Monday, December 28, 2009

Fed Wants to Drain Reserves

Today, the Fed announced hopes of crafting a policy which would drain banks of their reserves[1]. Apparently, this is to keep reserves from being lent out[2], suggesting the possible initiation of a stronger dollar policy, or at least stop it from weakening further.

I've been commenting for awhile about the increase in base money supply by over $1T since September 2008. At the same time, it has not had an impact on the actual money supply because it all seems to be sitting in bank reservers not doing much of anything. So, does the Fed want that money back? I have doubts.

Anyway, this is all in the "announcement" phase and far from the "planning" or "action" stage. I prefer to wait until the action stage, or the planning stage at the earliest, before commenting on anything. However, the articles have an interesting statistic: The Fed's balance sheet is now $2.2T with the intent of absorbing $1.25T in mortgage-backed securities through March.

Since most of these securities are probably toxic with minimal chance of being paid back, this amounts to a pure infusion of around $1T into the economy.

This kind of money should be inflationary, however we continue to see deflation, particularly in the housing market, due to the much greater contraction of credit, both through defaults, and the general resistance and reduced ability of the the public to take on more credit.

1. Fed Proposes Term-Deposit Program to Drain Reserves.
2. Fed Proposes Tool to Drain Extra Cash.

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