Fed Saves the Day by Sterilizing Money
By Staff News & Analysis - March 08, 2012

Fed mulling sterilized bond purchases … Federal Reserve officials are considering a novel approach to bond buying aimed at countering some of the worry that another round of asset purchases by the central bank could fuel inflation, according to the Wall Street Journal. Citing people familiar with the matter, the newspaper reported on Wednesday that should the Fed decide to buy more bonds to boost growth, it could borrow back the money it used to buy those bonds for short periods of time at low interest rates. Doing so would take that money out of circulation, or sterilize it. Representatives from the Federal Reserve and the New York Federal Reserve Bank, which conducts the central bank's bond trading, declined to comment on the report. The Fed is holding a regular policy meeting next week but is not expected to launch another round of bond buying at that time. It cut benchmark interest rates to near zero in December 2008 and has bought $2.3 trillion in bonds to push down short- and long-term interest rates low to stimulate growth. − Reuters

Dominant Social Theme: The Fed has so many "weapons." We don't have to understand them; just be comforted that they are there.

Free-Market Analysis: Another day, another power elite dominant social theme. The more we study monopoly-fiat central banking, the more shocking it becomes. We wonder why and how we ever accepted its justifications. And now we are hearing once more about a hoary old monetary tool, sterilization.

Sterilization is an attempt by Fed leaders to reassure people that the big central banks can remove money from the system as well as add it in. But after a while, one who follows this stuff simply gets the feeling they are "making it up" with increasing desperation.

What these reports (see above) really mean is that Fed leaders are well aware of the anger that is rising over their constant injection of funds into the larger economy. Thus they have issued another statement using another kind of gobbledygook. Here's some more from the article:

Fed officials are considering different options should they decide to embark on another round of asset purchases, the report said. Among these is an approach in which they would buy bonds, but restrict how investors and banks could use that money.

The Fed has tested tools to take money out of the financial system such as reverse repurchase , or repo, agreements to prepare for the day when the central bank wants to begin to tighten financial conditions. Other bond buying options are avenues the Fed has already pursued, according to the article.

These are outright purchases of new Treasury or mortgage-backed securities, known as quantitative easing (QE); or selling shorter-term Treasury securities and replacing them with longer-dated Treasuries, a strategy that is already in place and known as Operation Twist.

All of this is old stuff. That is, it was explained in textbooks and newspaper articles in the 20th century and received with great admiration and credulous assent. Monetary sterilization? Of COURSE. Makes a great deal of sense.

But it doesn't. One can almost imagine top central bankers sitting around a big table at an expensive restaurant and trying to figure out how to convince people that in addition to printing money, central bankers could REDUCE the money supply.

Of course, one can always raise interest rates. That doesn't actually reduce the money supply but it certainly makes it SLOWER. (Of course, this assumes that there is DEMAND for money in the first place; demand, not velocity, is the prime mover of money.)

Anyway, after enough glasses of sherry, someone exclaims, "Let's swap short bonds for long ones and call it a twist!"

And another exclaims, "Let's borrow back money that we've already lent and say we're sterilizing the market!"

A third one wonders if the banking system will cooperate. He is scoffed at. "Of course the banking community will cooperate," he is told. "They will do whatever we ask."

"But that doesn't sound like much of a free market to me."

The rest of his remarks are drowned out by laughter.

And that is the point, of course. This type of market manipulation is truly ludicrous. It seemed logical in the 20th century when it was presented on the front page of the New York Times and nobody said a word against it. But in the Internet era, these kinds of manipulations are increasingly seen for what they are: price fixing.

There is no such thing as "sterilization" and central banks cannot perform it. Central banks, including the Fed, have printed something like US$50 TRILLION. Not all of this is currently in circulation but more and more will find its way into the "real" economy.

Price fixing, setting the volume and price of money, is always distortive sooner or later. It will cause first a boom and then a bust. The marketplace itself must decide on the volume and price of money without the arrogant and destructive hand of man.

After Thoughts

Thus, no matter what sterilization the Fed performs, there is too much money in the system already. There is already inflation. What the Fed is responding to is the possibility of price inflation. And that is already on the way as well.