Some people want you to believe that the Fed just injected the economy and stock market full of money that will now result in an economic boom and much higher prices in most assets.  That’s simply not true.  Here’s the actual mechanics behind QE.

Before we begin, it’s important that investors understand exactly what “cash” is.  “Cash” is simply a very liquid liability of the U.S. government.   You can call it “cash”, Federal Reserve notes, whatever.  But it is a liability of the U.S. government.  Just like a 13 week treasury bill.  What is the major distinction between “cash” and bills?  Just the duration and amount of interest the two pay.  Think of one like a checking account and the other like a savings account.

This is a crucial point that I think a lot of us are having trouble wrapping our heads around. In school we are taught that “cash” is its own unique asset class. But that’s not really true. “Cash” as it sits in your bank account is really just a very very liquid government liability. What is the difference between your checking and savings account? Do you classify them both as “cash”? Do you consider your savings accounts a slightly less liquid interest bearing form of the same thing a checking account is?

What is a treasury note account? It is a savings account with the government. So now you have to ask yourself why you think cash is so much different than a treasury note?  What is the difference between your ETrade cash earning 0.1% and that t note earning 0.2%? NOTHING except the interest rate and the duration.  You can’t use your 13 week bill to pay your taxes tomorrow, but that doesn’t mean it isn’t a slightly less liquid form of the exact same thing that we all refer to as “cash”.  They are both govt liabilities and assets of yours.

When you own a t note you really just traded your “cash” for a slightly less liquid form of the same exact thing.  If the Fed buys those t notes from you they give you back your cash minus the interest rate. That’s all there is to it. No change in the money supply. No change in anything except the rate of interest you were earning.  If the government removes t notes then all they’re doing is altering the term structure of their liabilities.   They’re not changing the AMOUNT of liabilities.

The other day, Ben Bernanke explained that he is not adding any new cash to the system via QE:

“Now, what these reserves are is essentially deposits that commercial banks hold with the Fed, so sometimes you hear the Fed is printing money, that’s not really happening, the amount of cash in circulation is not changing. What’s happening is that banks are holding more and more reserves with the Fed.”

This is very important because millions of investors are betting on the inflationary impact of QE.  But again, as Mr. Bernanke said there is no reason to believe that QE is inflationary.   Why?  Because they are not adding net new financial assets to the private sector.  The assets already existed!  They are merely swapping reserves for bonds.   They are giving the banks a checking account instead of a savings account.  What does this mean?  If Bank A owned a 1.2% 5 year note and they sell that note to the Fed they receive reserves earnings 0.25%.  Their savings account was changed to a checking account.  What changed?  Nothing.  Just the duration and rate of the paper.  The number of assets in the system is the exact same.   You can see this description in the following diagram (via Alea):

As you can see the net financial assets are UNCHANGED. They are merely changing the composition of the bank balance sheet.  The logical question that most people ask is: “where did the Fed get the money to buy the bonds?”  They didn’t get it from anywhere.  It truly is ex nihilo.  But it is not new money being injected into the private sector. It is merely being swapped with something that was already spent into existence.  Therefore, you’ll often hear that banks have new money to put to work.  That’s not true.  They had a 0.2% piece of paper that was already put to work and can be exchanged in markets for whatever they please.  There is not “more firepower” in the market following QE.  All that the Fed altered was the duration of the U.S. government’s liabilities.  The Fed took on an asset (treasurys) and also accounted for a new liability (the reserves).   But this transaction did not change the net financial assets in the system.

The point here is that from an operational perspective the Fed is not really altering the money supply.  There might be some slight market change in the bonds the Fed purchases, but this is offset by the fact that the private sector is losing interest income they would have otherwise earned.  For instance, in QE1 the Fed removed $1.2T in assets from the private sector.  Much of this was high yield paper.  We know the Fed turned over ~$50B to the U.S. treasury (its “profits”) from QE1.  What did the banks get in return?  They got a checking account at the Fed earning 0.25% or roughly $2.5B over the course of QE1.  So the private sector LOST ~$47.5B in interest income it would have otherwise earned.

So, now you must be asking yourself why the heck they’re even doing this to begin with.  Well, QE supposedly changes the term structure of the bond market.  Fewer 5 year notes should lower interest rates and entice borrowing, generate lending, make other assets more attractive, etc.  If you sell your bonds to the Fed and receive low interest bearing cash you might want to rebalance your portfolio.  Mr. Bernanke is hoping you will reach out on the risk curve and buy equities or corporate debt.  But the price you purchase those securities at will depend entirely on their fundamentals and the price that you and the seller agree upon.  If you run out and bid up risk assets just because you think the Fed is “printing money” then you’re making a mistake.  If you run out and buy stocks even though their fundamentals have not changed you are making a mistake.

This is probably best seen in the price of commodities presently where investors are hyperventilating over the “printed money” and buying up hard assets.  For instance, coffee prices are up 70% since QE started yet Howard Schultz, the CEO of Starbucks says the fundamentals have not changed at all in the last two months.  He claims the speculators are to blame (thank you for that Ben Bernanke!).  Inefficient market at work in real-time?   Sure looks that way and we can thank the Fed for causing the bubbly situation in commodities.  They’re advocating undue speculation, causing severe market distortions, driving down the dollar and rewarding speculators for further financializing this economy.

