There’s still a lot of confusion over QE and its actual economic impact despite some pretty clear-cut evidence about what the policy does.  A brief recap might help.

Just to be clear – QE in the USA does not work by “funding” the spending of the US government.  I know this is a rather unorthodox perspective, but the government does not have trouble funding itself.  It procures funds by requiring the Primary Dealers to bid at auctions.  There has been zero evidence in recent years that the Primary Dealers are foregoing this requirement.  Therefore, the fact that the Fed is buying bonds should not be viewed as a funding operation.  It is instead a form of standard monetary operations similar to what the Fed does with the overnight interest rate at the short end of the curve.

The keys to understanding QE is in the following points:

  • Because the USA is sovereign in the US Dollar, the government is always able to procure funds by harnessing the Primary Dealers to bid for bonds (who then on-sell the bonds mostly).  Therefore, the idea that QE is monetization is a myth.  Rather, QE serves as an interest rate operation that serves to lower long-term rates in a manner very similar to the way monetary policy works at the short-end of the curve.   See this article for more.
  • QE in Europe can actually “work” because it is essentially a form of fiscal policy that actually helps to fund the countries in Europe (or at least help them avoid losing funding).  This would be like the Federal Reserve buying municipal bonds from states in distress who can’t find Federal funding (this would essentially be a form of fiscal policy and would be “money printing”).
  • QE in the form of buying back government debt is not “money printing” or “monetizing the debt”.  It is a swap or a change in the composition of private sector financial assets.  No net new financial assets are being added.  The private sector gets reserves, the Fed takes the bonds.  The net loss is in the difference in interest income.  But the private sector is not left with “more money”.
  • Banks never lend reserves so more reserves don’t mean more lending.  Loans create deposits.  The money multiplier is a myth.  This is why QE1 and QE2 did not cause a surge in loans or inflation.
  • The wealth effect in equities is a myth.  The flaw in QE is that it reduces the number of specific securities so it can force investors out of one asset and into another.  This can drive up prices, but does not necessarily drive up the fundamentals.  It’s not unlike a stock buyback and its immediate effects which drive up price, but have no impact on the underlying corporation.
  • The portfolio rebalancing effect of QE can cause substantial disequilibrium in the economy.  We saw this in QE2 when I repeatedly predicted that QE was causing an imbalance in bond and commodity prices.  And when the air came out of that 2010 nearly turned into a nightmare….

If you still have questions on QE I would consult this more detailed primer.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

More Posts - Website

Follow Me:


  1. Cullen – long time no talk…

    regarding the wealth effect: the goal (as I’m sure you know) is for higher asset prices to get people to feel good and spend more money, thus magically jump-starting the economy.

    I’m not saying that has happened, but it’s the way it works in the Fed’s magic econ lab. I agree with your statements:

    “…QE is that it reduces the number of specific securities so it can force investors out of one asset and into another.”


    “This can drive up prices, but does not necessarily drive up the fundamentals.”

    and I agree that QE hasn’t magically healed the economy, but I do believe that the wealth effect in equities is more than a myth: when people see that their portfolios are worth more, they feel better and they spend more.

      • But if the wealth effect makes assets more money like … (today’s MMR discussion!) …
        BTW is MMR dabbling in monetarism now?

        • The more important part about QE is that it doesn’t add net financial assets. But it can stabilize markets or even misprice them. That’s why QE1 really was beneficial. The Fed made a market in assets that were illiquid and probably worth 50 cents on the dollar. They brought some semblance of normalcy back to the market by essentially guaranteeing certain assets. That helps. Buying tsys and swapping them out for reserves in a fairly benign economic environment is different though and I’d say not very beneficial at all.

          And yes, we’re trying to use MMR to work with many schools of thought. You’ll notice that many of the commenters are austrians, horizontalists, Keynesians, monetarists, etc. I agree with Steve Waldman’s posts from today arguing that these schools are more intertwined than most want to believe. We need to bridge the divide. Embracing monetarists and other schools is the way to do this. MMR doesn’t have all the answers we won’t reject their ideas. We obviously have some differences, but that doesn’t mean we aren’t open to listening and trying to work with other people where we overlap.

