Where are the Dollars?

A drop of line on where have the dollars, which were pumped in through Quantitative Easing gone?

This was rather shocking to me, when it came to my knowledge and it certainly would set disturbance in motion, Fed currently has a Reserve of monies deposited by the US banks to a tune of 1.8 trillion dollars. In addition, the Fed to banks, who are supposedly the owners of these funds, pays an interest.

Across globe, it was known that the quantitative easing affair was to facilitate economy to grow which had stagnated post the global financial crisis, but the verity is that bulk of the money pumped in by the Fed has not even gotten into the system as yet. In lieu, it is not even at the banks, but is at the Federal Reserve, the authority that actually planned QE to stimuli the economy. The story does not end there; Fed is also paying an interest to the banks on this reserve.

Just as the Global Financial Crisis was kicking up, Fed Chairman Ben (we can call him god of modern times, one statement he makes and markets go topsy-turvy) had announced that the Fed would start paying interest prospectively, on the reserve banks keep at Fed. Evidently, this announcement at the time of crisis would create an immediate explosion in the size of the reserves and that is what happened. In 2008, US banks had somewhere around 2 billion dollars parked as reserves in the Fed and the currently the amount is more than 1.8 trillion. In around half a decade, the pile has gotten nearly 1000 times heavier. This sudden event and insanity can help draw only one conclusion, which shall be a serious consequence down the road.

The graph below depicts the growth of these reserves in recent years,

In a flash this explains, why printing and pumping that Fed has been undertaking has not caused puffiness in the economy yet. Virtually, the money has not even gotten into the economy, but the big money is still sitting out there clouded quietly and at some point when the same pours into the economy, we could see a massive uncontrollable catastrophe of inflation.

Let us now have a look at a graphical, depicting the emergence of M2 money supply over past several decades. 

The melody has fairly been steady, but envisage what happens if we take a hockey stick from the chart above and is suddenly added to the top.

It might seem that God has given a good way out; it is controlling inflation and is stimulating the economy. But, longer the Fed continues to engage in quantitative easing (which is probable until mid-2014) and also continues to pay banks (interest) for not lending out the money in the economy, the inflationary bomb is being made and once the same is let out, situation cannot be imagined.

Why are we facing this nightmarish situation?

The creation of extraordinary reserves post financial crisis was inevitable, when the interest paid was quarter of a percent, which was not low in comparison to the short-term market rates, which were near zero. The interest banks received was an incentive for holding high reserves rather than lend to consumers in the risky environment.

Fed is now facing a 1.8 trillion dollar bomb; that they helped or rather created themselves. In this situation, if interest rates on income earning assets rise (which seems to be the case now), the Fed will have to pay more interest to hold this reserves and eventually hammer its Financial Statements.

Let’s consider a situation that interest rates move up dramatically, now banks will see an incentive to take the money out of the Fed and lend it to the customers. Evidently, this would create an "avalanche" of money. 85 billion a month would seem tiny, when this avalanche of $1.8 trillion starts exploding into the economy. It would not only lead to excessive inflation but an accelerated depreciation of currency. Therefore, if the Fed keeps printing, they would grossly distort the financial system and the bomb would just get bigger.

In recent time, when god suggested, tapering of QE, the financial market threw an epic tantrum. Interest rates with immediate effect began to rocket and markets started to tank.

So where are we heading hereon?

Regrettably, this experiment in financial manipulation by the Fed & the banks will ultimately bring about a disaster and the suffer would perhaps be larger then what has been faced by higher interest rate, inflation, and currency turmoil.

The largest bond bubble in the history of humankind has been created, even if Fed ends quantitative easing program, it would certainly be disastrous for global financial system.  Everything is so mingled with Fed that if they take it away, it will create a black hole. The Treasury bond in itself is one of the greatest bubbles and is at least twice or maybe thrice as large as the housing bubble. However, if Fed keeps printing, it will not be able to control the bond market.  In fact, the control is already in question and there are signs that they are starting to lose. The same is evident by a juxtaposition, where the Fed buys more bonds today than ever, then to interest rates keep rocketing, how can that happen.

It is certain they have lost control and that is the only reason why they are so desperately trying to get people, forget the word ‘taper’. Possibility exists that we might not even hear this word taper anymore because of the reaction it gave to the bond market recently and perhaps in the stock market too. They might give away the word and play around with the behaviour of the investors but fundamentally, system is out of control.

In addition to this, we have quadrillion dollars of derivatives. Thinking of what could be really going on behind the view, would just blow of a person’s mind. Moreover, not to forget that interest rate derivatives make up for the biggest chunk in this, as on day, there are approximately 400 trillion dollars sitting out there. Ideate, that interest rates begin to rise without a stop, shall lead to a straight creation of massive loss in the system and we are potentially talking about a consequence that would make Lehman Brothers failure look like a One-Day picnic.

The move is towards an unimaginable financial instability and the day catastrophe happens people are going to be shocked. America’s financial system is a mansion built on risk, leverage and debt and when the whole of this comes tumbling down, it should not surprise any of us as evidences are on hand, but public is still letting it go, optimism still seems to be present, the basis of the same is in question.

This article was first published by our authors on Seeking Alpha-Link: Where are the Dollars?