The Fed's Biggest Bubble

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"Creating money from nothing sends erroneous signals to traders."

Even top-flight Wall Street analysts seem to believe that the Fed's doubling of the monetary base after the credit crunch has not had an inflationary impact on our economy. Their logic can be summed up like so: "The money the Fed created and dropped from helicopters has all been caught in the trees." In other words, the Fed is creating money, but it is just being held as excess reserves by the banking system instead of being loaned to the public. Therefore, the money supply hasn't truly increased, there is no money multiplier effect, and aggregate price levels are behaving themselves.

But this is only a half-truth. Yes, most of the money created by the Fed has been kept by commercial banks as excess reserves. However, the Fed doesn't conjure reserves by magic. It first creates an electronic credit by fiat, then purchases an asset held by a financial institution. Those primary dealers then deposit that Federal Reserve check into their reserves. The act of creating money from nothing and buying an asset drives up the price of that asset in the open market, which sends erroneous signals to private buyers and sellers, eventually creating gross economic imbalances.

Therefore, the inflation created by the Fed first gets concentrated in whatever asset it has chosen to purchase - before spreading throughout the economy.

While it is true that we have been spared from the imminent curse of skyrocketing consumer prices, thanks to the falling money multiplier, it is blatantly untrue that the trillion-plus dollars the Fed created have been rendered inconsequential.

U.S. sovereign debt should only enjoy such historically low yields due to an overabundance of savings, low inflation, and low debt. None of those preferable conditions currently exist.

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