November 5, 2013 at 1:15 pm #17661
I read and analyzed the BFO’s team’s in depth 1 November report on QE. The report was thorough and quite helpful, but maybe a bit complex for a “small town Southern boy”, such as I. That said, below I’ve taken a more direct and simplistic approach to the topic. I’ve made some basic assertions, and if any are inaccurate, please advise and add your corrections. I also raise multiple questions, and, if you know any answers thereto, please post them.
QE For Dummies
One) The US Treasury must issue bonds to cover deficits (The Treasury must also renew current debt caused by past deficits, however, for the sake of this simplistic thought piece, I will ignore renewal debt.).
Two) Certain banks (hereafter “T Bond banks”) purchase a large quantity of these Treasury issued bonds.
Three) Pursuant to QE, the Fed then buys many, if not all, of these bonds from the T Bond banks.
Issues and Questions Presented
These premises established, the following issues arise:
One) From where do the T Bond banks get the cash to purchase T Bonds?
Do they have the cash on hand?
Do they borrow it from the Fed? If so, is their “Fed Loan” then always paid off with proceeds from their Bond sales to the Fed?
Two) Can we compare the amount of yearly new T Bond issuance by the Treasury to the announced annual federal deficits?
If so, do these two amounts always equal? If not, has new T Bond issuance ever exceeded the announced deficit? If yes, by what amount?
We do seem to know what % of T Bond issuance that the Fed purchases each year. Do we know what % of new T Bond issuance that T Bond banks generally purchase?
Three) When the Fed buys bonds from T Bond banks, where does the Fed get the cash?
Do they always “print” or otherwise create this $, or is there ever another fund source to which the Fed can turn?
Four) If the T Bond banks buy the T Bonds from the Treasury, and the Fed then buys the same bonds from the T Bond banks, then is the Fed not using the various T Bond banks as a mere conduit, or cover, for its T Bond purchases?
If so, then is QE additive to the economy to the extent that it enables federal deficits (fiscal stimulus), which–at least under Keynesian theory—are expansionary? In short, is QE just the financing side of an explicit policy of fiscal stimulus? (Is the Treasury unable to finance stimulus with taxes or true borrowing, so the Treasury instead finances it via Fed money creation?)
Five) Federal revenues are at record levels, yet federal deficits, most recently a reported $700 billion, still remain high.
Was the last fiscal year deficit really only $700B, or was it higher? (Would it be true that the actual deficit for a given year is the amt of total federal debt at the end said year minus the amt of total federal debt at the beginning of said year?) As an aside, see this link re the debt increase in October 2013:
Whether the most recent fiscal year deficit was $700B or higher, has total federal spending really decreased? . . . or has it only decreased as a % of GDP from extreme % of GDP levels?
Further, if the most recent deficit was $700B, then, over the past 12 months, the Fed financed more than the deficit. ($85B per mo x 12 mos. = $1,002B of Bond purchases – $700B deficit = $302B of excess purchases) If this is true, then the Fed necessarily bought some of the “renewal debt” that, by the way, I said I would ignore for the purposes of this discussion.
Does this circumstance, in turn, suggest that either the $700B number is incorrectly low OR that Fed Bond buying equal to the deficit is insufficient to keep rates as low as “needed”?
Six) If most all of this is true, and one combines it with the fact that, (perhaps due to automation and cheap foreign labor), the lower and middle classes are suffering in a top heavy economy, then is the entire QE process tantamount to the “bread half” of a sort of “bread & circuses” scheme to mollify those not in the top 1% or the top 10%, or whatever?
Simply put, does the USA run deficits to placate the masses and then use the Fed to finance those deficits with printed $, perhaps with some “kicker QE” thrown in to decrease rates further and thus mollify Wall Street?
A footnote: Recent commercial bank reports show a relaxation in lending standards, but little increase in loan volume, reportedly because of weak loan demand, a circumstance consistent with weak aggregate demand, which, in turn, is consistent with a weak economy. Hence, QE has had little apparent effect on commercial loan volume, and, because money velocity depends substantially on loan volume and because inflation depends substantially on money velocity, QE has had little apparent effect on official inflation numbers.
