$1 trillion in new liquidity definitely impacting markets

All that's missing from the Federal Reserve's decision to inject $1 trillion in new liquidity into the marketplace is Oprah Winfrey calling out, "You get a billion! And you get a billion...!" So what's the impact been today? From a New York Times story:

The Federal Reserve’s decision to fire up the printing presses to the tune of $1 trillion continued to wash over world financial markets on Thursday, dragging down the value of the dollar and pushing the prices of oil and gold higher...

The Fed’s Open Market Committee also announced it would keep interest rates near zero, and said it expected its target interest rates to remain exceptionally low “for an extended period.”

Unable to cut its target rate any more to try to jump-start the economy, the Fed is now ratcheting up other efforts like buying securities and essentially printing money to try to loosen credit markets and put the financial system back on its feet. But economists said that such efforts could lead to long-term inflation, and could drive down the value of the dollar.

“They clearly bit the bullet,” said James Knightley, senior economist at ING Financial Markets in London. “There’s no guarantee that this will actually work. While they are expanding the money supply, it’s only going to generate economic activity if people actually borrow. You need the demand on the other side to actually get the credit growth.”

And of course there are concerns that this could lead to high inflation once banks and depositors decide to start spending that money. From an op-ed column in the New York Post:

Right now, there is about $800 billion plus currency in circulation sitting in wallets, purses and cash registers around the country. Another $800 billion is sitting in a vault at the Federal Reserve Board, for a total monetary supply of about $1.6 trillion.

In a vault? Yes. When Congress voted the TARP program to bail out banks, the banks actually took only a small part of the money. The rest they used to offset losses on their balance sheets while letting the Fed hold onto the money.

Why didn't the banks want the money? Because they're not about to make loans in this economy. They're more than happy to let the cash sit at the Fed earning them interest. (The Fed decided to start paying interest last November).

So now the Fed will, in essence, be creating another trillion of money supply to sit in the vault alongside the $800 billion already there. The new money will remain idle for the same reason the old money has because banks won't make loans in this environment.

And what of the money that is going out the door to buy Treasury bills? Those selling Treasuries won't run out and spend the money on flat-screen TVs. With higher taxes coming up next year and the economy in the tank, they won't spend it or lend it they'll probably just turn around and buy more T-bills.

Think of a parking garage filled with cars. The cars' owners leave them in the garage, because it's a bad day with rain and snow and conditions aren't suitable for driving. Similarly, banks and consumers leave their money in the vault at the Fed or in their bank accounts or under the mattress.

When conditions improve, though, all those metaphorical cars will suddenly be taken out for a drive. All at once. And a traffic jam of monumental proportion will ensue.

When everybody starts spending the money they're now leaving in vaults and mattresses, way too much money will be chasing way too few goods and services. Double-digit inflation will return to America.

Yesterday's Fed action won't help but it will put more money out there that the Fed will have to mop up once the economy, on its own, revives...