The Fed: This will be a multi-part series, including:
- QE isn't money printing and is mostly a game
- The Fed’s balance sheet is a fiction
- All the Fed can do is asset swap
- The Fed doesn't control interest rates
- What’s the motivation for this series?
This isn’t clickbait. I understand the dismissiveness and conflict these statements evoke. If you'll indulge me and allow me to defend these claims. This piece will focus on QE and its deceptions.
The QE “printer” is a misleading manipulation that gives the appearance of omnipotence and liquidity. Almost everything the Fed does is a deeply effective psychological game, because as former Fed chair Ben Bernanke said "I think monetary policy is 98% talk and 2% action.”
When discussing Fed actions, everyone is primed in a very religious sense that you “don’t fight the Fed”, the same way a Catholic would tell you “don’t question God”. These religious indoctrinations won’t be unlearned from this piece.
But ask yourself, “Do I have the same beliefs about the Fed as every person at Davos, CNBC, The Economist, and every Fed employee?” I bet you mostly do.
Everything you understand about the institution comes from people who exist to defend and promote the power of the institution.
These are the regime’s mouthpieces, they have 1:1 the same opinions as the Federal Reserve and State. So begin by recognizing you have exactly the same beliefs about the omnipotent magical institution as the very entities who maintain and promote the omnipotent magical institution.
Picture asking a priest about the power and grace of God, and if it’s real. Do you expect intellectual honesty and analysis from a person whose identity and life’s work is devoted to the institution in question? When you see an FOMC member speaking, please picture a priest.
I encourage you to approach this series with a fresh mind, and put aside what you've been told is true. Only look at the raw actions for what they are, and then draw your conclusions. Not what you’ve been told to think from Fed mouthpieces or financial media.
Where there’s monolithic orthodoxy, and everyone says the same things and you don’t ever question it, that’s exactly where you should start looking.
On Quantitative Easing:
First we must understand how money is calculated and reported.
M2 is what’s commonly referenced by economists to quantify the money supply. Here is what it entails (everything in M1 is included in M2):
Please note: nowhere in here are bonds of any kind.
So what does QE technically do? QE is when the Fed buys bonds (typically treasuries, sometimes MBS) from banks. They do not buy them directly from the Treasury (US government) itself, which is known as “monetizing the debt” (basically a sovereign selling its bonds to itself). The Fed goes to banks and simply takes the bonds off the bank’s balance sheet (BS) and gives them cash for it. The bond then goes onto the Fed’s BS.
What you just read is what everyone universally very passively describes as “money printing”.
Example: a bank has $1B of bonds, please instead view this as $1B in ASSETS. $1B of assets on its BS that the bank can lend against. But now it no longer has $1B of bonds, it has $1B of cash, however the $1B in assets is unchanged.
- It still has $1B in assets. The total assets the bank owns didn’t change. I can’t emphasize this enough.
- Banks issue loans against BS assets. They can provide loans against their new cash reserves like the bonds they used to hold.
- The bank had bonds on its BS to lend against. Now it can lend against the cash (reserves). Its lending capacity remains essentially unchanged.
- QE made no change to the total assets the bank holds or can lend against, it simply gave it a different composition of reserves that it lends against
To repeat: you swapped bonds for cash on a bank balance sheet. You changed the composition of a bank’s BS. This QE description is much less dramatic and sexy than “money printing”… but this is precisely what happens.
But look what it does to the M2 chart! REMEMBER: bonds are not a part of the M2 calculation, but now that one asset not included in M2 has been swapped for another… bam.
No one asks where all this “cash” actually goes, because it’s just sitting as bank reserves at the Fed. But everyone in one uniform chant calls it “liquidity” and dutifully accepts the Fed’s psychological game that you should go buy risk assets now.
Why? If we could ask buffalo why they stampede, I bet we’d get the same answer: everyone else is doing it, so it must be true, so I’m going to do it too.
QE quite literally just reorganizes part of a bank’s balance sheet, and leaves its lending capacity unchanged. And because of how M2 is calculated, makes the money chart explode; the psychology of this is not lost on FOMC members.
But maybe there’s a second-order effect here. Perhaps via fractional reserve lending, the change in reserves are causing the banks to lend more, which does create new money. Banks are the real money printers because they can lend against reserves (credit creation) and actually birth new assets into the real world.
So perhaps QE is the distal cause of liquidity, and bank credit creation is the proximate one… trickle-down liquidity?
I don’t see it. Banks are not lending more against these cash reserves as opposed to their bonds, in fact it appears credit creation has declined since routine QE has become the norm.
As you can see below, the credit creation trajectory has actually decreased since the Fed has routinely been doing QE. If QE was actually juicing lending that had trickle-down impacts on liquidity, this chart should not look like this.
Is money flowing through the US economy at a higher rate when the Fed “prints”? The phrase “liquidity sloshing around” is a common Fed-ism when QE is being used, this must mean the “sloshing” is quantifiable.
Maybe I’m not looking in the right places, but I still don’t see it. Velocity of money assesses the tempo that money is exchanged in an economy, measuring the frequency that money in circulation is used for purchasing goods and services. When there are more transactions being made throughout the economy, velocity increases. Seems like a “sloshy” metric to me.
Tell me if anything sticks out to you.
I’m not playing semantics here. I’m not cherry picking how M2 is defined or caviling over some minute details to defend a differentiated hot take. I’m looking at the raw actions of what something does, and then seeing if the thing I’m told is happening is actually happening, or if everyone just acts like it’s happening.
The thing that is universally, uniformly, and unquestioningly described as “printing money” takes bonds off a bank balance sheet, and puts cash there. The banks then actually seem to lend less than previously. Velocity of money stagnates and declines. And… everyone decides to buy risk assets because…liquidity? Ok.
This concludes Part 1 of my Fed series. Next will be on how the Fed’s balance sheet is an accounting fiction that does not exist in reality.
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