The Fed has caused this mass hysteria over a minor interest rate decline.  In short, there is not more cash in the system following QE. There is not more “firepower” with which to purchase equities.   Hopefully, the above description makes that very clear. This was most obvious in Japan where QE caused a brief 17% rally in equities as speculators leveraged up, jammed prices and then later realized that the slightly lower yields hadn’t really changed anything.  What happened next?  Their equity market fell 40%+ over the next two years.  QE was a great big “non-event”.  All it did was manipulate markets temporarily and cause a huge amount of confusion.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

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.

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  • john

    The mobility of cash destroys your argument. I can do anything i want with cash. A bond limits my ability to buy commodities, land any other type of asset.

  • LVG

    His point is that you can sell your t bill right now. You can sell them on the open market right now and go out and do whatever you want with your “cash”. You say a treasury bill is less liquid, but how much less liquid is it really?

  • LVG

    You often heard gold bugs make a similarly dumb argument. They argue that gold is a dollar equivalent or even better. But how liquid is gold? Is it really a better medium of exchange than a US dollar or even a US treasury bill?

  • DRS

    If all the Banks went to the Fed this afternoon and tried to get their money out, what would happen? Would the Fed be forced to sell securities, or would they THEN create new assets?

    Further, before buying the securities, what was on the Asset side of the Fed’s B/S?

  • http://www.pragcap.com TPC

    That’s like saying that there is less “firepower” when people own stocks. Is there really though? They are “less liquid” than “cash”. But I can sell my stocks at almost any point of any day and immediately exhchange it for “cash”. Then, someone else owns my stocks and I own their cash.

    The Fed isn’t adding firepower. They’re just trying to herd people into other assets based on the misconception that they’ve added firepower.

  • john

    If i sell 1000 T bill – i will grant you I have cash now however the other party has my bill, their actions are limited. However when you have the fed buying the T bill they are forcing more cash into the system because they are changing the compositon of their assets.

  • Captain America

    There isn’t enough currency in circulation for everyone to remove their money from the banks. That’s why we have bank runs. If you want to get really granular you could argue that there is technically too little money in the system.

    They create the liability from nothing. But that doesn’t mean new money was added to the private sector.

  • buckstar

    Fantastic post!

  • DRS

    ^ I didn’t say “banks” – I said Fed.

  • buckstar

    For me QE has been very much deflationary; when short term rates used to be 6%, that was a nice chunk of income…

  • Captain America

    I don’t know. If a meteor hits me in the face tomorrow will I die? What you’re asking can never happen. Banks don’t have runs on themselves.

  • buckstar

    Not sure that’s true; banks can lend you (out of thin air) ‘cash’ for your ‘treasuries’ so you can go buy commodities

  • Captain America

    Exactly. Cash has already always been put to work. I found this great letter from John Hussman that puts it together nicely. The fed is not adding cash to the sidelines. The cash was always there. It just took a different form with a different name.


  • DRS

    I’m more trying to comprehend whether the asset/liability examples always hold up…

  • Captain America

    Well, if youn want to be a bank in the USA you have to hold reserves at the Fed. So there is no removing the money from the fed funds system. Unless the banking system collapsed in which case we’re having a pointless conversation.

  • Old Timer

    Whiskey Tango Foxtrot!

    Perception = Reality (when it comes to ALL markets).

    TPC can shout all day long that QE does not increase the money supply but at the end of each day the markets have behaved as if the money supply has increased.

    Folks – this site is merely a mouthpiece for the folks who are trading against you.

    It is a set up.

    Caveat emptor.

  • http://seekingdelta.wordpress.com/ seekingdelta

    Thanks TPC. This section helps to clarify a lot:

    “The logical question that most people ask is: “where did the Fed get the money to buy the bonds?” They didn’t get it from anywhere. It truly is ex nihilo. But it is not new money being injected into the private sector. It is merely being swapped with something that was already spent into existence.”

  • DRS

    banks are holding WAY more than their required reserve limits. Banks can remove A LOT of it and still meet their reserve limits.

  • http://www.pragcap.com TPC

    Do markets always perfectly reflect reality?

    If you think I am wrong then provide some real evidence and not false accusations. Or should I sit on my perch here at TPC and tell people to buy gold “because we’re “printing money. Oh dear lord and baby jesus! Buy some gold because the world is ending and the govt is out to kill us all and steal our future prosperity via the printing press!!”. Personally, I think the honest and human thing to do is to spread the truth. If you don’t want to believe it then don’t come back. That’s fine. No one is forcing you to come here.

  • Captain America

    Yeah, but banks can’t get rid of the reserves in the fed funds system. They can trade them between eachother, but they can’t get rid of them. If bank of america gets rid of all of its reserves some other bank holds them.

  • Captain America

    The truth hurts TPC. You’re putting a damper on the stock market party and Old Timer doesn’t like it. He’s probably leveraged up on gold, silver and Apple.

  • prescient11


    I am very glad you reposted this chart as I was about to comment on it. Isn’t it clear to everyone what BB is doing and why it is genius/the right thing.

    He is liquifying banks with cash. That way, when the losses hit as Whalen describes and I think he’s right, the banks are going to be able to have adequate reserves to deal with it.


    We can argue the rights and the wrongs of it, and perhaps there’s a way to get this back once the dust settles via some kind of bank transaction tax, etc.

    But I would submit that BB is doing EXACTLY what is needed. Capital is going to flow where it is most welcome and the rules are defined. That is a fact.

    It is also going to flow where it can make the best return. I submit that devaluing the currency at this stage of the game is the only rational move and the other alternatives lead to nightmares, bread lines, and other ridiculous scenarios.

