So what's the deal with this? I've written ages back that it's a simple affair to print and sterilize by raising the reserve ratios as the offset. But Ron Paul has something a bit different in mind. Just grab the Fed Res by the short hairs and burn the US Treasuries they hold. And why not? It is, as he says, just the US owing itself it's own obligations.
Because it's Ron Paul talking about the Federal Reserve. If there's anything to this, it all involves brimstone for Bernanke.
As a matter of pure accounting this works just dandy if the T's are wiped off the asset side and the previously printed dollars are wiped off the debit side of the books. In essence it works just like a POMO and leaves the currency that's out there, out there. If it's not done in this manner exactly then the Fed's assets go even more south then they already are, the dollar takes a swan dive into parking block, and it's Goodnight Gracie.
But done in this manner means that the Fed no longer has any assets to account save swap lines -- which we are assured are responsible and money good -- and the various holdings along the lines of MBS's -- which we are assured are responsible and money good. Of course the various assets pulled in are not money good as you should be well aware. That requires a fast action on Bernanke's bit other than leaping out the nearest tall window.
And certainly you need not accept that this is the case. All you need know is that the banks do not believe they are money good and cannot have these things littered about on their balance sheets.
In either case this empties Bernanke's bazooka and he's going to need to restock on a boatload of US T's to get his house in order. Aside reserves his only policy possibilities are securities, T's, and lucre. And he'll be fresh out of T's. Which puts the Fed Res bad on paper and the dollar takes a swan dive with him in the fireman's seat.
Solving that for things requires that he unwind the loans made that are using the MBS's as collateral to get cash back on the coffer. This then needs to be turned right back around to wind the cash out and pull the unburnt T's back in from the banks. The cash stays where the cash currently is, in the vaults. But now the Too Big Too Fail is now faced eating that which cannot be eaten. Which is nicely nasty as this puts an even larger smoking hole in their balance sheets than exists already.
And that starts blowing things up, Lehman style.
Moreover, while this is all perfectly neutral, I'd lay a good wager that this would count as a credit event for all those CDO's that might be out there. Which leads to all manner of possibly crazy consequence and unwind that has us again rollin' like the Lehman Bros. And that one is completely unstoppable if it gets out the gates faster than Geithner can find the right entry box in Turbo Tax.
If things go beyond this and raise the reserve ratios as a consequence of keeping lids on for the sake of sterility in the money supply then it's far worse still. Not only do the banks get to eat their MBS on the balance sheet again, they can then use less of what little asset value their is to satisfy their Capital reserve ratios. And *BAMF* it's all down to bank holidays and the like.
If this comes to pass, and it won't unless they push a panic vote on the thing, then Bernanke will pursue the course mentioned here and damn the torpedoes. If he does not then the Fed Res gets mated in one. No matter how many sets of books he tries to keep. The alternate is to push it all back onto the banks, finagle around a CDO unwind, and cook the books at BAC and Citi even more than current. All to keep the Bair at bay and prevent utter destruction of everything.
The last possible alternative is that Congress turns around to immediately issue $1.6 trillion in new T's to sop up the problem at the Fed. Which has the same consequence on the dollar valuation regardless in the short term. It's a sweet bit of Machiavelli and really puts the pedal to the metal in collapsing the current monetary and banking system if it goes through.
It all boils down to how desperate the D's and R's currently are about keeping the checks flowing out on August 1 and beyond.
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