    • A good trader who might not understand the fundamentals of the banking system hears that the Fed is “printing” money. So he expects near term inflation, divests himself of bonds and buys up equities. A lot of people did this in anticipation of QE, enough to actually make equities jump in price. The problem was once they realized there was no inflation, prices dropped, they took big losses and stampeded back to bonds. Academics and mainstream economists may expect the same thing to happen again, but traders are generally loathe to make the same mistake twice.

    • The goal of QE is partially a desire to create a wealth effect by increasing the value of risk assets, but really that’s not it. This is a stealth transfer of wealth to the banks to prop up their earnings. First the Fed tells the banks in advance which treasuries they plan on buying, so the banks can front run. Then the Fed buys those bonds from the banks who pocket the profit, and then the banks park proceeds at the Fed and earn 25 bps of interest.

      I need to think more about your argument that banks don’t lend reserves , which seems odd if they are ever deemed to have excess reserves.

    • Probably when the fiscal policy contracts and sucks the economy back into a recession. It looks like QE is becoming the strategy of the future. Which is kind of like a football coach relying only on his pep talks to make everyone on the team a better football player. That works great until you get busted in the mouth and the adrenaline turns into pain.

  2. So what is the nature of the new money in a system context? Our system allows the FED to create digital dollars and those dollars go on to buy bonds in the secondary market. (I wouldn’t be surprised if there were some direct purchasing in the primary bond market by primary dealers, but it is illegal to my understanding. Congress prevents the FED from buying directly on the primary market, but we now know it is mostly semantics.) When the FED purchases bonds on the secondary market, it injects said digital dollars into the market, and said new dollars are now free to go on to buy newly issued treasuries on the primary market. Put another way, QE sweeps old bonds out of the market allowing space for entry of newly created bonds by the Treasury. This funds deficit spending by the government. As mentioned by Cullen, it also creates a usury path to the FED, as the FED gains interest on bonds that they bought with money created from nothing. This is a hit on people who saved, thinking thier money was a store of wealth. The saver’s labor and output is “supposedly” stored in those savings. But, saver’s and laborers soon find out that their productive output is manipulated away from them via law change and maneuvering by the FIRE sector and wall street.

    These newly created dollars then travel a path from the FED to the Treasury. The FED ends up holding a bond, and the Treasury ends up holding new dollars. This shell game magic is required for double entry bookeeping. An asset must enter the ledger to offset the creation of “credit.” The Treasury now has dollars to deficit spend.

    But, is a bond based on the good faith of American’s really solid credit? The run up in the housing bubble was predicated on Asset inflation and not real wealth creation. The government does QE in order acquire the cash to deficit spend, and not drain the money supply.

    A fraction of the new cash goes on to buy down the liability side of private credit banker’s ledgers. This liability side of the ledger was driven up during the bubble. Good heavens that we should go and erase the liability column and mark it to reality. We must never temporarily take private banks into recievership and adjust their ledgers? Instead we must create digital dollars at the government level and push them into the economy. While this is works for now, in a deflationary environment (paying down the liability column), it degrades the dollar and makes the economy act like it has a virus. Money itself signals its value inappropriately because of the poor linkage to real wealth. Instead we allowed our money to be linked to manipulations.

    Money has information encoded in it, and it is “assumed” that the law allows money to be created in proportion to real wealth. But asset manipulations by the FIRE sector, and their lackeys in Congress and the FED, have undermined the fundamental base of money itself. Asset inflating a housing bubble, or education, or land, or wherever the FIRE sector wants to attack next, allows the creation of credit based on asset inflation, not real wealth creation. Ultimately this always backfires in a bubble bust, because it is not real.

    The two headwaters for money creation in our economy, private banking and the government, allows them to play each other. It is a recipe for chicanery. MMT theory exposes this chicanery, but few comment on the nature of the money created and what it goes on to do in the econonmy.

    QE is just a mechanism. We could just as easily create money from nothing at the Treasury and spend it into the economy, like Lincoln did with Greenbacks. If new money is spent properly on one of the four modes of production (Labor, Land, Capital, Public Commons) it can multiply itself as real wealth increases. This is how we got rich in the past. But, I seldom hear discussion about how our deficit money is spent. Today, a good percentage is spent on unemployment, where it can go on to buy Chinese and other foreign goods, hollowing out economy and supressing real wealth creation.

