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Monday, 22 January 2018

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QE is just an Asset Swap

Welcome! Forums The Big Picture QE is just an Asset Swap

This topic contains 1 reply, has 2 voices, and was last updated by  SUNIL G. 4 years, 2 months ago.

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  • #17660

    SUNIL G.
    Member

    I was reading Chris’ article today regarding QE being an asset swap after having watched Fama’s interview with Rick Santelli on CNBC. Just wanted to post some thoughts here on this topic.

    The term Quantitative Easing refers to the purchase of US Government obligations and mortgage backed bonds by the Fed. The process of purchase is a follows. Suppose that the Fed buys a government bond. Whether or not that bond is a new issue it will be purchased from a Treasury Bond dealer (a Bank with a special status, allowing it to purchase government bonds from the US Treasury at the time of issuance). It is important to note that the Fed will purchase even newly issued government bonds from a dealer and not directly from the Treasury. As an aside, it is interesting to note that this results in the Fed paying commissions to the dealer through bid/offer on the bonds. This appears to be a subsidy to the bond dealers and provides one way that the Fed gives away money to these dealers, who book the spreads that the Fed pays them for the purchase of bonds as Revenue, which is overlooked in normal discussions. Back to the purchase by the Fed. When the Fed purchases bonds from a bank it credits the account of the bank it purchased bonds from. This money did not exist prior to the Fed’s purchase of the bonds. The money came into existence as an account entry showing a deposit in the account that the selling bank has with the Fed. The Fed pays interest on this money as long as the bank continues to hold this money with the Fed. As long as the bank has enough deposits in its account with the Fed, it may withdraw some of that money to be used for lending to its customers or to purchase other assets for itself, eg. corporate bonds, mortgage securities, stocks, etc. Now if the bank lends on that money it will become an account entry in the bank account of the borrower. If that borrower has an account with another bank, the money will show up in the account of the other bank and will ultimately appear in an account with the Fed. If the money is used to buy a stock, it will appear in the account of the seller at his bank and again will show up at the Fed in the account of another bank at the Fed. Thus money created by the Fed remains with the Fed but just shifts between accounts at the Fed.

    Does QE stimulate the economy? The theory is that by reducing interest rates, businesses will borrow and put the money into new projects thus hiring people, who will earn a wage and spend that money thus growing the economy. Also, with low rates all the money sitting in bank accounts will be used to purchase stocks by people who seek a higher yield. That will push up stock prices, and cause people to spend more as they will feel wealthier. Now, here is a problem. If I buy a stock because I am not earning much of a return with money in a deposit account , somebody else will get that money (unless it is an IPO and the firm is raising that money to invest in a business). It will then go into the account of the person who previously held the stock. Now this other person has cash in a low rate environment. You can imagine this person deciding to buy that stock back at a higher price because he/she does not like the rate of interest being earned. Imagine that the original buyer now sells that stock back for a profit. This can go on and on, with each person feeling wealthier and spending their spare cash because they feel wealthier. In order to spend some of their spare cash and to continue to invest in the rising stock they will start to borrow. However, there is no real wealth being created. Eventually at some point the investors will have borrowed so much that they will not be able to borrow any more and keep the stock moving higher. That is the point at which the stock will break lower, leaving the last holder nursing a massive loss and a nice big loan to pay off.

    #18104

    F W D.
    Participant

    There have been folks who are pleased to buy Troy ounces and sell avoirdupois ounces at the same price. A profitable fraud. Some sophisticated folks are unaware of the difference.
    So please call ounces (as in 12 ounces of silver as the basis for the British Pound Sterling) “Troy ounces” if they are indeed such.
    Point of information – “Sterling” can be as little as 92.5% silver. The “Sterling” in the British pound was/is Fine Silver, usually .999.

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