The Fed balance sheet and Inflation
By Robert Perrego, at 2:06 pm on April 24th, 2009Much has been said about the Fed blowing up its balance sheet in the past months and how it should ‘inevitably’ lead to inflation. This inflationary threat is what has all the ‘gold bugs’ loading up on gold ETF’s and the stocks of gold mining companies. I should know – I am in this camp.
Well, today the Fed released its balance sheet and one item shows that the Fed took $74 billion of toxic debt onto its balance sheet from Bear Stearns and AIG and that these assets have already depreciated by $9.6 billion.
This buying of assets by the Fed means they pay out dollar bills into the financial system increasing the supply of dollars in circulation. This increase in the supply of dollars floating around is what decreases the value of all the other dollars. This is result of the Law of Supply – as the supply increases, what is out there decreases in relative value. The gold bugs are saying that with more dollar bills out there that number of dollar bills you trade for an ounce of gold, which is more difficult to put into circulation, increases, i.e. the price per ounce goes up. This would be true for all purchases made with the dollar. Voila – Inflation.
The Fed contends that they can control this future inflation simply by selling or removing these assets from their balance sheet in the future at the ‘appropriate’ time. A recent conference held by some of the Fed policy and decision makers left one guy, who knows a little something about the Fed, a bit confused. This guy was none other than Paul Volcker, one of the most famous inflation fighters of all time. If what the Fed intends to do to control inflation confuses Volcker as to how well it will work… well, that is a bit scary.
By not taking sides in whether the current decision makers at the Fed can control future inflation through their deft machinations, I have one question; ‘What about that $9.6 billion?’
Seems to me its gone and the greenbacks are still out there. The Fed cannot sell the toxic assets to get those dollars out of circulation – that capacity is gone for good.
That my friends feeds inflation right there.
So what else did the Fed buy? What is it all worth now? What will it be worth in the future and how many dollars can the Fed pull back in out of circulation when these toxic debts are worth a lot less?
Maybe this is why the worlds largest holder of dollar bills, China, is quietly buying gold.
