QE2 and "Money Printing"
May 12, 2011
– Comments (15)
My position has been (contrary to many other published thoughts) that QE was not in fact "money printing" in the sense of how it is normally defined, which goes like: the Fed printed billions of dollars out of nowhere and exploded the monetary base and that this added a slew of new dollars to the system and is therefore inevitably inflationary.
Did the Fed print new dollars out of nowhere: Yes.
But in doing so the Fed used those newly printed dollars to buy Treasury bonds in the Open Market. The Fed created a new dollar (asset for the market, liability for the Fed) out of thin air. But then didn't dump them on the market (free money that was given away), it bought Treasury bonds and removed those bonds from the market. So you can see that it was nothing more than a swap from the markets perspective. No new net financial assets were created.
And technically a deflationary swap since the dollars don't pay interest, and the Treasury bonds did. Interest bearing assets were removed from the system and replaced with non interest bearing assets.
Did the monetary base explode (M0 and reserve balances)? Yes.
... So what?
Like I have explored and demonstrated in the past (see links below) and as have many people that understand the banking system, banks are not reserve constrained. The money multiplier model is a myth. When a bank wants to lend, it simply lends. It tries to find reserves after the fact. Either on the open market or at the Discount window. Since the Fed controls the discount window, there is always a source of reserves. The only thing that changes in this case is the "price" of reserves (the interest rate that they will fetch on the interbank lending network). This is the overnight rate that the Fed manages. Either buy buying or selling Treasury bonds in its portfolio (which either adds or drains reserves respectively).
Since there is a large excess of reserves in the system right now, all it means is that short term interest rates will be low for a very long period of time. Because a healthy bank doesn't want excess reserves (reserves are not lent out), they are just an asset that pays 25bp. They would much rather buy a Treasury bond with it, since it pays interest. This is why there is an interbank market for lending reserve, because when there is a deficit of reserves, the short term interest rate gets bid and is repsonded to by the Fed. Because there is a large surplus of reserves, there is no competition for them and the interest rate will then remain low.
As I stated in my last detailed posts on QE, the only thing that it encouraged was a long of speculation. See (Follow Up: QE is not Inflationary, Thoughts on Risk Asset Instability - http://caps.fool.com/Blogs/follow-up-qe-is-not/533092) and (One of the smartest comments I have read yet regarding Quantitative Easing - http://marketthoughtsandanalysis.blogspot.com/2011/02/one......).
It is no secret or wonder than margin debt (leverage, not an inflationary phenomena) has exploded: http://caps.fool.com/Blogs/more-margin-debt-please-no/579298. It is this speculative mentality regarding the misunderstading of QE rather than 'money printing' that has sustained this rally across nearly every asset class for the last several months.
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QE2: Captblogain, your ship is sinking
Warren Mosler
http://moslereconomics.com/2011/05/12/qe2-captblogain-your-ship-is-sinking
So imagine the corn crop report comes out and it surprises on the upside at up 30%
What happens? The price of corn probably starts to fall. Commercial buyers back off, farmers rush to hedge, and, overall, players of all ilks try to reduce positions, get short, etc.
A few weeks later it’s further confirmed that the farmers are producing a massive bumper crop.
What happens? The same adjustments continue.
But what if that crop report was wrong? What if, in actual fact, there had been a crop failure? And market participants never do get that information?
What happens? Prices go down for a while as described above, but at some point they reverse, as sellers dry up, and as consumption overtakes actual supply price work their way higher, and then accelerate higher, even if no one ever actually figures out there was a crop failure.
QE is, in fact, a ‘crop failure’ for the dollar. The Fed’s shifting of securities out of the economy and replacing them with clearing balances removes interest income. And the lower rates from Fed policy also reduces interest paid to the economy by the US Treasury, which is a net payer of interest.
But the global markets mistakenly believed QE was producing a bumper crop for the dollar. They all believed, and some to the of panic, that the Fed was ‘printing money’ and flooding the world with dollars.
So what happened? The tripped overthemselves to rid them selves of dollars in every possible manner. Buying gold, silver, and the other commodities, buying stocks, selling dollars for most every other currency, selling tsy securities, etc. etc. etc. in what was, in most ways, all the same trade.
This went on for months, continually reinforced by the pervasive rhetoric that QE was ‘money printing’, and that the Fed was playing with fire and risking hyperinflation, with the US on the verge of suddenly/instantly becoming the next Greece and getting its funding cut off.
Not to mention Congress with it’s deficit reduction phobia.
So what’s happening now? While everyone still believes QE is a bumper crop phenomena, QE (and 0 rate policy in general) is none the less an ongoing crop failure, continuously removing $US net financial assets from the economy.
And so now that the speculators and portfolio shifters have run up prices of all they tripped over each other to buy, the anticipated growth in spending power-underlying aggregate demand growth needed to support those prices- isn’t there. And, to throw more water on the fire, the higher prices triggered supply side repsonse that have increased net supply along with a bit of ‘demand destruction’ as well.
Last week I suggested that higher crude prices were the last thing holding down the dollar, and that as crude started to fall I suggested its was all starting to reverse.
It’s now looking like it’s underway in earnest.
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