    As TPC has pounded the table many times, our short term debt is by no means the problem. Run deficits, get the private sector healthy again, and then TAKE A FRIGGING HATCHET to the long term entitlement programs.

    If we do that, we will regain a lot of our economic strength back.

    AND PARTICIPATE in the currency war that has been fought against us for 25 years, instead of failing to fire a shot. No more volcker.

  • kayman

    so, now that we’ve had a pop ala Japan – is it time to short since the fundamentals are pretty much the same…and might be worsened by the dislocations of QE2

  • j

    You must be smarter than Bill Gross. Bill Gross must have it all wrong. That is why he is a billionaire and you are a blogger.

  • Randall

    What is missing from this discussion is the money that was originally “spent into existence” when the Government spends more than it takes in. That is new money in circulation. I understand your argument that this is soaked up by the issuance of treasury bonds, and not inflationary as the net amount of cash remains the same, after the bonds are sold. But if the Fed buys those bonds back, that money that was “spent into existence” is back in the bank accounts, is it not? So, how is this not adding new money to the total supply?

  • prescient11

    Bill Gross is a pimp and part of the “club”. How about we take those anti-fed people and say fine smart guy, your FNM and FRE bonds are worthless??

    How about that??

    He might not be a billionaire anymore, eh?

    This is how the banksters operate, don’t you see. Crisis hits — oh my God, the whole system will collapse if you don’t give us free money (already in the play of course).

    Then, a year later when everything is done and shored up, we MUST have fiscal austerity, please raise the interest rates of all the T-bills I’m holding, making these csuckers a FORTUNE.

    It is so predictable it is sickening.

  • Old Timer

    “where did the Fed get the money to buy the bonds?” They didn’t get it from anywhere. It truly is ex nihilo.”

    As you state – these new reserves are created “ex nihilo” or literally OUT OF NOTHING!

    You assume the Fed is only exchanging these new reserves with the banks.

    In fact they are buying those Treasury securities from anyone who choses to sell. They are Fungible, they do not know where they come from (just like any other form of money) and the market does not care.

    These reserves are not necessarily ending up in the banks, in fact, none of these reserves may end up in the banks. The Fed is increasing it’s balance sheet through QE2 as it did through QE1.

    According to the REAL world, these new reserves are actually very real (even if they were created out of nothing) and they are diluting the existing supply of dollars (inflation by any other definition).

  • http://www.pragcap.com TPC

    That’s always my favorite argument. Would Bill Gross and Warren Buffett look so smart if they hadn’t convinced the US govt that they needed to be bailed out? It’s a nonsensical and pointless argument. Gross made bets that nearly sunk his firm. The fact that the US govt bailed out the GSE’s does not make him some sort of genius.

  • DRS

    How is he liquifying the BANKS specifically? Theoretically, the Fed could purchase $600B of treasuries from money managers such as PIMCO.

    Prescient – Banks need CAPITAL to deal with losses. I am being naive to assume you are confusing liquidity and capital? Losses are non-cash events. If we write down a bond taking losses, we don’t have to fork over cash – its an accounting entry. What do reserves have to do with losses?

  • http://www.pragcap.com TPC

    This is not deficit spending. Treasury has no involvement.

  • Captain America

    reserves are held in the banking system. They can be traded between the banks, but they don’t leave the system. Just look at the reserve balances from QE1. There they are at the Fed banks:

  • j

    I think all of you who don’t think the Fed is printing money should go read the Paul Krugman textbook titled “International Economics”. The QE scenario is nothing more than basic expansion of the money supply. The text also indicates that money supply expansion without increased demand results in inflation and trade issues. If you don’t understand this basic relationsip, you will never pass the basic wall street interview process.

  • Cowpoke

    To make things a bit more interesting, can we throw in Credit Expansion and Contraction?

  • prescient11


    If you want real reform, then these clowns would be feeling an immense amount of pain, immediately.

    Germany has a claw-back for five years of pay and bonuses for bankers that make crappy loans. Not a bad idea.

  • prescient11

    DRS, with all due respect, who is being naive? For these entities, liquidity becomes capital and excess capital.

    What do you think they are doing with this $$, they are putting it to use and they have the power to frontrun their clients.

    Have you looked at the trading arms of banks. Tell me the last Q of any bank where the trading arms made a loss??

    Oh, they know what they are doing.

  • Obsvr-1

    The question is what happens next, if the banks use the reserves to buy new treasuries then the money moves from the monetary base (M0) into circulation (M1/M2) via gov’t spending which does increase the money supply (inflationary).

    Why would a bank trade a t-bill (savings acct) earning more interest for a reserve (checking acct) if they are not forced or coerced into covering up the money laundering from the FED to the UST — since the FED can not directly buy treasuries from the UST as it would violate the FRA by monetizing the deficit .. so they do it indirectly using the commercial banks. Very much different from buying and selling treasuries already in existence to use monetary policy in increasing or decreasing the monetary base in attempts to regulate/moderate the short term interest rates.

    Also when the FED bought up the MBS (+1T $) in QE1 they provided the monetary base expansion at the banks to purchase the first round of treasuries to prime the pump.

    Again if this is just a non-event of exchanging one asset for another, why is the FED doing it and why would a commercial for profit bank do this willingly and lose the interest revenue.

