Fed Prints Money for Banks to Hoard, Delaying Inflation

The New York Times covers the Fed’s rate cut yesterday. A few interesting tidbits from the article:

…the Fed bluntly announced that it would print as much money as necessary to revive the frozen credit markets and fight what is shaping up as the nation’s worst economic downturn since World War II.

Since September, the Fed’s balance sheet has ballooned from about $900 billion to more than $2 trillion as it has created money and lent it out. As soon as the Fed completes its plans to buy mortgage-backed debt and consumer debt, the balance sheet will be up to about $3 trillion.

“Right now, the crisis is created by the huge demand by banks for hoarding cash,” (says one expert.) “The Fed is providing cash, and the banks want to hoard it. When things start returning to normal, the banks will want to start lending it out. If that much money is left in the monetary base, it would be extremely inflationary.”

So we’re deflating in order to help banks bulk up their reserves enough to make them feel comfortable lending. After that, the Fed will have printed too much money, so it’ll be inflation city. Pray tell, how is this helping Main Street at all?

Credit Writedowns suggests an alternative scenario:

…what if the Fed came to my CFO and said we’ll trade you some of the Treasurys you own in your short-term investments for dollars? For the right price, we would say yes. Where do the dollars come from? Out of thin air of course. The Fed creates them in order to buy my assets. This is called quantitative easing. It’s basically inflating the money supply plain and simple. The difference between quantitative easing and low interest rates is that easing actually increases my reserves, giving me more money to lend.

To my mind, lowering interest rates in the aftermath of an enormous credit bubble where institutions have just destroyed $1 trillion in capital is wrong. It distorts lending decisions such that yet more money will eventually be lent out imprudently. The only way to increase credit availability is by getting reserves into the system. And normally you do that by making a profit. However, profits are hard to come by for financial institutions right now. So the Fed can step into the breach adding reserves by purchasing assets with money that the central banks creates.

He says this is inflationary, but so is what we’re doing now, in the longer term. Bernanke’s religious anti-inflationary policies remind me of Greenspan’s fervent free-market policies, which also didn’t end up working out…

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