This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Tuesday, November 9, 2010

"Hello, Your PIN is now 'CASH':” How to Get a $600 Billion Hit from the Money Machine

Before the final votes had been tallied in many midterm elections, and the potential impact from the recent shift in power both in Congress and among governors around the country, Federal Reserve Chairman Ben Bernanke announced on Wednesday that the Fed will begin a second round of quantitative easing (dubbed "QE2" by market pundits).

Apparently the first round of quantitative easing – read: “money printing” – didn’t quite have the impact that regulators had hoped. This time around they’ll be printing somewhere in the neighborhood of $600 billion to buy back government bonds and inject liquidity into the market.

For those who enjoy little comparisons, imagine this: if someone were to stack 600 billion one-dollar bills on top of each other (NOT long-ways), the pile would be over 40,700 miles high.

In politics, though, all that money is just another line on an ever-expanding spreadsheet; and its “pounds of prevention” likely won’t add up to one ounce of positive economic impact.

The problem with all this “quantitative easing” nonsense is that none of the new funds being created are trickling down to the business community, much less consumers. Instead, all the Fed is doing is printing money and giving it to banks. The banks then turn around and redeposit that money with the Federal Reserve in the form of excess reserves, on which they are paid interest.

You read that right. Banks are being GIVEN money – at the expense of American taxpayers – and rather than using it to stimulate the economy, they hoard it. What’s more, they get REWARDED for their hoarding.

Although this series of events serves to expand the monetary supply – which is inflationary – that inflation is not realized in the economy because none of the new money is actually flowing around the economy. In other words, the velocity of money is too slow.

In order for any injection of liquidity into an economy to make any kind of positive impact, that new money needs to start flowing around the economy. Velocity must pick up in order to see a sustainable economic recovery.

Sound familiar? Maybe a little like the “trickle-down effect” that was a main focus for Reaganomics?

What few people seem to understand is that, contrary to popular opinion, the Federal Reserve has absolutely no desire to support either the business community or the citizens of this country.

Truthfully, the name “Federal Reserve” is a misnomer. The powerful central bank is neither federal, nor a reserve). In fact, it is little more than an interbank lending center that is privately owned by several of the world’s largest banks.

What this means is that the Federal Reserve is looking out for its own best interest by protecting the banks that own it. Like any good subsidiary, its sole focus – and Bernanke’s primary goal – is to help make money for its parent companies, namely big banks.

In order to increase velocity, the Fed needs to make some policy changes – possibly under pressure from a more conservative Congress.

First and foremost, the Fed should stop paying interest on excess reserves held by banks in the system. In fact, the central bank should start charging banks a holding fee for holding such excess reserves. That would quickly shift the banks’ motivation from wanting to hold reserves for small interest payments from the Fed. Suddenly they would have a reason – and a very strong one – for wanting to make loans to businesses and individuals.

This, in turn, would fuel economic growth in this country. Suddenly, instead of businesses and consumers have to bend over backwards to find banks willing to lend, banks would be competing for their business. Corporations would instantly find new expansion projects financially profitable and individuals would be able to loosen up their purse strings. Some might even start their own businesses.

If they’re smart, Republicans better do something to shift monetary policy in this country to encourage economic growth, and they better do it before the 2012 elections. While they might not have taken a majority in both houses of Congress, the ball is definitely in their court now.

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