Wednesday, April 9, 2008

What will the FED do next?

Fundamentally, the Fed would have two options: It could increase the size of its balance sheet by issuing cash, which would require sacrificing its target Federal Funds rate target and letting that rate drop to zero. This option is referred to in the trade as "quantitative easing", but that's just a fancy term for printing money and tolerating any inflation that results. Alternatively, the Fed could expand its balance sheet by borrowing from someone else — from the US Treasury, from banks with excess cash, or from the public directly. This would permit the Fed to increase the scale of its asset swaps without sacrificing its ability to conduct ordinary monetary policy.   Source

The Fed is now considering borrowing from the Treasury (US taxpayers). Were the Fed to have to do this to remain whole, i.e., have the Treasury underwrite the Fed's balance sheet, the US central bank would be de facto insolvent, having insufficient assets to carry out its mandate. The perceived invincibility of the Fed's ability to reflate is now clearly in question. The Fed's own discussions prove it.  Source