The US Money Supply is about to soar. Since general price levels in the US Economy, as measured by the CPI for example, are a direct consequence of Money Supply changes, Americans are in for a bout of high inflation over the next few years.
To understand why, we must look at one way that the FED works. The FED tries to contol the Money Supply by influencing Interest Rates. It does this mainly by buying and selling various securities, mainly short term US Treasuries.
If the FED buys these Treasuries, using newly created electronic Dollars, the Treasuries go on its balance sheet and the new Dollars make their way onto Bank balance sheets. New “demand” for the Treasuries push up their price, which causes the effective interest they pay to go down.
The Banks, holding these new Dollars, have choices of what to do with the Dollars, but they all boil down to investing them somehow to earn a safe return. For the last decade, safety has been hard to find. The FED in recent years has offered to pay interest on these Dollars, and most Banks have accepted the offer.
Banks are required to keep a certain amount of Reserves on deposit with the FED to backstop some of their loans – currently about 10%. Looked at from the other direction, if a Bank gets a Dollar on deposit, they may lend out $9 (systemwide) while keeping $1 on deposit with the FED. The $1 becomes $10 – all out of thin air! This is known as Fractional Reserve Banking.
So far, with all the Trillions created by the FED during all the QE operations, the interest they pay to Banks on Reserves has kept most of the newly created QE Dollars, that the Banks hold, on deposit with the FED. The Banks have not lent out these Reserves at the 10 times multiplier.
So, now enters both the FED’s new (correct) policy of raising rates and President Trump’s efforts to re…
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