I do believe in the multiplication of the monetary base through fractional reserve banking. You are correct that the broader money supply (M1, M2, etc.) measures have not expanded in proportion to the expansion of the monetary base, as measured by the multiplier (MULT = M1/AMB, which is what I think you are referring to.) MULT has fallen dramatically, as you say, because credit markets are “frozen,” no lending is occurring, and therefore the increase in the monetary base is being held as excess reserves at the FED, as I said previously.

However, I think you are wrong about draining the monetary base. Though theoretically possible, the problem is not a question of timing or luck, and from a practical perspective it is impossible. The FED simply isn’t holding a sufficient balance sheet at this point to be able to fetch enough money in the open market by selling its assets. If it sold every bit of gold and every bit of US Treasury paper it holds, it could not make a sufficient dent in the monetary expansion which has occurred to this point. Plus it would be holding trash (mortgage paper) as backing for the US dollar, which would encourage a run. It would also drive up the Treasury’s borrowing rates, which would threaten Uncle Sam with bankruptcy. In order to sell the trash at a sufficient price to bring down the money supply, the FED needs to see inflation in the prices of these assets (e.g. the housing market), which as we all know is presently in a nosedive. So, the FED needs inflation to reduce the money supply. It’s a catch-22.

The only workable way I can see in the long run to prevent expansion of the broader money supply as a result of the expansion of the monetary base is for the FED to increase the reserve requirement. Which is to say, it must repudiate fractional reserve banking itself. Which would be fine by me, but would be a tacit admission that the system itself is a hopeless, unworkable fraud (which it is), and further, would in large part eliminate the reason for the FED’s existence, which is to make a hopeless, unworkable, fraudulent system function in the real world. Bureaucracies typically don’t like to admit their failings or undermine their own authority. So don’t hold your breath.

No, the truth is, the FED absolutely needs the inflation in order to “solve” the crisis. Which means that this crisis will be resolved through yet another crisis, the destruction of the US dollar as a currency, or at least put us all through one heck of an inflation.

Hang on folks! It’s gonna be a wild ride! You ain’t seen nuthin’ yet!

The FED traded Treasury debt with the banks to get the mortgage debt off the banks’ books (so they would not have to “write it down”/”mark to market”/whatever-you-want-to-call-it and have a loss showing on their books). The FED did this so that the banks would not look bankrupt, which they are. This was called the TAF program, and did not increase the monetary base. Treasuries came out of the FED, awful mortgage paper went in. No cash was transferred.

TARP and related programs are what caused the increase. TAF was not enough. The banks had just too much bad paper. The FED did not have enough assets to part with to cover the bank debt, so they printed the money and bought more mortgage paper. However, the FED offered to pay interest on deposits held with the FED, so the cash never went out to the banks. They preferred to hold the cash on reserve with the FED, as this is essentially a risk free “investment.” It is still in the FED’s vaults, not circulating in the money supply (M1, M2, etc.) But technically it belongs to the banks, so it is part of the monetary base.

The FED is running out of assets. Right now, it has mostly mortgage paper. It has a good amount of gold, but if it trades this out, the only thing “backing” the currency will be awful mortgage paper. If there is a run on the dollar, the FED will have nothing to sell in defense of the currency (assets going out of the FED, money going in, thus reducing supply and defending the “value”). So it opted to print the new money.

Anyway, that’s the basics of what’s going on.

1. The only thing worse than inflation is deflation.

2. Most of this money was used to unfreeze the commercial paper markets, which I think is a good thing.