provide capital to qualified bank holding companies for the purpose of credit issuance to C&I
interests under incremental inflationary conditions at near-zero interest rates. The current monetary policy requires

4. this kind of accommodation. Otherwise, credit issuance would be null. Without the necessary credit issuance, C&I
interests would become unsustainable.
Market Response to Perceived Asset-Purchasing Reduction
Chairman Bernanke's 19 June 2013 statements caused ripple effects within the world's financial markets—
more for what was deducted from his statements and less for what was actually said. His June 19th
statements, the
June 19th
FOMC statement, and the April 31-May 01 2013 FOMC minutes are congruent and reflect no policy
change unless the targets of 2% longer-run inflation and 6.5% unemployment levels have been reached. The FOMC
clearly stated in page 7, paragraph 3 of their May30-April 01 2013 minutes that they reserve the right
to adjust the pace of its
purchases up or down as needed to align the degree of
policy accommodation with changes in the outlook for
the labor market and inflation as well as the extent of
progress toward the Committee’s economic objectives.
The market response to Chairman Bernanke's statements reflected shock, surprise, and disappointment. The level
of volatility and downward trajectory of equity and bond values was unprecedented. In light of FOMC consistency
in policy implementation and statements, the volatile market response to Bernanke's remarks begs the question:
why? Why did the markets respond in this manner to Bernanke's remarks which reflect the FOMC's consistent
policy position? The widely-promoted answer is that the volatility in the markets is due to the hinting by Bernanke
that the asset-purchasing program may be “tapered-off” earlier than expected. Most economists expect the asset-
purchasing policy to be incrementally-reduced by mid-to-late 2015. It was deducted from Bernanke's remarks that
asset-purchasing reduction may begin as early as Q4 2013. What precipitated this deduction? Does current market
activity reflect economic improvement? If so, why would asset-purchasing reduction signal uncertainty as reflected
by downward equity and bond values (the equivalent of upward bond yields)? What is the fear? If asset-purchasing
reduction occurs, which assets the markets fear will be purchased at a reduced rate? Treasury bonds? Or mortgage-
backed bonds? As previously stated, the purchasing of mortgage-backed bonds provides direct liquidity to qualified
bank holding companies for the purpose of credit issuance to C&I interests. Without MBS purchasing, credit
issuance would be null under current monetary conditions. Conclusively, without this necessary credit issuance, C&I
interests would become unsustainable. It can be logically deducted that it is the reduction of MBS purchasing that
the markets fear.
Why fear MBS purchasing reduction when the FOMC economic objectives have not been met? Do the
markets perceive improvement in the US labor market and the FOMC's longer-run inflation goals? To better
elucidate the root cause of this perception, an analysis of the FOMC's April 30-May 01 2013 minutes must be
conducted. It may be this perception that triggered the volatility in the markets after Bernanke made his June 19th
remarks.
Analysis of FOMC April 31-May 01 2013 Minutes
Commercial and Industrial (C&I)Credit Issuance
The increase in C&I credit issuance may have attributed to the perception of improved economic conditions
in the US. According to page 4, paragraph 4:
Yields on corporate bonds fell roughly in line with
those on Treasury securities of comparable maturity,
generally leaving their spreads little changed. The rate
of corporate bond issuance by nonfinancial firms remained
robust in March and April. Consistent with
recent trends, some companies reportedly retired a notable
portion of their outstanding commercial paper
and issued longer-term bonds in comparable amounts.

5. Syndicated leveraged loans were issued at a record pace
in the first quarter, supported by strong demand for
this type of asset, particularly from nonbank institutions.
Gross public issuance of equity by nonfinancial
firms was solid over the same period.
According to page 4, paragraph 5:
Conditions in some segments of the commercial real
estate (CRE) sector continued to improve in recent
months. Outstanding CRE loans held by commercial
banks edged up in the past two quarters following a
prolonged period of decline, and commercial mortgage-backed
security issuance was strong in the first quarter.