  • gaius marius

    you don’t even have to sell — in a deep and liquid market you can repo the thing for zero haircut. these are cash equivalents entirely UNLESS you’re in a severe liquidity crisis where even government repo breaks down.

  • LVG

    You missed the whole point of the post. The money won’t move from reserves into treasuries. It could be exchanged, but that’s it. It’s just an exchange. Someone buys treasuries and someone else holds the reserves. What changed?

    Primary Dealers are always required to show up at treasury auctions. That’s the rule. And that’s why the auctions never fail. TPC has covered this thoroughly.

  • DRS

    To make an extreme example, a bank could have 100% of their assets at the Fed earning 25 bps, and they would be considered liquid as the ocean – but that wouldn’t mean they’d have strong capital. i.e. their tier 1 may be very weak. Liquidity doesn’t always become capital – especially not when so much money is sitting in low earning securities and NOT being lent out.

  • LVG

    The point being with regards to auctions that the money used to buy bonds is already in the system!!!!!

  • gaius marius

    this is discussed far too little. ZIRP is killing systemic interest income at a time when income leakage from the consumption stream to pay down debt has become a major concern.

  • http://www.pragcap.com TPC

    credit expansion is a result of the private sector’s demand for loans. Loans create deposits. Banks don’t lend out reserves or deposits. This is a demand side issue, but we have a fed chairman who believes in all things supply side.

  • j

    Let’s see you purchase a loaf a bread at the local store with a TBill. Tell me how that works out. On wall street, we laugh at the Democrats. They can’t see the oil spill in the gulf. They can’t see the recession. And, now they can’t see the Fed printing money. Smart bunch.

  • http://lebleu.org Guillaume Lebleu

    David Anfaltto who is an economist at the Fed, wrote a good piece on whether asset purchases by the Fed are inflationary or not. Hi point is that they are inflationary only if the assets purchased default. This may not apply to Treasuries but would apply to MBS.


  • http://www.pragcap.com TPC

    This has nothing to do with politics.

  • gaius marius

    running large deficits IS creating money, randall, i agree — which is why fiscal stimulus really does work to juice an economy and enable it to pay down private sector debt. but that’s not what the Fed is doing at all.

  • j

    Untrue. Assets purchased for more than fair market value is also inflationary.

  • prescient11


    Here’s my point and the key analogy to understand what’s going on and why QE is genius given the Fed’s limited tool set.

    Say your dad keeps $95 out of $100 that you make in savings, and only lets you go to the casino with $5. The amount of leverage and bets you need to make is very limited, thus, even on a very hot streak, you most likely come home with $50-100.

    Now assume your dad gives you the whole $100 to gamble (or “trade” with), then you’ve got a TON of leverage.

    The banks are in the casino with a boatload of cash. And guess who they are prying the money from, CHINA, et al. IT’S A BRILLIANT FRIGGING MOVE.

    And here’s the final kicker, quite frankly, it is justified given the pure demand for raw materials from the BRIC countries.

    TPC, Schultz is way off base on that coffee demand, I believe. Demand for coffee has been steadily increasing for years…

  • gaius marius

    it’s also the wrong framework. if you think deposits and reserves are “hgih-powered money” which create loanable funds in the system, you don’t understand banking.

    krugman is a smart man and knows plenty about trade, but the crisis and its aftermath has demonstrated how little he and many others know about banking and how it works. the two are not the same.

  • j

    That must be why Obama gave his support to QE during a news event in India, and why the unions, a big Democrat support group, is cheering the money printing operation. After all, the unions demand a huge currency change such that a union worker with gold plated benefits and retirement in the US takes jobs away from the dollar per hour worker in southeast Asia. This is unfair to the American public who will land up with a big inflationary bill in the name of union workers.

  • http://www.pragcap.com TPC

    Whew. Good thing I passed that interview many many years ago!

  • prescient11

    And since there is no demand to take on extra debt during private deleveraging, and frankly the banks shouldn’t be giving a lot of these loans anyway, where do the banks go with those funds…….

    To their wonderful trading arms that don’t ever ever lose money….

    And the final act to this tragedy will be, if we don’t get long term debt or FRN or whatever you want to call it under control, the fear over those issues will cause a significant bid to the market for several more years….

    Yes, the market can go up in bad times and quite violently.

    Show me a country that’s never defaulted or completely debased, and I’ll give you a prize.

  • http://lebleu.org Guillaume Lebleu

    Yes, I don’t disagree with this. I think that’s the general rule. They are inflationary by the difference between price purchased and market price. Is this highly significant at this point in the context of Treasuries?

  • http://www.pragcap.com TPC

    Bernanke is a Republican….

  • j

    Econ 101. A larger money supply chasing the same goods and services increases the price level. Did you miss that in school?

  • prescient11

    Lol, that kills TPC’s entire stance!! Governments always default, whether outright or by devaluation.

    It has never been otherwise…….


  • http://www.pragcap.com TPC

    All loans net to zero and are therefore only short-term sources of inflation. This is why a credit expansion is inflationary and bust is deflationary. The GSE’s were govt guaranteed so there was never solvency risk. Was there some deflation alleviated from the other purchases? I think you could argue that.

  • j

    If not for QE1, QE lite, and QE2, Treasury notes and bonds would be sporting a higher yield. That is inflationary.

  • gaius marius

    that’s the point, j. there’s NOT more money being created.

    we’re seeing a big speculative rally, and that surely is being fueled by balance sheet expansion — banks lending call money to speculators. if you’re looking for money creation, there it is. but that has nothing to do with QE.

