Base Money and Fed Bailout

In violent times
You shouldn't have to sell your soul
In black and white
They really, really ought to know
--Tears for Fears

In his always insightful weekly piece, John Hussman updated his graphic of 3 month T-bill yield vs base money as a % of GDP.

The value relative to the x-axis alone should give cause for pause. Base money as a fraction of GDP has never been higher.

Why hasn't this translated into huge increases in prices? Because with ultra low returns on cash being suppressed by the Fed (y-axis), people (including banks) have been holding onto most of the money that's been printed out of thin air rather than using it in transactions.

Stated differently, the velocity of money has slowed way down.

If this propensity to hold cash changes, then velocity will pick up and interest rates (and prices of milk and bread) will rise--despite the Fed's best efforts to suppress them.

As Dr J notes, normalizing yields to just 2% would require the Fed to unload half the bonds on its balance sheet (read: it would need to contract the money supply by about $1.5 trillion).

Anticipating that it won't want to do that, Fed Chair Bernanke last week testified that the Fed will create a 'deferred asset' line on its balance sheet to deal with its duration mismatch. As John notes,

"In effect, to the extent that the Fed experiences losses because it overpaid for Treasury securities that it bought from primary dealers (comprising the too-big-to-fail banks and Wall Street investment firms), the US public will pay for those losses without any need for Congressional legislation."

Stated differently, Bernanke is positioning the Fed for its inevitable bailout...funded by we the people as always.

position in Treasuries