I got this question this morning from a poster over on the Stool Pigeons Wire.
Am I correct in stating that regardless of whether or not the new reserves that will be added once the FED purchases the GSE/MBS paper are utilized to increase fractional-reserve lending (at least initially), there would still be substantial direct monetization because the Treasury account at the FED will be credited by the same amount of the purchases ( since they are the conservators now?). Unless the FED and Treasury have some sort of agreement for the latter to not spend that fresh cash, I don’t understand how this would not be inflationary.
Am I way off base here? – coastiepilot
This spurred some discussion. My response follows.
Whether any expansion of the Fed’s balance sheet is inflationary or not I think depends on what the recipients of the cash do with it. It also depends on whether the expansion is really monetization or just a circle jerk. If the Treasury or the banks are deposting cash at the Fed, and the Fed then lends that to somebody else, or back to the same players, that’s just a circle jerk. Only if those players then lend to other third parties would the money supply expand.
We need a lawyer to explain how conservatorship works. I don’t think that the accounts of Fannie and Freddie are consolidated with the Treasury’s balance sheet. I also don’t know that the the funds would be deposited at the Fed, or where or what the GSEs would do with the funds. I also don’t know how much of the paper would be purchased directly from Fannie and Freddie and how much from third parties. What will the third parties do with the funds; hoard or lend?
Also, as I have discussed in the Fed report, the Fed is now stepping in where the FCBs have stepped out. What difference does it make to substitute a subsidy from one set of central banks with a subsidy from another central bank? I guess it depends on the relative size and timing of the purchases. The FCBs have already dumped over $100 billion of GSE paper in the past two months. The Fed says it will buy $100 billion. Not enough, since the FCBs will only pick up their pace of selling now that the Fed is willing to replace them as bagholder of last resort. The Fed says that it will buy $600 billion of other MBS. What will the holders do? Will they lend, or will they just breathe a sigh of relief, say “thank you very much” and stick the cash in their pocket?
So although virtually everyone is doing it, I don’t think it’s prudent to automatically assume that any of this will result in inflation at any time in the forseeable future. We remain in a deflationary debt collapse, and until I see evidence that this slide is beginning to reverse, I want no part of any major committment to an inflation trade.
I am more interested in what is than in what will be, because I don’t think in this environment that you can count on any particular outcome. The trick is to identify when the game is changing as early as possible, but not too early. That is the point at which we adjust our strategy and tactics.
Japan already tried all this crap and they were never able to inflate. Why the inflation camp ignores this obvious and undeniable fact, I don’t understand. I suppose it comes back to what I have said in the past about the attachment to gold being more like religion. Goldbugs hold gold as a matter of faith. Not that there’s anything wrong with that. Sometimes it works. It has worked since 2001. I’m just not sure that it will continue to work in this environment. So call me an agnostic on the potential for future inflation.
Those are my thoughts at this time. I will continue to discuss these issues in greater depth in the Wall Street Examiner Professional Edition Fed Report. An update will be published today.
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