The Fed to the rescue?

The Fed, also known as the Federal Reserve, had to ride to the rescue of financial markets today and yesterday.

The market suffered from a liquidity crunch this week, which means that many investors were unwilling to put their money into markets. This causes a dry up of so-called liquidity, or ready money.

You see, most financial institutions operate on a lot of borrowed money. When they can’t borrow money, their operations seize up for a lack of a better term.

The Fed came to the rescue by pumping $24 billion into the market in two transactions yesterday and $38 billion into the market in three transactions today, more than the $50 billion pumped into markets after 9/11. (As an aside, the European Central Bank pumped almost $200 billion into their markets to keep things going)

How does the Fed do this? They lend money to banks at low rates. Not surprisingly, the Fed does not create value from thin air, they must do something for this so-called liquidity to appear.

The long and short is that they “printed” money out of thin air for the banks to borrow. I put printed in quotes because it’s almost all done electronically now, so the printing is purely in computer bits.

Does such market aid come at a cost? You betcha! Printing money faster than economic growth causes inflation. As Milton Friedman said, inflation is everywhere and always a monetary phenomenon.

Perhaps that is why the price of gold decoupled from the stock market today. You see, the gold market has been moving in conjunction with the stock market lately, which is very unusual. Today it stopped moving in conjunction with the stock market, though, perhaps indicating that buyers and sellers of gold recognized that the Fed printing money to rescue the financial system is just another way of saying, “Here comes some inflation for ya!”

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.