Tuesday, December 30, 2008

Robert Higgs

Robert Higgs has made a detailed study of the Great Depression and understands it better than the other famous student in high places. He is concerned about the Fed flooding the banking system with reseves. Excess reserves have gone from $2 billion to $559 billion in three months.

So much potential new money is now impounded in the commercial banks’ holdings of excess reserves that it is difficult to see how the Fed will be able to stem the flood once the banks begin to transform those excess reserves into normal loans and investments. If the Fed attempts to sell enough government securities to soak up the growing money stock, it will drive down the prices of Treasury bonds and hence drive up their yield, increasing the government’s cost of borrowing to finance the huge budget deficits the government will be running because of its various bailout commitments and so-called stimulus programs. This scenario holds the potential for a complete monetary crackup.

I have never been inclined toward touting doomsday financial scenarios. I raise the possibility now because I am unable to foresee how the Fed and the Treasury can navigate through these treacherous waters - waters that their own previous actions have whipped to a foam - without creating terrible financial and economic harm.

1 comment:

Gene Redlin said...

I am really enjoying this series.

Learning Much.

Keep it up.