According to the Senior Loan Officer Opinion Survey
on Bank Lending Practices (SLOOS) conducted in
April, the fraction of banks that eased standards on
CRE loans over the past three months increased to a
relatively high level, while demand for these loans
strengthened further. CRE prices continued to move
up slowly, and price indexes for various market segments
reached levels last seen in late 2008.
Note that lending standards have been eased for C&I interests. This significantly increased loan distribution within
commercial and industrial credit markets.
According to page 4, paragraph 8:
Total bank credit expanded moderately during the first
quarter of 2013. Gains continued to be concentrated in
commercial and industrial (C&I) loans, which increased
especially strongly at domestic banks. In the April
SLOOS, relatively large net fractions of these banks
reported having eased standards and reduced spreads
on C&I loans to firms of all sizes.
The increased loan distribution within C&I credit markets and the subsequent gains may have contributed to the
perception of economic improvement and the nearer attainment of FOMC's longer-run inflation and unemployment
level goals.
Consumer Credit Issuance
Consumer credit markets are riskier than C&I credit markets due to the limited revenue-generation
components which significantly affects the frequency and sustainability of repayment on loans. Loan distribution
within the consumer credit markets have been narrowly-focused on collateralized, or asset-backed loans such as auto
loans and home loans. According to page 4, paragraph 7:
Consumer credit continued to expand in January and
February, mostly driven by sizable increases in nonrevolving
credit. Growth was particularly strong in auto
loans as well as in student loans extended through the
Department of Education’s Direct Loan Program. In
contrast, total revolving credit was about flat amid continued
tight underwriting standards and terms on credit
card loans. Issuance of consumer asset-backed securities—
in particular, those backed by subprime auto
loans—remained robust in recent months.

6. Consumer credit markets experienced a tightening of underwriting standards and terms due to the above-mentioned
risks under current monetary conditions.
According to page 6, paragraph 6:
Financial conditions appeared to have eased further
over the intermeeting period: Longer-term interest
rates declined significantly, banks loosened their C&I
lending terms and standards on balance, and competition
to make commercial and auto loans was strong.
Businesses were reportedly still borrowing to refinance,
but they had begun to take out more new loans as well.
Auto loans were strong due to their asset-backed nature. This also fueled demand for gasoline consumption.
According to page 6, paragraph 1:
Participants saw the housing market as having
strengthened further during the intermeeting period
and pointed variously to rising house prices, growth in
home sales, a lower inventory of houses for sale, a reduction
in the average time houses stayed on the market,
and encouraging reports from homebuilders. More
all-cash or investor purchases were being reported, and
the pace of home purchases overall appeared to be
constrained less by a lack of demand than by a lack of
homes for sale, in part reflecting fewer newly foreclosed
houses coming onto the market. The rate of
new delinquencies on mortgages declined nearly to precrisis
levels, and the pipeline of properties in the foreclosure
process was being slowly worked down, in part
through modifications and short sales. Over time, the
supply of homes for sale was expected to increase as
new construction picked up and sellers saw more attractive
opportunities to put their houses on the market.
The improvement in the housing sector was also
seen as contributing to a pickup in activity in related
industries.
Due to inflationary pressure precipitated by Treasury bond purchases, home values began to rise and due to the
asset-backed nature of home loans, the consumer credit market experienced an expansion of credit issuance in the
residential real estate market. The upward trajectory of home values increased demand for residential investment
properties. The increase in home sales and home values may have contributed to the perception that the US economy
had made significant improvements and the FOMC may be getting closer to attaining their unemployment and
longer-run inflation targets.
The question is: Is there actual significant economic improvement? Are the FOMC unemployment and longer-run
inflation targets being met?
If not, why not?
