Saturday, November 22, 2008

A Flood of Liquidity & the Surge in Inflation

The broad M3 money supply – "which the ECB uses as a gauge of future inflation," as Bloomberg notes – rose 12.3% from Oct. last year, the fastest rate of growth since July 1979. And this monetary inflation will only rise faster when November's numbers come out late in Dec.

The Fed offers money to the big New York banks in exchange for good-quality securities – securities such as, say, US Treasury bonds or government agency debt. And it will lend money for anything between 24 hours and two weeks or more.

The Fed has always been happy to accept mortgage-backed bonds as security for the short-term cash injections it makes. If the New York interbank lending rate needs a little shot in the arm to cool it down, AAA-rated mortgage-backed securities are just fine.

   But as you can see, the big banks stepping up to the Fed's auctions have always been keen to use more mortgage-backed securities (MBS) as collateral than the Fed would accept.

   Indeed, the ratio of MBS submitted to MBS accepted averaged only 0.55 between Nov. 2000 and the end of July '07. More times than not, the Fed said "no" to home-loan backed bonds. It demanded US Treasury notes or agency debt as security for lending hard cash instead.

   But since the credit crunch first bit at the start of August, the New York Fed has relented somewhat. The ratio of MBS submitted to MBS accepted when bidding for the Fed's cash has risen to 0.85.

A Flood of Liquidity & the Surge in Inflation | Gold News

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