  • http://www.pragcap.com TPC

    If that were true then Japan would suffering catastrophic hyperinflation.

  • prescient11

    Why will no one answer the question I have posed numerous times on here though?

    Which of course matters for the economy, not your nerdy balance sheet analyses.


    Again, does no one recognize that Asian nations have launched a currency war on our manufacturers for over 20 years and we have DONE NOTHING but bs around with piddly non-responses.

  • DRS

    great point – that was what I was saying above – its not necessarily from the banks.

  • Captain America

    Watching people argue with TPC is like watching men walk off a cliff. I love it.

  • Captain America

    A stronger Yuan would kill China’s economy right now. Do you have any idea what that would do the global economy? China is our only hope dude.

  • j

    Sorry. Asian workers perform the same service as USA union workers at a much lower price. That is the issue. Union people love to call it a currency problem when it is really a union problem.

  • Captain America

    Hmmm. How about the USA? We have never defaulted on our debts.

  • Captain America

    Seriously! Do you really think the jobs will come back home? No way. They’ll move to Malaysia or somewhere else. They’re not coming back because it costs too damn much.

  • gaius marius


  • j

    Japan is not printing the reserve currency. We are. Big difference.

  • prescient11


    A country with almost $2T in cash reserves can handle it. It’s just shifting some of the balance. Dropping to 5% growth, if such a thing were to happen while we got some rebalancing, would not end the world. trust me.


    Sorry, but a lot of that doesn’t hold up. I agree unions overall suck, but many CEOs cite a lot of other issues, too many frigging regulations, etc., etc.

    Think about this, do you know the US is the only country in the world that taxes income on money earned while living overseas, so you get to pay to sets of taxes just for the joy of being an AMerican. Talk about f’ing nuts. You wonder why businesses are loathe to open here or locate here, the rules are ridiculous.

    I don’t want free trade, I want competitive trade, and the first place we can achieve that is through monetary policy. imho.

  • Daily Reader

    “I don’t know. If a meteor hits me in the face tomorrow will I die? What you’re asking can never happen. Banks don’t have runs on themselves.”

    CPTN America

    LMAO—I absolutly love this BLOG guys. Keep up the great posts.

  • http://goodrichardsalmanac.com Richard

    TPC is a democrat.

  • prescient11


    I would suggest you printout that post and save it.

    While nothing has occurred yet, it will.

    One thing that not even TPC can beat is math.

    Balance sheets matter, not even the Fed can make this up. Default (direct or by devaluation) is clearly the only result unless we can get the long term obligations under control.

    That’s the real play I think TPC is missing and what the market is finally starting to see.

    I said this at least a year ago, if Repubs do something to stop the snowball, then maybe I’ll reevaluate. But as I see it, we’re only picking up speed. There is no Chris Christie in charge of the feds.

  • bighedge

    Bill gross is so smart that he owns tons of GSE bonds that would be worthless if it wasn’t for the generosity or stupidity of the governments bailing them out. I remember in the summer of 07 Bill Gross switched sides saying he was now a bond market bear and he expected the world economic growth to be strong and bond rates would move higher. I pretty sure I know how that ended. I can’t remember how long exactly it took him to completely flip flop again after he was completely proved wrong. It’s easy to make a ton of money when no matter what you buy the government makes sure you don’t lose any money. I bet Bill Gross has also never thrown a gutter ball in bumper bowling either but I wouldn’t say that he is an excellent bowler. Capitalism with no losers makes a lot of people look real smart.

  • http://www.pragcap.com TPC

    Exactly. If there is any lending going on here it is via the carry and if that unwinds – whew! Buckle up boys and girls. That unwind we saw in the dollar back in May will look like a walk in the park!

  • prescient11

    With all the rapid fire comments on here, I still do not understand why QE is a bad thing or QE2.

    Can someone please explain it to me, especially if it is a balance sheet nonevent, which although I technically agree with, I think liquidity can become excess capital (at least domestically) very quickly.

    And what would one do in the alternative???

    I have to say that the silence is deafening to these questions and makes me very glad to have BB in there, in spite of his crappy predictive powers.

  • Adam

    FYI Old Timer, in a fiat monetary regime ALL money is created out of nothing regardless if its credit money created by the banks or high powered government money.

  • j

    Go to the gas station, and fill up your car. Check the bill. That is inflation due to a doller drop from money supply expansion without demand.

  • http://www.pragcap.com TPC

    Pros: will help prevent another credit crisis.
    Shores up the banking system to some extent (if MBS is eventually purchased)
    Reduces interest rates (supposedly)
    makes other assets more attractive

    Cons: Causes market distortions
    Can create bubbles
    Doesn’t add net new money (pvt sector is not more wealthy)
    Has been proven not to work in Japan & UK to stimulate aggregate demand or borrowing.

    I’ve missed a whole bunch, but that’s the quick and dirty.

  • DRS

    Captain – So the reserves chart shows an increase of $1T give or take. That is nearly the whole size of QE1 correct? If so, that means you are saying that the proceeds from these asset purchases have stayed at the Fed? On a high level it seems unlikely that so much of the purchases were ACTUALLY BANKS. We know that asset managers don’t have Fed accounts, so the proceeds if they purchased would not show up in reserves but in other assets (i.e. junk etc..)

