Insider Predicts Inflationary Catastrophe

HOT: Fed Prez Spills the Beans on the Excess Reserve Inflation Time Bomb

by Robert Wenzel
Economic Policy Journal

Recently by Robert Wenzel: The CIA-Soros Partnership

For the second time in two weeks, Philadelphia Fed President Charles Plosser is warning about the time bomb that is excess reserves.

I first reported on this last week, exclusively in the EPJ Daily Alert. I wrote:

Here’s something very big. There has been very little coverage in mainstream media about the Fed super-money printing and how much of it is going into excess reserves. But what if it doesn’t go into excess reserves and instead ends up in the system bidding up prices?

While mainstream media is pointing at Bernanke’s QE3 and not reporting beyond that, the Fed knows it is all about where the money they print ends up.

Continued below.

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Here’s part of a very important interview Philadelphia Fed President
Charles Plosser gave yesterday to MNI News. It spills the beans:

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Plosser also warned that QE3 “could be highly inflationary.”

“I don’t think it would occur immediately,” he said. “Inflation is going to occur when excess reserves of this huge balance sheet begin to flow outside into the real economy. I can’t tell you when that’s going to happen.”

“When that does begin if we don’t engage in a fairly aggressive and effective policy of preventing that from happening, there’s no question in my mind that that will lead to lots of inflation.”

Bernanke and other Fed officials have often said that the Fed will be able to contain the outflow of reserves into the economy and thereby limit wage-price pressures by raising the rate of interest it pays on excess reserves. But Plosser said the IOER and reserve draining tools cannot be relied upon.

“How fast will we have to do that (raise the IOER)?” he asked. “How rapid will it have to go up? We don’t have a clue. Raising the IOER where you have a trillion and half or two trillion dollars in
reserves, we have absolutely zero experience with it.”

“We have the tools to do it, but we don’t know the consequences of the tools,” Plosser said.

“If the IOER doesn’t work and we have to sell assets, MBS, how will that affect housing?” he asked. “Will we be able to unwind from this at a pace that doesn’t disrupt the economy?”
—–
Plosser’s comments are about the core of the Fed’s problem. If those funds start to move out of excess reserves and into the economy rapidly, the Fed will have to take counter measures, such as boosting interest rates on excess reserves (IOER) or liquidating some of their mortgage backed securities. Plosser is entirely correct, no one knows how high interest rates will have to be raised to stop the flow into the economy. It could very well end up a tiger by the tail situation, the higher the Fed boosts rates, the higher nominal rates climb (Sort of the reverse of what is going on now). This is why it is very dangerous to hold long-term bonds, when rates reverse and start heading higher, they could move very rapidly, as the Fed could be forced to battle the very inflationary flow of money out of excess reserves.

As Plosser points out, there is approximately $1.5 trillion in excess reserves, given that the multiplier for reserves and money supply (M2) is now roughly 100, there is no way the Fed can allow that amount of excess reserves to get into the system. It would mean an increase in M2 of $150 trillion! On a current base of only $10 trillion. The Fed would have to fight such an outflow very aggressively, and that would mean much higher rates.

The fight against the outflow of excess reserves will come, but the Fed will likely be slow to act, so a lot of money will get into the system which is why Plosser is also correct in that we are on the edge of a very explosive inflationary situation.

Thus, the key right now is to watch to see if the Fed’s new money printing of $40 billion per month ends up in the system or as excess reserves. Further, excess reserves themselves have to be monitored to see if any of those funds start to enter the system. In other words, if any increases in required reserves occur, it could result in an artificial boom to the stock market and economy, but also be very price inflationary, very quickly.

Now, Plosser is warning again about the excess reserves exploding into the system and what it may mean for interest rates and the entire financial system.

MORE HERE