  3. Cullen and others:
    I understand that 61% of the new Treasury debt was bought by the Fed. If true, this seems to indicate that demand for Treasuries is waning.
    Don Levit

    • I don’t think it’s right to say demand for Tsy’s is declining just because the Fed buys back bonds. The Fed transacts monetary policy largely by forcing the pvt sector to give up the bonds. The PD’s make a market for the Fed to transact policy. So the fact that the govt has bought back all these bonds doesn’t necessarily mean the pvt sector wouldn’t have wanted to hold them anyhow. Think about it logically – would you rather own a govt note at 0.25% or a govt note at 2%? The banks have lost substantial interest income from this operation….

      • OK. The banks have lost substantial interest income, but so have savers. When will the Fed allow interest rates to rise back to produce a reasonable return? – they can’t.

        If the return on Tsy’s was not being held down by the Fed, our $15T in debt would yield a huge interest expense. So, while the Fed could always produce the necessary funds for the interest, such actions would tend to expand the money supply even further. The Fed’s policy has placed the monetary system in an unstable equilibrium, and the Fed has lost its ability to respond effectively to the future recessions.

        • Right. Higher interest payments would mean a higher deficit. But it would also mean higher interest payments on pvt debt and more expensive credit which could prove counterproductive. The Fed’s just kind of in a bind in terms of policy.

  4. If the Fed were to “vastly overpay” for bonds (e.g., pay full mature value to put the yield at 0%), would that count as creating net financial assets in the private sector? In a strict accounting sense the reserves are worth what the bonds were exchanged for so “no”, but if the Fed is the only buyer willing to pay 0% then the concept of net financial assets doesn’t seem to be capturing what’s happening.

    Help me out here.

  5. The Fed gives ‘reserves’ and buys back the bonds.
    So what are the reserves? … The sovereign printing power?
    Is there a limit to the Fed’s reserves? Are the reserves merely a record of money that must be printed later, or the money that we have printed?
    It still sounds as if an asset is created. You had a bond… but now you have a bond (held by the Fed) and the dollars in the system. I guess the new asset is balanced by the added reserve.
    What happens to the reserves?

      • Isn’t the Fed merely paying off the loan early in an attempt to get money into the system.
        Mr. Bank has a $1 trillion bond due in 10 years. It’s an asset. It’s earning interest. The Fed buys it off today (sidelight, why would Mr. Bank do that … wouldn’t it prefer to keep the bond and collect the interest?) and the Fed keeps the bond.
        Now The Fed can’t sell the newly acquired asset, because that would take money out of the system — deflationary.
        So what happens in 10 years when the bond comes due? The Treasury has to pay off the bond (from taxes), right? It has to pay the Fed? Or does the Fed just give the Treasury money to pay off the bond. This transaction is what makes your head explode.
        Just a layman here, but again, this seems like part of the pattern of taking a future asset (the long bond) and paying it off early. We’re spending our future money today and hoping that it won’t matter in the long run.

        • The Fed acquired the bond because it wanted to increase reserves. When it decides the time has come to raise interest rates it will acquire reserves from banks and replace them with the bond. It doesn’t need to be “resold” by the Fed because it is now playing the role for which it was intended: a tool for hitting a target overnight interest rate.

        • When the FED is holding the US Trys, it receives interest payments from the UST and then remits the interest right back to the UST (Effectively these US Trys are now at 0% AND the FED gets to boast about the record number of profits being returned to the UST).

          When the US Trys matures, the UST must pay the FED to redeem the bond, and again the FED remits the funds back to the UST (Effectively these US Trys don’t exist).

          Once the FED purchases a US Treasury (outside of normal FOMC ops) it is effectively evaporated. But, remember the US Gov’t spent money into existence in the first place, and when in deficit the UST issues the US Treasury to “account” for the deficit spend. So those original dollars (NFAs) were spent (transferred into the private sector) and the UST/FED QE Bond Game evaporated the US Treasury bond. So they might as well go ALL IN and eliminate the US Treasury market as a deficit/national debt tracking tool (which requires interest payments) and issue debt-free money into the system; use Federal Funds Rate and Interest on Reserves to manage the target interest rate as the monetary policy tool; also place tight capital controls to limit leverage and regulation to minimize risk with strong prudential regulation to ensure financial system stability.