  • gaius marius

    the real answer for banks is 99% back into treasuries, i’m afraid, as they incur no capital charges in a capital-constrained bit of the world.


    but the point is to box the entire private sector and view what has changed about the composition of the assets within it.

    the fed is taking 5-year notes out and putting cash in. these are very similar assets, so the effect on the composition of assets in the private sector has been very minimally affected.

  • http://www.pragcap.com TPC

    Unleaded gas at the NY Merc has been flat for three years. $2.35 to $2.18. Despite all of this horrid “money printing”.

  • Cowpoke

    Yes, it is these “distortions” that get the semantics based confusion with regards to the whole QE Process rolling.

  • Old Timer

    OK, so let me see if I understand you TPC.

    Dallas Federal Reserve President Richard Fisher states QE2 is strongly inflationary. You say he is wrong.

    Are you saying you understand the market effects of QE better than the President of the Dallas Fed?

    Are you saying we should not believe what Fisher is saying?

  • Captain America

    Well they’re buying them from the banks. They’re not buying the bonds from the public at auction or something. So yes, the banks hold all of the reserves within the banking system. QE2 will send this chart to 2 trillion or so and we’ll continue twiddling our thumbs.

  • Adam

    The US government is sovern in its own currency. It is NOT fiscally constrained. Taxes do NOT pay for anything. The US government is not fiscally constrained so it by definition can always pay its debts (so long as the debts are in US dollars). Now it may for political reasons at some point choose to default but politics is different from fiscal constraint.

  • The guy who does not get it

    Question for the better minds here:

    if banks now have a reserve account at the Fed, using TPC’s thinking, they can theoretically draw on that account to lend when loan demand perks up, which would allow the Fed to reverse its QE in time and thus remove stimulus when the economy recovers. But, they can draw on that account for any reason they choose, including pure speculation in trading right? So then isn’t it fair to say that by “forcing” banks to release treasuries, the Fed is pushing them to chase other assets, which means more dollars chasing the same asset and thus inflationary?

  • http://www.pragcap.com TPC

    I’m actually more of a centrist. I don’t particularly care for either party right now. They’re mostly full of idiots and people who don’t care about you or I and instead just care about getting re-elected somehow some way.

  • DRS

    Correct me if I’m wrong – but these are open market operations. There’s no way for the Fed to know who they are buying bonds from. For instance, when they bought MBS, they bought from the TBA market. This is my whole point, they are not necessarily being bought from banks

  • http://www.pragcap.com TPC

    Banks don’t lend reserves. Loans create deposits.

  • Cowpoke

    HAHAHAHA.. This is Classic for these threads:

    Any Theory Of Fed Independence Was Destroyed By The Nixon Tapes

    In our most recent Broyhill Letter, we explained that, “Evidence from the Nixon tapes clearly reveals that Nixon pressured then Fed Chairman Arthur Burns to engage in expansionary monetary policies prior to the 1972 election. Blaming a modest rise in the unemployment rate as one of the reasons he lost the 1960 election, he demanded an expansionary monetary policy in the run-up to the 1972 election.”

    Read more: http://www.businessinsider.com/any-theory-of-political-independence-of-the-fed-was-destroyed-by-the-nixon-tapes-2010-11#ixzz14orw1WYs

    So I guess we can add politics to the Mechanics of FED Decisions as well..LOL

    Geez who can a fella trust these days?

  • Adam

    Uh yeah! Why would anyone believe anything that comes out of the FED. The FED denied having anything to do with the housing bubble. The FED denied that the decline in housing would spread to the rest of the economy. The FED is full of religious zealots who don’t really know jack about how things work!

  • http://fridayinvegas.blogspot.com Kid Dynamite

    TPC – do you think that if you wrote a post about The Fed buying gold in QE3 via high frequency trading, that it could possibly blow up the internet? Maybe if you worked in Obamacare and/or cap and trade it would fry all of Skynet

  • http://www.pragcap.com TPC

    I guess I am saying that in a way. You probably would have beaten me with a stick if I’d told you that Alan Greenspan didn’t understand the monetary system in 1999.

    Being a person in a position of power does not make you right or smart. It just means you’re a person in a position of power. Alan Greenspan’s entire career should make you question the beliefs of every banker in US history.

  • prescient11

    Exactly TPC. And I want to go even further:

    Two of your cons are really not cons at all, to wit, 1) it doesn’t work; and 2) doesn’t add new money. These are just kind of a wash/neutral.

    So, the only real potential negative is: 1) creating bubbles (sorry TPC, I lodge market distortions in that category).

    But if you google bubble and market I would say that that term has been used so damn much recently it’s in its own bubble.

    I have never seen a bubble widely recognized as such, ever. Which makes me think the market and commodities have a ways ways to go. imho.

  • Pod

    Here is “Tyler Durden”‘s (zero hedge) reaction to your note.

    Well, either this is right and $100 trillion of assets are wrong, or this is completely wrong.

    What the Fed is doing is implicitly dropping the FF rate. The mechanics of QE are such that when inflationary expectations are realized, the $2+ trillion (and/or much more) in upcoming excess reserves will enter the economy, and M1 will triple. And that is not inflationary? Good luck. The market does not care about what the instantaneous maturity, risk or leverage transformation looks like, it cares about what happens at the end, ergo the term discounting. And now it is discounting endless money printing, nothing less. In other words, it is discounting that the money will eventually enter the economy, because in a closed loop only that will stop money printing! However, judging by the price of gold it is always saying the pieces of paper (when finally part of M1, M2 and M3) will be worth that much less when they finally do. Comparisons to like BOJ actions are irrelevant. The BOJ was rational. The Fed is the last backstop and will print to infinity if needed. Which is what is being discounted. It will generate inflation at any cost, even if that cost is hyperinflation. Nobody seems to get this. This post should be revisited in 5 years when banks have one quadrillion of excess reserves, as the Fed stops at nothing.

