First, what exactly does it mean when
you say the Federal Reserve’s balance sheet has swelled to nearly $2
trillion on this crisis? (Or if you want to get technical –
Bloomberg just estimated the Fed and U.S. government had pledged
$12.8 Trillion in stimulus programs when the stock market finally
started to recover in March.)
Where does all that money go?
It’s often said the Fed simply “prints
more money” to cover this alphabet soup of stimulus programs,
bailouts, and market crises. While that’s true, it doesn’t
necessarily tell the whole story…
What “Printing More Money” Really Means
Personally, every time I hear about
the Fed printing more money, I always imagine the iconic image of
the German woman shoving deutschmarks into the fire to keep herself
warm, after her currency collapsed in WWI.
The implication is that every time the
Fed prints more money, there are more dollars circulating, and the
dollar edges closer to becoming worthless. Possibly even kindling
for a future fire.
Now here’s the truth in that
statement. The Fed does drag down the dollar’s value with
their mountains of spending, their cut interest rates, and other
programs designed to prop up the equity markets. So you see the
dollar’s value drop in value, as the Fed spends more.
But the Fed doesn’t really have to
“print money” to grow their balance sheet. They don’t have to run
the printing presses or circulate mountains of dollars.
No here in 2009, if they want to
expand their balance sheet, they simply add a couple extra zeroes to
the bottom line. Or in other words, they massage their accounting,
to the point that makes Enron look tame.
You must understand the Federal
Reserve bankers are the masters of “fractional reserve banking.” Now
fractional reserve banking takes place all over the world. It
basically means banks only have to keep a small percentage of their
deposits in reserve, but they still have to be able to lend out all
these deposits on demand.
It’s a tricky business. But it means
banks don’t really have to keep enough dollars in their vaults. They
simply have to have the future promise of money to pay back future
(And thanks to institutions like the
FDIC, banks can still stay open even if the public knows the bank
doesn’t really have enough money in its vaults to pay off everyone
if they all showed up at once.)
It’s the same with the Federal
Reserve. When they expand their budget or their balance sheet,
they’re really creating the promise of future money
creation. In the meantime, they keep a fraction of these money
promises in reserve, and loan it out to banks and other institutions
If they were just running printing
presses to create more dollars, they could spread those dollars and
eventually spark inflation (assuming consumers started spending
those dollars). But as it is, they’re just promising money some time
in the future, with their own brand of accounting.
Our Head Researcher at World Currency
Watch, Ashish Advani calls the Fed’s accounting rules
“mark-to-make-believe” instead of “mark-to-market.”
In other words, the numbers are
estimates at best. You can see the proof right on the Fed’s website.
They have their own version of the “money supply” and also show how
loans are calculated and channeled through the various banks and
other institutions. If you look at them, you’ll notice the numbers
are very close.
And yet, you’ll also notice that the
rate of loan growth in the past 30 years has been greater than the
growth of money supply. This shows that the Fed is less dependent on
the printing press and more dependent on the rules it uses to allow
banks to create money.
For example, low interest rates allow
people to take out loans they otherwise couldn’t afford. The Fed can
also set the reserve rate of money banks need to keep on hand. And
thanks to lax rules there, it’s significantly less than the 10%
Eerily Alike, But Loans Grow Faster than
Money Supply …
Why does this matter? It’s important
to understand that the vast majority of this money creation takes
place electronically, with some very interesting accounting rules
that would land the accountant of a real company in prison. It means
the Fed essentially is paying its ‘crisis intervention’ tab with
dollars that don’t exist yet.
Or they do…but just on their books.
So in the long run, the Fed may as
well be running those printing presses because the result is
essentially the same. It systematically breaks down a currency’s
value when you constantly create more money out of thin air.
Tomorrow, we’re going to dive into the
most interesting investments that the Fed is buying this year and
why. Till then…
Good Currency Investing,
Rohr, Editor of FX University
P.S. The Fed has done more than just
create money out of thin air to fix this crisis. Bernanke and his
buddies are also pouring money into a few key investments to help
prop up the markets. In fact, they may be fueling one of the largest
bubbles in market history. Later this week, your editor Chuck Butler
will release a special “Fed awareness” video that gives the details
on how to protect your dollar holdings and the rest of your
portfolio from this coming threat.
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