          This is all happening in a Multi-trillion dollar process and with a huge run up in the FED balance sheet, unprecedented event along with extraordinary fiscal support (4.5T over 3 years, and trillions / year into the future) — so I don’t think anyone has a clue as to what is going to happen and what the unintended consequences will be. The only certainty may be in that there will be unintended consequences ? …..

  6. Cullen, your analysis in this area has been bang on from day one. Congrats. Unfortunately, even after all this time, the general perception out there is still that QE is “printing money”. All those excess reserves sloshing around in the banking system don’t help calm the inflation fears, either. Therefore, I don’t see QE becoming the strategy of the future, but Operation Twist (OT) is another story. OT is much more palatable to the general public as it does not increase reserves or expand the Fed balance sheet. It is simply selling short bonds and using the proceeds to buy long bonds. I think the Fed would have liked to continue with OT but it has only a limited amount of short bonds to sell, and it is quickly running out. But never fear, OT2 is here. Well, it isn’t here yet, but if we are to believe the leaks in the WSJ, OT2 will involve the Fed borrowing short and lending long. This will give the Fed much more buying power than under the original OT. So hopefully OT2 is the strategy of the future, not QE.

    • The Fed already owns >90% of the issuance for long term bonds. When they do QE4 (OT is QE3), they will buy mortgages, just like with QE1. The Fed will stop at nothing to prop up the stock market because the solvency of all pension funds, insurance companies, and banks depends on the stock market staying up. QE may not do anything direct for the real economy (as Cullen says it provides no new financial assets), but it does prop up stocks, and that in itself prevents the financial system from collapsing in a self-reinforcing deflationary black hole. In other words, QE does nothing to create new financial assets, but it does prevent existing financial assets from being destroyed.

      • Agreed, although keeping yields down is not exactly helping pension funds and insurance companies, either. Also good point about the Fed’s inability to create new NFA’s, which highlights the relative weakness of monetary policy.

        I’m afraid Mr. Bernanke is impotent.

        Figuratively speaking :)

  7. Do equities create wealth?
    If you answered NO. then go to zero hedge and buy gold
    If you answered yes…then I have a follow up question.
    Does QE or the FEds programs..cause Risk assets to go up?
    If you answered yes..then can you help me understand how….equities plus the fed supportive programs don’t create wealth? How is that a myth?
    Please don’t offer me 7-10 durable returns. or that the SPX needs must be held from peak to trough.
    Before you launch into defending the unemployed or long term investors..that is not what I asked. Ask your self..how long YOU hold a stock or SPX before you lecture eveyone on why the FEd is wrong.
    I have found very few on this site hold any investment long term. Only..and I’m sorry I forget your name…but the guy who loves John Bogle(I agree with you on him) and always lists the past market calls of Dr. Hussman etc. He and only he should be pissed with the FED. on this site. But most of us sell when we make money and lock in the wealth. My statement of Financial Position increase from this wealth effect is not a myth. My problem is I believed it was a myth and didn’t increase it as much as I should have.
    NO it’s not durable but neither is anything you buy so you can sell. Even the one person who detests the QE addicts …is constantly hedging and raising cash. Thus…it seems to me he is market timing based on Aunt Minnies rather than QEs.
    It will never be durable for him. But show me the RULE BOOK on investing that says we have to HOLD the SPX for some durable time period we KNOW will lose us money? WE Don’t have to. That is not a RULE. So why discuss it like we must? He has created this mythical rule book and invests according to it.
    LIke the RED Coats fighting the Revolutionist…lining up like gentleman in clean lines…only to be shot down dead. No one said you had to fight fair. Fight the FEDeralist/Revolutionists at your own peril.
    that’s the point. If you stay on the buss to Dover to long you will die. That is why the QE buyers sit right by the exit. And yes..if you sold today from your buys off of QE1, QE2 and OPT..you have increased your wealth…
    SO to prove this is not a myth…EVERYONE sell your gains and lock them in. And give life to the tooth Fairy and the easter bunny.
    Now the markets selling off and everyone will wait….until the perfect time to buy. How do many of you say that QE does not create wealth…but wont’ buy stocks unless you know the FEd will do QE3?