Unemployment Levels
During the so-called World Financial Crisis/Credit Crunch of 2008, most companies were unable to sustain
their revenue-generation levels and profit margins due to falling prices and rising debt levels. This forced companies
to cut costs at a frequent and significant rate. The major portion of those cost-reductions were labor costs. Most

7. laborers had only the options of accepting lower pay, accepting reduced benefits, or losing their jobs altogether. This
created a very large unemployment pool. The supply of skilled and unskilled laborers is significantly higher than the
demand. This positions companies to be very selective in their decision-making when it comes to making the right
investments in the labor pool. This may explain why according to page 2, paragraph 4:
After faster gains in January and February, private nonfarm
employment increased at a subdued rate in March,
and government employment declined slightly. The
unemployment rate was 7.6 percent in March, a little
below its average in the fourth quarter of last year. The
labor force participation rate also edged down to below
its fourth-quarter average. The rate of long-duration
unemployment and the share of workers employed part
time for economic reasons declined somewhat in
March, but these measures remained well above their
pre-recession levels. Indicators of near-term labor
market conditions were consistent with projections of
moderate increases in employment in the coming
months: Measures of job openings generally moved
up, but the rate of gross private-sector hiring and indicators
of firms’ hiring plans were subdued, on balance,
and initial claims for unemployment insurance trended
up a little over the intermeeting period.
Due to the supply-demand factors affecting employment levels, the high supply of laborers significantly affect the
wages and salaries of those who are currently employed. This is why according to page 6, paragraph 5:
Most of the recent reports from business contacts revealed
little upward pressure on prices or wages.
This clearly demonstrates that the high supply of labor significantly dampens the demand for that labor which is
reflected not only in hiring levels but also in labor costs (wages and salaries).
There are other factors affecting employment levels as well. During the height of the so-called World
Financial Crisis/Credit Crunch of 2008, many of the skilled laborers, professional-class employees, and unskilled
laborers had to look for employment outside of their traditional fields. Many went into business for themselves, and
others had to seek relief through employment insurance. This may explain why according to page 6, paragraph 4:
Participants generally saw signs of improvement in labor
market conditions despite the weaker-than-expected
March payroll employment figure. Employment
growth in earlier months had been solid, and
more-recent improvements included the further decline
in the unemployment rate in March and the gradual
progress being made in some other labor market indicators.
However, several participants cautioned that
the drop in the unemployment rate in the latest month
was also accompanied by another reduction in the labor
force participation rate; the decline in labor force participation
over recent quarters could indicate that the
reduction in overall labor market slack had been substantially
smaller than suggested by the change in the
unemployment rate over that period. One participant
commented that assessing the shortfall of employment
from its maximum level required taking account of not
only the gap between the unemployment rate and its
corresponding natural rate, but also the gap between

8. the labor force participation rate and its longer-term
trend—a trend which was admittedly subject to considerable
uncertainty. A few participants mentioned that
job growth may have been restrained to an extent by
businesses postponing hiring because of uncertainties
over the implementation of health-care legislation or
because they were unable to find certain types of skilled
workers.
Why would the implementation of health-care legislation be a factor in making hiring decisions? Considering that
health-care insurance companies must spend 80% of their premium, this may force health-care insurance companies
to raise their premiums in order to maintain profit margins. Considering that most businesses buy group health-
care insurance for their employees and recoup the costs through wage-garnishing methods, this would significantly
raise labor costs for those businesses.
All of these factors may explain why according to page 7, paragraph 4 under “Committee Policy Action”:
Labor market conditions had shown some improvement
in recent months, on balance, but the unemployment
rate remained elevated.
Inflationary Effects of Treasury Bond Purchases
The purchasing of Treasury bonds have the very real precipitous effect of keeping dollars in circulation up
to 30 years. This particular effect can induce what is known as inflationary pressure. Inflationary pressure pushes
prices in the upward direction. Since the US dollar enjoys the world's largest area currency usage (ACU) and all
currencies are still directly pegged to the US dollar, US-induced inflationary pressures directly affect world markets.
Purchasing Treasury bonds at the rate of $40 billion per month increases inflationary pressure incrementally. Even
incremental inflationary pressure is subject to the law of diminishing returns where prices eventually fall due to
reduced demand caused by costs eventually catching up with revenue levels—diminishing profit margins and
productivity levels. The US dollar's unique position enables the Treasury bond purchases to directly affect the
direction of price in all global markets including commodities, equities, and debt.
