The Fed's Binge: How the Federal Reserve Engineered the Most Dramatic Peacetime Experiment in Monetary and Fiscal Stimulus in U.S. History without Anyone Noticing

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UP UNTIL SEPTEMBER, Federal Reserve Chairman Ben Bernanke effectively sterilized all his financial crisis-fueled monetary injections, either by directly trading Treasury bills for riskier financial securities or by indirectly loaning to financial institutions with money recouped by selling Fed-held Treasuries on the open market. Either way, there was no major impact on the monetary base. As a result, the annual rate of growth of the monetary base remained in the neighborhood of 2 percent through August, with total bank reserves remaining virtually constant.

But after September 17, when the interest on T-bills briefly went negative, Bernanke opened the monetary floodgates. In August the monetary base had been $847 billion, with total reserves constituting $72 billion of that. (None of these figures are seasonally adjusted or adjusted for changes in reserve requirements.) A Fed press release on October 22 put the base at $1.149 trillion, a shocking 40 percent jump over the previous year. What has exploded even more is total bank reserves, where the base increase is concentrated. Reserves increased by an astonishing factor of five over the course of just one month, and as of late October were somewhere between $343 and $358 billion.

And that's not all. Federal Reserve Bank credit also doubled to around $1.8 trillion. Although Fed credit once closely mirrored the monetary base, that is true no longer--not since the Fed activated its U.S. Treasury supplementary financing account in the fall. This boosted additional Treasury deposits from zero to approximately $560 billion. The new deposits resulted from what the Treasury calls its Supplementary Financing Program, initiated in September to try to staunch the growing demand for Treasury securities manifested in falling T-bill rates.

Essentially, the Treasury is now issuing extra securities to borrow money from the economy, then loaning the money to the Fed in these special deposits so that Bernanke can re-inject it to make his bailout purchases of various securities, all without increasing the monetary base. In other words, what the infamous bailout act permitted the Treasury to do directly is something it had already started doing indirectly through the Fed to the tune of half a trillion. All in the name of easing a tight Treasury market.

This means that the total bailout is not the $700 billion that Congress appropriated, but at least $1.2 trillion. And that figure doesn't include the Fed's mid-October promise of $540 billion to bail out money market funds, which if not covered by the Fed's sale of other assets, will require either further monetary increases or further Treasury borrowing. Thus we now have the worst of both worlds: a massive bailout financed both by Treasury borrowing (in order to avoid inflation) and a Federal Reserve increase of the monetary base (which heralds future inflation anyway). …