The Fed should actually be shrinking the money supply

It's interesting, the speculation over the past week was whether or not the Fed would or should initiate a new round of quantitative easing, that is where the Fed effectively prints money by purchasing U.S. Treasuries with money it creates out of thin air, by key stroke entries into a computer. The fancy term for this is Quantitative Easing.

The government then uses that money to fund government operations along with the money it obtains through taxation and borrowing.

Kenyesians advocate this sort of thing as a way to stimulating the economy. To critics like Rick Perry, this is nothing less than the Central Bank trying to support Obama in his re-election hopes.

The latest round of printing, known as QE2, ended June 30 and the Fed has made no indication that there would be a third round. But with the economy now looking like it is headed for a relapse, there has been some speculation that the Fed would once again crank up the printing presses in in an attempt to stimulate the economy.

Well, excuse me for being contrarian, I think what the Fed should be doing at a time like this is to some of those treasuries the Fed been accumulating these past few years. It was when the Fed purchased those treasuries that they were effectively printing money. Increasing the money supply they like to call it.

I come at it from a different angle. Most of those treasuries the fed bought were purchased when the market rate on treasuries was quite low. People were seeking safety and treasuries were percieved as safe. What would happen if the economy began to take off? All the money that's been put out there would be put to use and all that latent inflation would begin to exert itself. To reign it in, the Fed would have to increase its interest rates it and it would have to reduce the money supply by selling treasuries. When the Fed sells treasuries, gets dollars in exchange which thereby is no longer in circulation.

But here is the problem: market interest rates would then be higher then when te Fed bought those treasuries and the Fed would get less dollars for those them then when it bought them. When market interest rates increase, the market price of bonds, including Treasures goes down. The Fed would be getting less on those treasuries then what it paid for them. Buy high and sell low.

I saw something recently that surprised and disturbed me. Don't have the exact data and don't feel like research it just now. But apparently out of the two or three trillion in assets and the two or three trillion in liabilities on the Fed's balance sheet, there is only something between $30 and $40 billion of net equity on the Fed's balance sheet. Maybe I am overstating it, but this strikes me as an hugely over-leveraged house of cards. Banks by their nature are highly leveraged. All it takes is a slighly degradation of the quality of its assets and it becomes technically bankrupt.

This was the essence of the financial crisis. But Central Banks like the Fed have traditionally avoided these problems by limiting themselves to the purchase of short-term high quality Federal debt. This time however, during the recent crisis the Fed (I understand) picked up assets with a range of maturity dates. This means today's market price for those securities can easily go down.

This means the Fed can easily find itself underwater, in very much the same way as so many homeowners that find themselves underwater.

With the debt crisis in Europe, there is a new flight to safety and people have been buying treasuries and gold likd hot cakes driving yields down. A month ago, yields on 10 year treasuries was near 3%. Now it is closer to 2.

When the Bank of England was a private corporation, beholden to its shareholders, this would have been a no brainer. Buy low, sell high. They should be taking advantage of this situation to unload treasuries and gold (why not?).

What would the effecf be on the economy? To Kenyesians, this would be a shrinking of the money supply which would be nothing less than suicidal.

I am not so sure. I am still gaming it out in my mind. I think the opposite would occur. Initially of course, the money supply would go down. But such a move would also signal to the world that the Fed has quit playing silly kenyesian games with our money, that the dollar will be a store of value that does not erode through inflation. People would prefer dollars of gold, dollars over Euros and the demand for dollars would increase. The Fed could then increase the supply of dollars without imparing its value.

Overall, such a move would improve the solvency of the Fed which would enhance the quality of the notes they issue.

Ron Paul rising in the polls

I like Ron Paul. He resonates with me. If you vote for Ron Paul, one thing's for sure, you'll get smaller government, the one thing this country badly needs.

"We should just mind our own business!" Another thing of Ron Paul that resonates with me. Imagine a U.S.A. that minds its own business and doesn't spend trillions to mind other people's business; States as well Countries!

I also think it's long past time we take our our currency out of the hands of those who continually mess with our currency and return to a gold standard of some sort.

All good stuff.

The only problem is that Ron Paul is nuts. The first criteria to be President: you can't be crazy! If he wasn't nuts I'd vote for him in a heart beat! Even if he is crazy, he looks way better than the guy we gut now.