Will the Fed drain $1 trillion from the money supply?


It looks like the Fed is getting ready to start cutting the supply of money. This could be terrible news for gold bugs, because they've been betting that inflation would spiral out of control and gold would be the only way to protect against it. But now the Fed is talking to bond dealers about selling them $1 trillion of so-called reverse repos that would remove $1 trillion of cash from the financial system.

That $1 trillion is a significant amount when you consider that before the financial crisis began, the Fed had a mere $800 billion worth of assets. But when Bear Stearns collapsed, the Fed became the financial sponge for huge amounts of Wall Street's toxic waste -- bulging out to $2.14 trillion in bad assets that were sinking the banks.

With the reverse repos -- short for reverse repurchase transactions -- the Fed would sell securities to its 18 primary dealers for a specific period, which would decrease the amount of money available in the banking system. If it issues $1 trillion worth of reverse repos, the Fed would be able to use the cash to restore its balance sheet part of the way back to its pre-August 2007 condition.