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Strategies & Market Trends : Mish's Global Economic Trend Analysis
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To: Bill/WA who wrote (76992)3/27/2008 10:22:19 PM
From: Moominoid  Read Replies (3) of 116555
 
The Fed "prints" money by buying bonds outright for cash. The cash is new. This new money is in theory a loan from the public to the central bank. The Fed's balance sheet treats it as a liability:

en.wikipedia.org

They did such an open market transaction in the last few days though they are not so common. Much more common is the Fed temporarily lending to the banks using bonds as collateral. These repos turn over all the time.

There is no limit on how much money the Fed could "print". But this would cause inflation. In general they carry out temporary and permanent transactions to keep the Federal Funds Rate at their target rate set at the FOMC meetings.

Where the Fed is limited is in their new program to lend Treasury Securities (bonds) to banks. They can only lend out as many as are on their balance sheet. Some have suggested that if they ran out the Treasury could step in and buy assets by selling new bonds for them.

It's a bit like a fixed exchange rate regime. If your currency is undervalued you maintain the rate by buying foreign currency with newly printed domestic money at the fixed exchange rate. You can do this forever, but as China is seeing the result is inflation. On the other hand if your currency is overvalued you must buy it at the fixed exchange rate by selling foreign currency you own. And you can eventually run out of that.
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