The Effects of Asset-Purchases on Global Markets
Food Inflation
Food inflation in both developed and developing economies has been around since September 2005. It
initiated from the raising of interest rates during the deflationary period of September 2005-March 24, 2009. During
this period, it was the justified increase in ethanol-production that initiated food inflation due to the increased
demand for corn which is the staple ingredient in most food products. Food inflation increased further since
Treasury asset-purchasing began on March 25, 2009 when the FOMC purchased $100 billion worth of Treasury
bonds. Food inflation directly affects the cost of living and therefore affects labor costs. If food inflation is allowed
to outpace wage and salary earnings, then productivity levels will suffer. This was seen in Haiti, India, and other
developing economies.
According to page 3, paragraph 7:
Economic growth in foreign economies overall in the
first quarter of 2013 showed only a small improvement
from that registered in the second half of 2012. Real
GDP growth picked up in the United Kingdom, and
recent indicators suggested that the pace of contraction
moderated in the euro area. In contrast, economic
growth in China slowed abruptly after surging late last
year. Foreign inflation appeared to increase a little in

9. the first quarter, partly as a result of higher food prices
in several emerging market economies, but remained
quite moderate.
Precious Metals
The purchasing of Treasury bonds has pushed commodity values in an upward trajectory, in particular gold
and silver. However we have recently witnessed price drops in precious metals. Why? The price of gold and other
precious metals has dropped for a couple of reasons:
1. As previously stated, prolonged inflationary pressure will result in costs catching up with revenue. This
results in the reduction of profit margins. When this occurs, the demand for such commodities dampen.
The productive output decreases due to increasing expenses to maintain the same level of productive output.
Equipment prices increase, refining costs increase, shipping costs increase, and of course labor costs
increase. The increase in price/value of these precious metals lowers the demand because the increasing
costs lower the profit margin generated from production of these precious metals.
2. Labor costs is the second reason. Labor costs (skilled and unskilled) increases because the cost of living
increases. This is the source of the many mining disputes going on around the world like in Azania (S.
Africa) and Papua New Guinea. Labor costs become a major factor in the production of mined
commodities. If left unattended, the increased cost of living with no upward movement on wages and
salaries will significantly reduce production. The decline in production and increasing production costs
significantly reduces the profit margin which also lowers the demand for those mined commodities. This is
appropriately referred to as a “correction” as demonstrated in the falling prices of these precious metals. As
everything in nature, market prices must eventually reach equilibrium or balance. Prices will continue to
fall until demand increases. The lower price and lower production levels will eventually increase demand
for the mined commodities. As demand increases, production will follow as long as the spread (difference)
between revenue and costs increases.
Energy and Other Commodities
According to page 3, paragraph 5:
Overall consumer prices, as measured by the price index
for PCE, edged down in March and rose just
1 percent from a year earlier. Consumer energy prices
declined in March, and retail gasoline prices fell further
in the first few weeks of April. Consumer food prices
only edged up in March. Consumer prices excluding
food and energy were flat in March, and their increase
from 12 months earlier was similar to that for total
consumer prices. Near-term inflation expectations
from the Thomson Reuters/University of Michigan
Surveys of Consumers were slightly lower in April, and
longer-term inflation expectations in the survey were
little changed and remained within the narrow range
that they have occupied for several years.
According to page 5, paragraph 5:
Spending by consumers continued
to expand, supported by better credit conditions,
rising equity and housing prices, and lower energy
prices;
It appears that energy prices also are subjected to the law of diminishing returns as demonstrated by the sustained

10. lower prices and the recent price jump experienced in the energy sector. This is the natural behavior of price
movements during a period of prolonged inflationary pressure. The fall in commodity prices may be the key to why
the FOMC claims they have not reached their longer-run target of 2% inflation.
