The Fed’s Real leash (Credit is not Currency, part II).


I don’t have any information on the rate at which the US Treasury can print physical US Dollare notes, but nevertheless this article on the privately owned FED’s ability to create credit explains quite simply what it can and cannot do.

I was going to leave this subject alone for awhile, but recent comments have overcome my intentions. Recently, I saw a post that  stated that ‘The Fed could create $100 Trillion in about two nanoseconds’.

I am out of superlatives, so I will start by just stating that this is impossible. And if they Tried, the effect would be profoundly Deflationary.

That’s right. DEflationary.

The last time I checked on the matter, for every $100 in checking accounts, there is about $2.50 in actual currency floating around. This gives us a baseline approximation for the aggregate faith the mean $US holder has in the safety of his bank deposits, vs. the surety of cash in hand. in this case, it might be helpful to think of dollar bills as the poor man’s CDS – and they have (again, in aggregate) elected to so ‘insure’ 2.5% of their holdings. Or, conversely, they have 97.5% faith in their banks.

Now I fully realize that there are distortions here – for example, some of these $US are circulating overseas, with no checking accounts involved, so the domestic ratio may be a bit smaller. But since the cash ratio presented is unlikely to go lower in times of mounting financial turmoil, I think it remains a useful first approximation.

This ratio presents a Severe check on any notion of the federal Reserve being able to ‘brute force’ inflation.

First, bear in mind that the US Government can only print actual currency so fast. I have seen estimates here on SA that printing a $trillion worth of $100 bills would take 80 years. If they rerelease $1000 bills (and get them to be acceptable to the masses) that would cut it down to 8 years – still to slow to effect the sort of prompt inflation ‘desired’. So Any such “100 trillion dollars in 2 nanoseconds” can only be done by creating Credits.

And here’s the important part: The dollar holders of the world have voted that they want to draw about $1 in cash for every $40 in their checking accounts. So if the fed creates credits more than about 40 times faster than it can run its physical printing presses, at some point, some one is going to walk into a bank, try to make a withdrawal . . . and be denied, due to lack of currency on hand.

In this, the Twitter Age, that event will be generally known in about 14 seconds. And then a general bank run will begin, as many, Many customers rush to secure their comfort level of cash, which they will (rightly) see to be endangered. In this circumstance, banks will necessarily have to suspend operations – and the severity of the situation will ironically be in direct proportion to the degree of credit inflation up to that point. The ‘comfort’ ratio will rise, and the value of bank account credits (and that’s all they are, credit, in law and in fact) will deflate drastically, to pennies on the dollar.

This would represent a staggering destruction of $-denominated purchasing power. It would wipe out every bit of $-denominated credit in the system that was in excess of the available currency pool, And it would absolutely stymy any further credit inflation attempts by the Fed, as credit requires a willing participant, and at that point the vast majority would view Fed credits as worthless.

This doesn’t mean they won’t try. I imagine Somebody at the Fed understands these truths, but, as I have said before, Bernanke is clearly as delusional as any Sophoclean protagonist. But the results of any such exercise will Not stop deflation. It will herald it.

So, please, no more silly talk of umpti-trillions at the snap of a finger.

Jasper M’s blog on Seeking Alpha. July 03, 2009.

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