Can the Fed Successfully Exit?

That is the title of an important article posted on the Mises Institute's site today. It explains a couple of important points that have been made on this blog.

First, the reason we have not seen high price inflation is because most of the new money created by the Fed in the last couple of years has gone to the banks. The banks have kept this money as excess reserves and have been unwilling or unable to lend it out.

Second, the Fed will have trouble exiting its "quantitative easing" (creating money out of thin air) from the past. When the Fed created this new money, much of what it bought were bad assets. For instance, it bought mortgage backed securities that are considered subprime. The bottom line is that these assets are not worth near as much as what the Fed paid for them.

If the Fed paid $1 trillion dollars for some bad assets that are really only worth $600 billion, then the Fed could only sell back these assets on the open market for $600 billion. What happened to the other $400 billion? It is new money in the system. If it sits on reserve with the Fed, this helps keep a lid on price inflation. If it finds its way out of the banks, it will eventually cause price inflation.

The Fed is in a tough place. It will not be as easy as they say to "exit". Watch the adjusted monetary base and watch the excess reserves held by banks. This will be your guide in preparing for high price inflation.