US Stock and Bond Markets
When Chairman Bernanke made his June 19th
remarks, the US stock markets fell and bond yields rose.
Why? Is it that they perceived that there was significant economic improvement and feared the reduction of
mortgage-backed asset purchases? As explained before, without subordinate banks receiving the liquidity available
from the FOMC's purchases of MBS, credit issuance to C&I entities would be null under the current monetary
conditions. C&I interests would then become unsustainable. It is natural for US markets and companies to fear the
reduction of MBS purchases at any time under the current monetary conditions. Why did bond yields rise? This
naturally means that the value of the bonds decreased which may signify an increase in credit risk. A reduction in
MBS purchases means less liquidity available in C&I credit markets. The US bond markets may respond the same
way to a reduction in MBS purchases at any time under the current monetary conditions.
Chinese Stock Market
The CSI300 slid 3.3% on Chairman Bernanke's June 19th
remarks. Why did the Chinese stock market fall?
It can be for several reasons:
>Incremental inflationary pressure has significantly increased labor costs in China. This has made
manufacturing (one of China's staple sectors) more expensive. This has a dampening effect on Chinese exports.
Even worse, labor costs are beginning to equal that of the US labor market. Many US companies are now
considering manufacturing their products in the US where quality control can be better maintained. China risks
losing significant business from US companies.
>The double threat is that if MBS purchases are reduced, then China would lose business from the US
market anyway because US companies would not be able to sustain their operations and continue purchasing
Chinese products or continue having US products manufactured in China. The US market is one of China's largest
export markets.
>Incremental inflationary pressure also erodes the purchasing power of a currency. China currently holds
approximately $16 trillion of US debt. Under current monetary conditions, if MBS purchases are reduced and US
companies are unable to sustain operations, the US could possibly face credit default. China would then be left
“holding the bag” and face a $16 trillion loss. Of course this is an extreme possibility, but a plausible possibility
nevertheless.
Japanese Government Bond (JGB) Yields
Japanese Government Bond (JGB) yields rose on Bernanke's June 19th
remarks also. Japan's central bank
has recently initiated its own asset-purchasing program during this period when the markets perceived that
Chairman Bernanke hinted at a reduction in asset-purchasing. The Japanese yen is reported to currently be under
deflationary pressure, and a government bond-purchasing initiative is appropriate for that kind of monetary
condition. Why did JGB yields rise on Chairman Bernanke's statements? China is one of Japan's largest export
markets, and Japan export the raw material that is used by China to manufacture US products. If China loses
business with US companies due to MBS purchasing reductions, then Japan also loses business with Chinese
companies due to export reductions. The current conflict between China and Japan over the rights to the Senkaku
(Jpn)/ Diaoyu (Ch) islands has significantly damaged trade relations and has adversely-affected Japanese exports to
China. The US currently is Japan's largest export market and face possible loss of business from US companies if
MBS purchases are reduced. This poses a credit risk for Japanese companies as reflected in the JGB's rising yields.

11. Conclusion
The Treasury bond purchases at the rate of $45 billion per month was strategically implemented to induce
incremental inflationary pressure which drives prices up and puts the US dollar at currency devaluation risk. The
near-zero interest rate makes credit issuance nearly impossible due to the risk of a lender precipitating negative
balances. The MBS purchases at the rate of $40 billion per month provides direct liquidity to subordinate bank
holding companies for credit issuance purposes to C&I interests. Without this credit issuance, C&I interests would
become unsustainable under the current monetary conditions. For this reason, the world markets are concerned
about the reduction of MBS purchases at any time under the current monetary conditions. It was the perception of
economic improvement in the US that caused the world markets to respond the way they did to Chairman
Bernanke's June 19th
statements. Due to the current monetary structure of the US economy, any reduction of MBS
purchases will be the equivalent of pulling the rug from under the world economy. US businesses would not have a
leg to stand on. The MBS purchases are the required accommodation necessary to sustain the US economy under the
current monetary conditions.