JrowL, yes at the moment the banks are essentially loaned money at 0% from the FED in exchange for what is often poor quality collateral, such as Greek/Italian govt bonds and Mortgage Backed Securities (MBS) that are not marked to market. They are buying US government paper for negative real returns because these bonds are still the most liquid market on the planet and in this market US government paper is still considered to be 'risk free return'. When that paradigm changes and they start to be seen as 'return free risk', then we will see a run on the bonds. Remember that the central bank is the Bankers' bank and its job is to keep the banks in business. Governments come and go but big banks generally hang around a lot longer. Banks make money by earning interest on credit and through massive leverage (and also engaging in financial fraud) so they do not like de-leveraging although they cannot prevent it.
When government debt and other toxic assets start to threaten the solvency of the banks they either go bankrupt or if they are 'TBTF' the debt is transferred to the tax payer via the central bank balance sheet, as we have seen repeatedly over the last few years. The FED is forced to step in to the market (open market operations) and buy assets directly, including government paper *. Generally this occurs when there are no other buyers but right now there are still plenty of buyers of US government bonds including foreign central banks. Note that the bond market in a fiat/debt-based currency system is more or less just another ponzi finance scheme whereby there must always be more subscriptions than redemptions for it not to collapse. Maturing debt is not payed back in full, it is rolled over or financed with more new debt issuance. So the cheque always comes but in real terms it has been devalued.
When Chinese exporters exchange their dollars for renminbi, the Chinese central bank prints currency to maintain a peg and so inflation is effectively exported to China. That's one reason we haven't seen very high inflation in the US to date (it gets exported). The other reason is that although the FED has 'printed' trillions or created trillions from thin air since 2008 to inject 'liquidity' into the banking system, at the same time the elastic/endogenous money supply has contracted by a far greater amount. What we see when these two forces are at work, based on superposition, is stagflation (rising unemployment and rising consumer prices) along with asset price deflation in real estate, stocks, etc.
Armstrong says it best
"We are experiencing a Destructive Inference whereby we have INFLATION being generated by government through the expansion of debt in the classic sense and the elastic money supply capacity of the Federal Reserve. This, however, is being offset by the DEFLATIONARY trend created by the deleveraging and fall in value of the “real" money supply composed of all things tangible including real estate, stocks, and even gold. If government were expanding the currency supply (currency and bonds) in isolation, we would have the risk of HYPER- INFLATION. However, since we are deleveraging still in the private sector, these two trends are offsetting each other creating a DESTRUCTIVE INFERENCE, which is why gold has NOT broken through that $2,000 barrier."
* If anyone needs convincing that the big banks are in bed with government and that central banking is a complete fraud designed to keep the elites in power and you in perpetual debt, think about what this actually means. We are borrowing money from ourselves and paying interest on it! It used to be that the treasury issued its own debt-free notes which did not have to be payed back with interest. Now as government continues to grow so much tax revenue is spent servicing government debt and deficits.