At the same time, if the Fed is financing $700B or more of deficit spending each year and it is using created money to do so, is the Fed not dumping $700B or more of inflation inducing ‘excess currency’* into the economy each year? If yes, then is this why the $3 tube of store brand oats I purchased not long ago now costs $4?
* ‘Excess Currency’ is here defined as currency unjustified by true goods production.November 20, 2013 at 3:17 pm #27096
Dear Hense, from what I understand about QE, your points are absolutely right and bang on. You do have a lot of questions and they are all very pertinent. On your first question, regarding where the T Bond banks get the money to buy government bonds, there are a few things to note before getting to the final answer:
1.) The Treasury only issues debt to named banks, these are called Treasury Dealers and they must be specially approved by the Treasury. Their role is to purchase bonds from the government and then to distribute (re-sell) to the ultimate buyers who may be insurance companies, pension funds, other banks, bond mutual funds, etc.
2.) Banks generally tend to buy bonds using a mechanism called the repo. Here the bank buys the bond and pays for it by taking a loan from a short term lender, eg. a money market fund. The bond purchased by the bank is used as collateral for the loan. Why ndo banks do this? Well, two reasons: (a) bank earns a higher rate on the bond as it is longer dated, eg. a ten year bond pays 2.70% or thereabouts, but a short term lender, using the bond as collateral would charge, say, 0.30%, depending on the day. The bank gets to pocket the interest rate differential. (b) When a bank lends to a G7 government, of which the US is one, it has to put up zero capital against the bond it owns. Typically when a bank lends money to a coporate,, or a non-bank/non-government entity itis required by regulation to hold equity capital against a portion of that loan. Typically 8%, although there are a set of complex rules that determine the exact amount of capital. With a government bond they are effectively getting free money as long as their short term borrowing costs don’t go above the long term interest rate offered by the bond.
3.) When the Fed comes to market to purchase bonds, the Treasury Dealers sell them those bonds. Typically, the Fed is buying right around the time of issuance of new bonds. Also note that the Treasury Dealers are also members banks of the Fed. A member bank of the Fed has an account with the Fed, just like you may have an account at your bank. Effectively, the Fed is the banks’ bank. So, when the Fed purchases a bond from a bank, all it has to do is to credit the account that the bank has with the Fed. This is an electronic entry and no cash changes hands.Where did the Fed’s money come from? Nowhere. The Fed just has an accounting entry.If the bank were to use the cash from the Fed to buy something else, all it would be doing is to pass on its acounting entry as cash at the Fed to another bank.
Your point 4) is correct the Fed is just using the Banks as a conduit for its purchases. Furthermore, QE on its own will not cause inflation. The printing of money does not do that. The use of the new printed money does. This is why Government fiscal policy is so important. If the Fed is only buying new government debt, ie. to increase deficits, rather than to re-finance, then that is how the money finds its way to the economy. The government is the ultimate spender of that money, and is the one that is trying to increase the velocity of money.
SunilDecember 4, 2013 at 10:05 am #18118
Thanks, Sunil. I read your reply once and will read it again. This is just the kind of detailed inside info all members need to really put the QE puzzle pieces together. It’s all a kind of monetary shell game, is it not? 😉
The details on the table, it also seems to me that there is a larger issue that underlies the entire game, namely, how to allocate resources in a new era of automation, computerization, and overabundant labor. If we are approaching a time when machines (and cheap emerging mkt labor) do more and more of what developed nation people once did, then how can a newly idle population stake a claim to the goods these machines produce? Creating tech and real estate bubbles hasn’t worked; so what is next? Will printing money and doling it out via fiscal policy work any better? I was pondering this question as far back as 1981 when a Professor of Public Policy raised it in class one day. He predicted that his own job would become obsolete some day b/c of video technology. Well, what do we now witness? . . . Online universities and training courses.
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