Why The Fed Swaps, Announced Today, Will Expand The Monetary Base

Tony Crescenzi,Senior VP,Strategist and Portfolio Manager at Pimco explains how the swaps announced by the Fed will expand the Fed's monetary base:

[A]ny use of the Fed’s swap facility expands the Fed’s monetary base: all dollars, no matter where they are deposited, whether it be Kazakhstan, Japan, or Mexico, wind up back in an American bank. This means that any time a foreign central bank engages in a swap with the Federal Reserve, the Fed will create new money in order to make the swap. Use of the Fed’s liquidity swap line in late 2008 was the main cause of a surge in the Fed’s monetary base at that time. The peak for the swap line was about $600 billion in December 2008. Some observers will therefore say that the swap line is a backdoor way to engage in more quantitative easing.

Keep in mind that the monetary base is important, however, money in the base does not mean it is necessarily money in the economy. For example, most of the money created by the Fed in 2008,and up until recently, went into excess reserves and thus did not impact the economy. Bernanke may not be so lucky this time. If the money stays in the system and doesn't end up in excess reserves, the price inflationary consequences will be huge.. The money created by the swaps is being used to bailout Greek, Spain etc debt. That money is likely to end up being used to buy even more PIIGS debt, which means it will end up in the hands of the Greeks, Spaniards, etc. and not as excess reserves. German Chancellor Angela Merkel fought tooth and nail to prevent the ECB from .monetizing the PIIGS debt, so instead, Bernanke has stepped in to inflate. Bernanke is playing with fire here and Americans are all likely to get burned with soaring prices.

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