Fed Bombshell - Barokong - Teknoiot

23 May 2020

Fed Bombshell - Barokong

The Fed just announced "extensive new measures to support the economy." What's this all about?

The PMCCF will allow companies access to credit ... This facility is open to investment grade companies and will provide bridge financing of four years. ... The Federal Reserve will finance a special purpose vehicle (SPV) to make loans from the PMCCF to companies. The Treasury, using the ESF, will make an equity investment in the SPV.
When the Fed buys a Treasury bill, it creates new money with which to buy the bill. It simply increases the amount of reserves, which banks can freely transform to cash, so you can think of it as printing up money to buy the bill. Why doesn't this cause immense inflation? Well, the Fed backs the money with the bill. The overall quantity of government debt has not changed, just the composition.

When the Fed lends money to a bank or business, it looks the same as a matter of accounting. The Fed prints up money, figuratively, and gives it to the bank or business. The loan then counts on the Fed's balance sheet just like the Treasury bill as an asset backing the money.

But there is a difference. Banks and businesses can default. That "asset" may be worthless. Printing money and giving it to business and counting the loan as an asset leads to all sorts of problems.

That's why the Fed is funneling this through the Treasury. The Fed prints up a dollar, gives it to a "special purpose vehicle" along with the Treasury, and the Treasury is supposed to take the risk of default. That is, in my view, appropriate. The Fed cannot stay independent if it lends to specific risky businesses, and takes on the risk they won't pay back.  The Treasury is politically accountable.

Overall, though, the government is printing money and handing it out to businesses. Functionally it is the same as if the Treasury borrowed money, lent it to business, and the Fed bought the Treasury bills. But it happens faster, and gets around the debt limit and lots of other interference.

This post refrains from judgement. I just thought it useful to explain what's going on.

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