Open Market Operations - OMO

The buying and selling of debt securities on the open market to either add or drain liquidity from the market. When the Government buys a lot of bonds, they are injecting liquidity - their cash stash - into the marketplace; when they SELL a lot of debt, they are sucking liquidity out of the system.

OMOs are kind of the financial Navy Seals affecting economic world peace in the daily wrestling match between inflation and interest rates and the global appetite for credit risk.

The open market operations are active, actual things that the government does to affect the price of renting money... and/or the ability of Joe Sixpack and corporate America to rent that money.

Specifically, there exists a group of 7+ angry people who run the reserve open committee, which buys and sells government securities, namely T-Bills, notes and bonds, in order to regulate and control the supply of money to western investors.

So, how does this work? In any given month, the U.S. government transacts in 100s of billions of dollars of debt instruments. Things like T-bills, notes, etc., either as a buyer of them or a seller of them.

Sounds like a very strange process, in that paper is paper, right?

And a T-bill can be liquidly converted into cash, right?

So, you’d think the government simply borrowing from Peter to pay Paul, and then doing the reverse, wouldn’t really matter all that much to interest rates and the liquidity of money in a multi-trillion dollar economy. But, maybe surprisingly, it actually has a huge effect, mainly because that last 2% of people needing cash or wanting to invest cash are transacting in the market, while the remaining 98% or so of the world just kinda sits there, happy with the poker hand that they have been dealt cash-wise, at least this month.

Relatively small percentages of the total, like “only a few hundred billion dollars” actually have a dramatic effect on liquidity in the marketplace. So when the government wants to increase the supply of money, or cash, or liquidity so that borrowers have an easier time getting banks and other lending institutions to loan them money, the government then buys securities.

Or, said another way, the government takes its cash stash and spreads it around to buy back things like T-bills, notes, and other flavors of bonds. And the opposite works the same way. When the government wants to restrict the supply of cash, maybe it’s worried about inflation or an overheated borrowing economy, it then sells a bunch of debt instruments, soaking up like a financial sponge the excess cash in the marketplace, and replacing it with lovely pieces of paper, with a big fat IOU on the cover.

So this is the playing field in which open market operations happen. And specifically, when the Fed buys securities, it usually buys them from banks, injecting loads of cash into the bank, which then feels pressure to get those cash monies loaned out to little and big business and Joe Consumer alike.

Think about it like Dole pineapple has just injected 18 million pineapples, at a really cheap price, into the chain of Safeway stores. Safeway is the retailer of the pineapples obtained wholesale from Dole, in the same way the cash was obtained by banks wholesale from the government.

So now there’s big fat pressure to get those pineapples sold before they rot, or at least create a drag on the earnings, or inventory turnover ratios, that grocery stores and banks care so much about. With more access to capital, and more liquid availability of cash, banks often create their own equivalent of Macy’s white flower day sales, where some lucky borrower gets their money at 3.712% instead of 3.998%, and those 28-ish basis points add up to a small fortune over time.

And, in case you’re wondering, the same is true, in reverse...