The Fed's Nuclear Option: Printing Without Selling Treasuries

Good Afternoon Folks

Its pretty quiet on the news front. I wanted to share an article from the Economist that I thought was very interesting:

"The sobering lesson is that conventional policy may not prevent a prolonged deflationary slump. This lesson has not been lost on policymakers. The nuclear option, conceived in America but untried in Japan, is to finance public spending or tax cuts by printing money. This requires the central bank to go along with the fiscal authorities (which may prove easier in America than in Europe). It could work like this: the government announces a tax rebate and issues bonds to finance it. But instead of selling them to private investors, it lodges them with the central bank in exchange for a deposit. It draws on this account to clear the cheques mailed to taxpayers. This scheme is essentially the same as the proverbial “helicopter drop” of money, but with neater accounting and a less erratic distribution of cash. It bypasses banks and money markets, and puts money directly into people’s pockets.

Monetising a slug of public debt in this way is bound to be inflationary. But by this stage, inflation would be a blessing: an economy where conventional policy tools had failed would suffer from falling prices. A burst of inflation would lift asset prices, ease the weight on debtors (whose real burdens are increased by deflation) and improve public finances. Some central bankers will shudder at the thought. Some, but not all. Ben Bernanke, now the Fed chairman, recommended this course of action to Japan’s policymakers in 2003 (when he was a Fed governor). Indeed, he went further. One way out of a slump, he argued, is for policymakers to commit themselves to a period of catch-up inflation, to break deflationary expectations and heal the wounds from past price falls.

If all else fails, it seems, the one sure way to secure solvency in the private and public sectors is to inflate away debts and buoy up asset prices. That nuclear option is the ultimate bail-out: rescuing the indebted by hurting those with savings. In essence, if not degree, it is not so different from conventional policy. Interest-rate cuts are a salve for debtors and a penalty on savers. Fiscal-stimulus schemes impose a cost on all taxpayers, even those well placed to endure a downturn. But the cost of a prolonged slump, in terms of idle resources, lost income, decaying skills and an erosion in the trust that keeps civil society going, would be far higher."

My Take:

Interesting and frightening theory from the Economist. It appears the Treasury is considering an internal print where they create their own bonds and hold onto them versus selling them via the treasury market.

These bonds would create their own internal deposit base from which they would then start dropping money out of helicopters via tax rebates. This would create massive inflation. I can totally see Hank and Ben pulling the trigger on this one if things get bad enough. It would be the ultimate move by these two criminals. This would the the classic new "theory" type tool that an academic like Ben would want to try.

This would be the epitome of "lack of transparency". It appears the Fed is desperate for inflation just like Japan was throughout the '90's. If interests rates eventually go to zero and the economy doesn't respond, this could be the Fed's response. It won't really matter at this point though because the economy would be on the verge of total collapse.

This would throw the deflationary play under the bus as we then inflate out of our debts. Consider this to be a "stealth" hyperinflation. Of course this is just a theory and I have no idea if it will actually happen.

If it does, the deflation trade goes out the window. Anyone getting caught short in this situation would be killed as all assets would rise because the dollar would be massively devalued.

Lets hope our economy never sinks to the point where this nuclear option is actually on the table.