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Last month I read some news about the Fed printing money to devalue the U.S. Dollar compared to other currencies.

But what do they do with this extra money?

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closed as off-topic by ChrisInEdmonton, Dheer, JoeTaxpayer, Chris W. Rea, C. Ross Oct 20 '13 at 0:03

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2 Answers 2

First of all, just for the sake of clarity, the Federal Reserve doesn't actually "print" money - that's the job of the BEP. What they do is they buy US Treasury bonds - i.e., loan money to the US government. The money they do it with are created "from thin air" - just by adding some numbers in certain accounts, thus it is described as "printing money". The US government then spends the money however it wishes to. The idea is that this money is injected into the economy - since the only way the US government can use the money from these loans is to spend them on buying something or give it to some people that would spend them.

As it is a loan, sometime in the future the US government would pay these loans back, and in this moment the Fed would decide - if they want to "contract" the supply of money back, they just "destroy" the money they've got, by erasing the numbers they created before. They could also do it by selling the bonds they hold on the open market and then again "destroy" the money they got as proceeds, thus lowering the amount of money existing in the economy.

This way the Fed can control how much money is out there and thus supposedly influence inflation and economic activity.

The Fed could also inject money in the economy by buying any assets after creating the money - for example, right now they own about a trillion dollars worth of various mortgage-based securities. But since buying specific security would probably give unfair advantage to the issuers and owners of this security, usually US treasury bonds if what they buy.

The side effect of increased supply of money denominated in dollars would be, as you noted, devaluation of dollars compared to other currencies.

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Its interesting that, even though the dollar bills are devalued, the overall value that all those dollar bills represent remains the same. It seems that all they are doing is transferring wealth by injecting more money into the system. –  triforcelink Jan 2 '11 at 12:52

Usually the FED uses newly printed money to buy US treasuries from Goldman Sachs, JP Morgan, etc.. These banks then lend out the new cash which expands the money supply.

During the height of the crisis the FED printed over $1.0 Trillion and bought....well...almost anything the banks couldn't offload elsewhere. Mortgage Backed Securities, Credit Default Swaps, you name it - they bought it. Must be nice to always have a customer to sell your junk investments to. They also bought these securities at face value - not at market value. Chart from here. alt text

The FED announced in early November, 2010 that they will print another $600 billion and buy US Treasuries. They will be buying ALL the debt that will be sold by the US government for the next 8 months. This was admitted by the Dallas FED chairman in this article:

For the next eight months, the nation’s central bank will be monetizing the federal debt.

"Monetizing" is a fancy word for printing money.

I think this was done because the US government ran out of customers for its debt. China has reduced its purchases of US debt and the Social Security Trust Fund is no longer buying US debt since it is running a deficit.

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I do not think the last paragraph is true. First of all, almost any debt can be sold with right yield attached, especially sovereign debt, some just require higher yields (such as Greek or Irish sovereign debt). So I have no doubt US govt could sell the debt, the yields required is the only question. Fed wants to push the rates down as much as possible. I think the Fed is doing it because economical indicators show that we're still balancing on the precipice of further recession, and Keynesian theory recommends doing exactly that is this case. –  StasM Dec 31 '10 at 0:19
    
@StatsM - OK. You're correct. I should have said the US government ran out of customers for 2-3% debt yields. –  Muro Dec 31 '10 at 0:57
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ok, I'll bite, isn't the demand for these bonds what results in the rate? i.e. the price that one bids is what results in a given yield to maturity. If everyone wanted 5%, their bids would all reflect this, and that's what the YTM would be, coupon aside. –  JoeTaxpayer Dec 31 '10 at 6:24
    
@Joe - I agree with you - in a bond market the rate is set by what customers are willing to pay for the bond and accept as a yield. But what happens when one customer steps forward and says it will buy ALL the bonds issued by the government for the next 8 months? How is a rate determined then? I really don't know. Any ideas? –  Muro Jan 1 '11 at 16:26

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