    • VII -

      I agreed that we are all speculating and using the misinformation of the QE to make money. However, for every seller, there is a buyer. So unless the FED money made it way into the general population to increase the NFA then no QE has not increase wealth. it has shifted the wealth from those who understood and gamed the sytem. Like you said, those traders /investors who understood the misinformation about QE is sitting by the exit. So who is sitting on the bus and getting off/on at the wrong time?

  8. QE1 was cash for trash. The FED created new money, pushed it down into their private banking system, and traded it for bad paper. The FED’s balance sheet then balanced with the newly recieved paper offsetting the new money creation. The private banks looked healthy as their asset base appeared to improve. Of course at the time nobody wanted to borrow, because you can’t push on a string. The housing bubble had crashed, and people were not going to borrow, thus pushign the economy over into asset deflation.

    Enter QE2: QE2 was sweeping bonds out of the secondary market, putting new cash in, and ultimately funding deficit spending.

    The deficit spending went on to become used in the money supply, e.g. laborer’s money used to pay down private banker ledgers – ledgers improperly run up during the bubble. Asset inflating the land/housing bubble, starting in the mid 90′s, seems to be a purposeful maneuver by the FIRE sector and greedy government officials.

    After the crash, without the deficit spending by government, where would the needed money come from, especially since credit bankers weren’t loaning. (Private credit is 70-80% of the money supply.) But, deficit spending is indiscriminate and often causes sector inflation and other distortions. One could argue that without QE we would have entered into a depression, which I agree with. However, we could have just as easily taken over the failed banks and “adjusted” them, just like we did with the Savings and Loans in the 80′s.

    We also never really fixed the underlying problem, which was caused by breaking Glass Steagall. Graham Leach Bliley act allowed insurance and other monetary mal-actors to sneak in and back up private formation of credit. After all, a loan looks really good if AIG is backing it up. A bank can create new credit money because AIG is a counterparty. Additionally, Democrats greased the path for GLB by demanding provisions of the CRA be adjusted. This morphed into NINJA loans and other predatory behavior to prove to gov’t officials that banker’s weren’t red lining. Wink wink nudge nudge, the minorities are now getting predatory loans and banks are not red lining. Never mind that during the bubble crash, democrats screwed the minorities they were supposedly helping, as mostly minorities or those without other assets to trade, lost their homes.

    We also haven’t fixed the shadow banking system, which allows short term money to attach and buy “housing loans.” A NINJA loan (no income no job) is OK, because the private banker can immediately offload the loan to the Shadow Bankers and take his profit now. This disconnets private bankers from taking a long view. Buying short to lend long is a fundamental money law Shadow Bankers operate under, and it is wrong. The money in shadow banking is now growing again and exceeding that of regular “commercial” banking economy. Shadow bankers also create fraud at the moment the turn our FDIC housing loans into securities, by pretending the “asset” has more value than it should by assigning a higher fradulent value. They then shove the new “derived security” at a mutual fund or other short term money, which in turn screws laboring saver’s once again during the transaction.

    Shadow bankers funnel cash from the market to private bankers, and in the other direction, our housing loans go and get turned into derivitives and new “securities.” What is secure about short term money attaching itself to long term housing loans?

    The government isn’t necessarily the bad actor for doing QE, but they are a bad actor for not understanding the money system, and allowing labor to have their wealth siphoned away. How many lawyers or glib politicians understand that at its root, money is law? And most of these lawyers and politicians willingly follow along with advice from selfish predators of Goldman Sachs and others from the FIRE sector.

  9. Cullen,

    “…. The private sector gets reserves, the Fed takes the bonds. ….”

    I understand and agree with this. But isn’t it misleading to suggest…

    “…. This is why QE1 and QE2 did not cause a surge in loans or inflation….”

    The fed is not creating any net new assets, but it IS replacing the bonds with cash. The primary dealers can choose to do what they want with the cash. They can choose to redeposit it all at the fed for their risk-free 0.25%, or they can speculate with some of it. I agree they are not lending it, but they ARE contributing to substantial inflation in all the cost of living commodities. The point is, is that it is the choice of the banks on where it goes, not the govt, not the fed, and leaving it to banker judgement seems to be a substantial risk to me, and that risk seems to be too under-weighted by claiming minimal impact of all the QE mechanisms, in my view.

