Central Bank of the USA, FED cut down the interest rates to zero. Furthermore, it announced that the expansion in its own balance sheet is a long-term trend. Balance sheet of the FED has tripled times in the last year. Now, they announced that this was not a short-term step and the trend would continue. Instead of asking "What does this mean", we will assume another approach. We will ask: If the US government applied to the IMF and enumerated the steps taken, would it be able to sign an agreement? The answer is, no it would not. Then, if the US was not monetizing and was dependent on the IMF for foreign funds, what would be done in such hard circumstances? It should have first taken the steps initiated today and then apply to the IMF. And this brings us to the topic of today: In the recent period, it is not a good idea to knock IMF's door to ask for advice. First, it will be wise to acknowledge exactly what you want. You might ask "has not that always been so?" Yes, it has been, but the statement is more valid now.

What is that so? We are at a time that transcends the policy designing ability of the IMF and walking on unknown lands that do not have a roadmap yet. And the decision the FED made this week is quite appropriate for such a time. We are in a period where the countries applying to the IMF can easily receive funds but cannot take any advice on how to proceed. It is important that Turkey acknowledges this in advance.

Why is it important? Because, it seems that the IMF agreement will most probably be concluded in January. And the terms of the agreement will not be unusual at all. For a while, the IMF was getting prepared as much as possible to protect us, but we were acting reluctant. Now, things have changed. But w have to know that, it will not end here and we will soon learn it is not wise to knock IMF's door without taking the preliminary steps. It is a possibility that the economy contracts even we receive the fund since the credit channel will narrow down rapidly. Have you noticed; 2009 is definitely not like 2009.

We had a purpose in saying "IMF agreement is not enough alone" a while ago. Until today, IMF agreements had two objectives: First, to obtain resources for external financing and second to have a credible economic program framework. These are both important. However, it seems that, this time the IMF will ensure only the former. This is a new situation. So, we shall start to focus on the preparations for this new situation. Since everyone has lots of things to deal with, Turkey has to make effort to decide what is needed. However, considering the shallowness of the discussions going on around, it seems that our creativeness in policy design is quite limited.

On the other hand, the US breaks creativity records on policy design. The FED has transcended all limits. What is FED trying to do? As Hasan Ersel defined it for the previous period; it seems that, it is trying to block the holes in the dam with its fingers to sustain the payments system.  So, what is FED doing? In the balance sheet of the FED, liabilities show the money it issues and the assets show the financial assets purchased with the money issued. Therefore, if the balance sheet of the FED is expanding, it first of all means that the bank is continuously issuing money. Furthermore, the bank itself directly puts the money into circulation.

Is this a good thing then? First thing to say, the FED does this because it has to. In the past, a bank with excess liquidity made overnight lending to a bank in need of liquidity, through the interbank market. Now, the system does not work this way. Excess liquidity is used to purchase US Treasury bills. To this end, the US Treasury issues Treasury bills and transfers the access liquidity to the treasury account in the central bank. And then, the central bank transfers it to banks in need of liquidity.

How is the transfer made? Let us assume that a bank in need of liquidity holds an asset backed security, backed by real estate credits. The central bank adds the security to its balance sheet for a while and in exchange gives cash to actors in need. Let us say that a company in need of liquidity carries out the transfer transaction directly with another company.  The FED, as recently announced, also purchases the long-term bills you hold and provides short-term liquidity. It seems that the FED is willing to accept any option. By this way, a number of transactions that were traditionally carried out of the central bank balance sheet are now moved in the central bank balance sheet. Therefore, the balance sheet of the bank continuously expands. And the whole financial asset price set gets to be determined by the central bank.

Perhaps the most important part of the statement made by the FED this week is the "expansion in the balance sheet will continue" part. The central bank says: "I will go on determining financial asset prices and I warrant the operability of the payments system." In saying this, the bank also expresses: "In the current climate, banks are refraining from giving loans to each other and to the corporate sector. Therefore, the bubble in the central bank balance sheet will be permanent." This part of the statement is important: Lack of confidence in the markets continues despite all the time passed since the balance sheet damage in the system has not been eliminated. The FED is trying to operate the payment system alone. And in doing this, it in a way has to determine the price of almost all financial assets from overnight borrowing facilities to mortgage backed assets and securities alone. One shall be careful in deciding whether this implies that the FED has assumed the 'common wisdom of the markets' role or proves FED's desperateness.

Fat lady steps on and off the stage, and the song does not start. Balance sheet of the FED is continuously expanding, and everyone is waiting for Obama.

This commentary was published in Referans daily on 20.12.2009