The Federal Reserve is on track to pump about $3 trillion into the banking and financial system.
Eventually, that money has to come back out of the system.
What then?
It appears the Fed is already thinking about that to a degree. That explains why the Fed is not buying assets directly. Rather, it is lending money to buyers and holding assets as collateral.
That's important, because it's much easier to let a loan expire than it is to sell an asset at auction. All the Fed has to do to unwind many transactions is let them expire. It gets the cash back and returns the asset.
In theory.
In practice, it won't be easy to pull a couple of trillion dollars out of the banking system right away. The Fed will have to do so over time. A couple years? Ten? Your guess is as good as mine.
And what happens if there are losses and the Fed does not get back 100 cents on the dollar for each loan? Time to sell the collateral?
Doing nothing is not an option. If the Fed leaves all this money in the banking system and the economy recovers, then you'll have inflation. Big time.
You can see how this will get complicated fast.
Clearly the first step is the rescue. No sense in worrying about where the water goes when there is a fire to put out. But one day the fire will go out and it will be time to clean up the mess that's left.
Comments
With the last eight years of increasing deficits this additional borrowing and less tax revenue will leave few options.
I see inflation hitting 12% by next Thanksgiving.
What we need is a tax system that discourages consumption and encourages production and investment.
A switch from an income, wage and corporate tax to a universal transaction tax with a pre-bate equal the tax paid on subsistence consumption would achieve this goal.
The rate would be too small for cheaters to risk not paying. The banking and credit system's existing IT infrasturcture, could make tax collecting and pre-bate payments very efficient.
The idea is that if you have money to buy, then you have money to pay taxes. While at the same time everything dollar you earn you can keep, creating a huge incentive to work and take-on business risk.
The way to retain the value of the dollar is to increase our productivity faster than our consumption.