    Think about it logically…….the fed’s entire focus has been on propping up banks on life support, their program’s impact is not going to be one that is limited to COSTING those banks interest earnings…..there’s clearly more to the story. With interest rate sensitive derivatives on bank books that would still bury them all with even a small uptick in rates, all the fed’s claims about other goals are little more than a smokescreen. krb

  10. QE2 funded deficit spending, increasing the money supply. Some of the extra cash went to sector inflation, such as that in commodities. Some of the cash went to buying more foreign products, screwing over mainstreet manufacturing. Some of the extra cash went to carry trade hot flows, causing overseas inflation in dollar zone economies. A lot of the deficit spending went to wall street, re-inflating price/earnings ratios.

    A small fraction went to paying down the Balance Sheet Recession BSR, or liability column on banker’s ledgers. This is where we should have targeted with fiscal operations (taxes and law), but we didn’t. We forced the FED to do monetary operations instead, because our politicians ignorantly and selfishly helped cause the problem.

    QE2 also slammed savers against the wall as their returns fell toward zero. Deficit spending drives the overnight rate toward zero (ZIRP), putting downward pressure on interest rates. In other words, the Treasury and the FED work together with their “cash” using open market operations. Using repos and reverse repos to add and subtract to the interbank loans.

    When Grandma gets her social security check, if it is deficit spend money, it is exogenous to the private banking system, and is usually seen as extra reserves, hence going on the overnight market. This deficit spending drives rates toward zero.

    So, the interlocking game of money flows, which includes QE1,2 money creation, ultimately redounds to a lot of negative behavior in the economy. There are better ways. Since money is law, and it also codes for information, it is the key unit in our economy -governing our behavior. Jacking around with the dollar and breaking obvious monetary rules should be landing people in jail. But most people, even government, cannot agree on what the rules are. Cullen is trying to shed a little light on the subject, and technically he has been correct. I think the more important subject is to follow the money from creation to destruction, and observe what it does in the economy.

    With regards to operation Twist as mentioned earlier, the FED simply sells their formerly bought “short bonds” and re-invests their cash to buy long bonds. This doesn’t change the money supply volume as one asset class is traded for another; but don’t forget how the fed bought short term bonds to begin with: Keyboard entries during QE2.

  11. Cullen,

    Has anyone looked at QE from the perspective of how decreasing available treasuries and increasing banking reserves impacts the “shadow banking system”?

    That is, if reserves do not behave as “collateral” as treasuries and other debt can, then QE would be net deflationary to the shadow banking system?

    Alternatively if reserves behave as “collateral” much like treasuries or other debt does, then there maybe no impact to “effective money”. (Provided that reserves do not have some greater “collateral velocity” which then may increase effective private money).

  12. Paul McCulley and Bill Miller discuss Macro policy and liquidity trap on Wealth Track

    They don’t feel that monetary policy works in the household delever environment and more need for fiscal policy. USA can take on much much more debt but next generation will require too high a tax to pay Boomer retirement and health care.
    Both like equities and avoid or short bonds esp 10 yr.

    McCulley is entertaining!! What is the feeling here on McCulley? He said that LTRO in EU was a convincing move that ECB would provide unlimited support and also Bernanke would avoid a 1937 type of fall .

    • McCulley is very good. Especially now that he’s no longer with PIMCO and the tight compliance. I haven’t had time to watch the interview yet, but I’ve been meaning to. Thanks.

  13. How much bad debt does the FED have on the books? How much “bad” debt has the FED guaranteed? We know this all started with the guarantee to JP Morgan to take over Bear Sterns bad debt. That was the first FED week-end meeting in 30 yrs. How much of it is or was bad? I could go down this road all night with AIG etc etc. Bottom line, until the FED is audited, I don’t think we know as much as we think. Does anyone have a best guess as to how much “bad debt” the FED is holding or guaranteeing? I’d really like to see their balance sheet with assets marketed to market… wouldn’t you? Or does it really matter, as long as the market will take their electronic data entries for money, what difference does it make? None! Just keep adding zeros and some people will say it doesn’t matter… until it does!

  14. When commentators say “vast chunks of this cash ends up in commodities and stock markets”, then can I safely ignore them?