    Capital Markets 101: the market is a discounting mechanism. Even if that means discounting the insanity of a madman.

    It would be interesting to hear your response

  • gaius marius

    old timer, i would suggest that, rather than listening to theoretical noodlings of economists who have been confused on this thing from the start — for example, where was fisher before the crisis? or bernanke? any warnings? — you first look at the evidence regarding quantitative easing during deleveraging periods (say, from japan). then try to find economists and bankers who were shouting about an imminent crisis from before the beginning, and evaluate what they have to say about QE.

    the hard truth is that one reason so few economists and central bankers predicted a crisis (or predict much of anything well) is because they are operating under profoundly false pretenses about the banking system.

  • http://www.pragcap.com TPC

    If you take a pile of cash to the IRS? They might shake your hand and thank you for being a fine American but that’s about it. If you actually pay your taxes in cash they’ll shred most of it. But the pretty pieces of paper will go back out for circulation.

  • http://www.pragcap.com TPC

    He is not correct. Reserves don’t “enter” the economy. Banks don’t lend reserves. They are never reserve constrained. We should know this from QE1. Look at CA’s charts above. It shows that the reserves are just sitting there in Fed banks from QE1….

  • http://www.pragcap.com TPC


    My head is about to explode from thinking about QE. Please don’t make me think about anything else complex. :-)

  • prescient11

    Yes, and it is for the losses that they still have a la Whalen. What all this cash does is allow them to sit at the casino for a while, and turn liquidity into additional capital.

    absolutely. And that is inflationary only from our perspective, we are sucking that capital in from foreigners.

  • http://None Marc Sanchez

    Great post and discussion. Very informative. However, one of the many things I still don’t understand is this. Why would the banks sell their bonds to the Fed for reserves and give up the higher interest except for capital appreciation? And if Fed pays the banks more than the banks paid for the bonds, don’t the banks end up with more money than they had to begin with? And wouldn’t that profit be equivalent to an increase in the money supply? What am I missing?

  • gaius marius

    prescient, you have to look at the balance sheet of a bank. reserves are an asset for the banks, alongside cash and loans and investments.

    assets do not absorb losses. when the value of an asset declines, a corresponding writedown must occur on the liability-and-equity side.

    normally at a bank, it is equity that absorbs those losses. when the equity runs out, anyone who loaned money to the bank — the owners of bank debt — take the loss. (pre-FDIC, this was the depositors. today, it is usually insurance companies and pension funds first, then the FDIC.)

    what the fed is doing does not increase the capacity for banks to absorb losses. it is a simple asset exchange.

  • Cowpoke

    TPC, if Banks are not reserve constrained, then why are they closed by the FDIC?
    Should it be prfaced that FED Banks are not reserve constrained?

  • remcoxyii


    First, thank you for your articles; I find them very informative. I have some questions, though.

    As I see it, Q.E. transactions are just open market operations: the Fed swaps treasuries for reserves, just as it would in an ordinary open market operation. But, as in an ordinary open market operation, when the Fed buys from the private sector (indirectly through the primary dealers), this would lead to an increase in deposits and thus M1. I agree it doesn’t change net financial assets, but it does change the money supply, no?

  • gaius marius

    sorry — i reread you and took your point more clearly i think — you think the banks have new capacity to speculate in order to recapitalize with trading profits as a result of this?

    first, the sums are too small. the kind of profits the banks could realize out of trading are a pittance compared to the scale of the losses we’re talking about.

    secondly, the banks in reality are increasing their treasury holdings as a percentage of their investments — and further increasing investments as a percentage of their assets. they do this because treasuries require no capital charge — there’s virtually no limit to how many a bank can take up. THIS is how the fed is attempting to recapitalize the banks — lending to banks at zero, paying them 2%.

  • LVG

    They don’t really have a choice do they? The Fed wants to effectively retire some of the debt. Its like getting called on a bond.

    Look at the math from TPC’s example. In QE1 the banks lost 47.5B in interest income. They did not make money on those transactions. The government made money which means the private sector lost money.

  • Nico

    TPC: great post that summarizes many of your previous postings. Couple things you might want to address:

    – impact on perception of inflation (e.g. commodity hoarding currently happening, not as a result of money printing but future steps to be taken to cope with public debt repayment, currency devaluations) and,

    – FED balance sheet; now they have these MBS and treasuries on their books, what do they do with them? Isn’t asset inflation strategies their primary way out so they can sell them for a nominal profit or repay them for less? It seems that with social security burdens, the only way (as the end game to this secular bear market) will be inflation to erase the debt, even if it’s 2 or 3 years from now, or next month.

  • LVG

    As TPC says, loans create deposits. These reserves are not new money and will not allow the banks to loan more.

  • http://goodrichardsalmanac.com Richard

    If they don’t loan reserves, what do they loan?

  • Pod

    I don’t know what you are missing, but aren’t you the Jets quarterback?

  • Marc Sanchez

    They don’t have a choice. Do you mean that when the Fed offers banks reserves in exchange for T-bonds, the banks have no choice but to accept the offer and no choice but to accept the Fed’s price even if it’s less than what the banks paid? If that’s not what you mean, please clarify.

