Saturday, November 22, 2008

Liquidating Money Market Fund Adds to Inflation

The U.S. Treasury recently announced further pro-inflation actions:

The U.S. Treasury agreed to help speed up the liquidation of the $6.3 billion Reserve U.S. Government Fund, ensuring investors are paid in full after their money was frozen in September.

The Treasury, drawing from its Exchange Stabilization Fund, will buy any securities the fund doesn't sell by Jan. 3, according to statements today by the department and New York- based Reserve Management Corp., the fund's owner. Shareholders can expect their money by Jan. 7.

The effect of the Treasury's actions will be to release dollars into circulation and eliminate the existence of illiquid assets in the Reserve Fund. This is a small-scale version of what the TARP was supposed to do, and the consequences are straightforward. More dollars chasing fewer assets in an economy is the concept known as inflation. This fund is small, only $6.3B, so the inflationary consequences of this particular action are small. The precedent is of course huge, as the Treasury is temporarily insuring the value of every money-market fund in the U.S. I expect the Fed's economists to monitor this, so they can estimate the effects of canceling the junk collateral they accepted from banks that signed up for emergency credit.

Never mind the impropriety of using the Exchange Stabilization Fund for something other than supporting the value of the dollar in forex markets. Any action to replace decaying assets with devalued currency is bad enough.