  • Marc Sanchez

    Want my autograph. I’ll exchange it for an increase in my money supply.

  • http://www.pragcap.com TPC

    Loans are made by crediting the borrower’s account by creating additional deposit money.

  • The guy who does not get it

    What I am confused about is what keeps a bank from turning one asset (reserves) into another asset (loan ,commodity etc)?

  • prescient11

    how is the fed paying them 2%? But yes, this is how the Fed is shoring up the banking system, or attempting to.

    Whether it’s additional $$ for trading profits, or simply the spread, this becomes the additional capital that can be available for the system.

    Which is their job.

  • prescient11

    Before securitization, I couldn’t buy a bar of gold with a mortgage note.

    Good way to think about it, the Fed is “securitizing” all the T-bills by sucking them all back up.

  • Dave

    I’m not talking about the IRS. If cash is a liability from the government, there must be a department (fed???) were I can change my government liability (cash) to physical assets. If there is no such department one can not claim that there is a liability for the government.

  • The Banker


    What China is doing is sending us real goods and services for pieces of paper with dead presidents on them. Our real terms of trade with China are immensely weighted in our favor. We get to consume all that we can produce plus all that China wants to export to us and all because we’re willing to give them balances in reserve accounts. These balances don’t even guarantee China’s rights to purchase US denominated goods and services (remember China tried to purchase Unocal?) as the right to exchange goods and services for dollars is a seller’s option. And you want to change this?

  • gaius marius

    sorry — whatever the yield is on the t-notes they buy. and yes, this form of recapitalization is part of what the fed is trying to do, transfer capital from savers and taxpayers to the banks.

    whether that’s their job is another question entirely. but the fed has done this before (notably following the latam crisis of the early 1980s) as have the japanese for the entire duration of their malaise.

  • The Banker

    Lower taxes drastically and let the private sector repair household balance sheets. This increases disposable income, boosts aggregate demand, and allows people to make their mortgage payments which shores up the banks organically.

  • Pod

    This chart says that the Fed bought the TSY and the banks converted their TSY into reserves and then sat on the reserves by leaving them at the Fed. But can’t the banks lend out those reserves as loans? Isn’t that what creates “new money”? I know they are not lending the reserves up until now, but is not the market’s fear that one day they will lend out those reserves, thus causing inflation?

    TPC – Banks don’t lend out their reserves. Loans are made by crediting the borrower’s account by creating additional deposit money.All you need is a healthy functioning bank and a creditworthy customer. For instance, Canada’s banks have NO reserve requirement.

  • dis737

    Let’s fast forward to QE5 or QE6 where the Fed essentially has bought all USTs and all newly issued USTs are bought by the banks and then immediately sold to the Fed. How are Foreign owners of US Dollars going to react. I realize the UST sales don’t fund anything, but they are a legal “discipline” to manage the country’s finances prudently. If we get to the point where we are blatantly monetizing debt (we are very close right now) versus other countries who have kept the discipline of a sovereign debt market as a check for spending, won’t investors rush into perceived more stable currencies. And isn’t this essentially inflation to a holder of US dollar assets?

  • Johnny

    TPC, I’m just wondering how you construct your portfolio. What asset classes do you play in? Everything? Currency pairs, individual stocks, futures, etc?

  • Obsvr-1

    @ LVG

    > They don’t really have a choice do they? The Fed wants to effectively retire some > of the debt. Its like getting called on a bond.

    > Look at the math from TPC’s example. In QE1 the banks lost 47.5B in interest >income. They did not make money on those transactions. The government made money >which means the private sector lost money.

    —- Reply

    If the FED bought the treasury (bond) to retire the debt, then they would “rip up the bond”, but they are keeping it as an asset on the balance sheet, so the debt is not retired it is transferred from the bank to the FED b/s.

    Banks do not lose 47.5B dollars, the private sector does not lose money they lose opportunity.

    So, the point is the economy is shrinking (deflation) with private and consumer debt delevering (deflationary) so the gov’t is spending like drunk sailors to try to stimulate (inflate) and the FED is QE’ing to blow asset bubbles to artificially inflate to cover up the D words, deflation and depression.

  • Suresh


    So US is creating $600bn USTs and Fed is buying these with $600bn of cash. TPC says this is not inflationary. In fact, if I understand it right TPC says this action can never be inflationary since this is a mere asset swap.

    How about this scenario? US creates $10000 trillion and Fed buys these with $10000 trillion of cash. What would happen to stock market and assets. Would that result in inflation? This is also just an asset swap.

    I fail to understand why it does not matter how much cash Fed creates? I hope TPC is kind enough to explain.

  • http://www.pragcap.com TPC

    LVG has it a bit wrong. They’re not retiring the debt as you said. The tsy pays the Fed interest and then the Fed turns over the int at the end of the year (kind of hilarious how that works actually).

    And you are correct. They are simply trying to paper over a massive decline in credit which has deflationary tendencies.

  • http://www.pragcap.com TPC

    I am involved in a lot of markets. I use a fairly complex multi strategy approach. Technically, I am always invested in something, but I am invested across a pretty broad range of differing strategies (some timing, some not). I laid out the foundation here:


  • Dave

    This discussion shows, that a correct money supply and a good monetary police (by the government) is NOT possilbe. Everyone beliefs something else and everybody thinks he is right.
    We must assume that QE will have very severe side effects, which no one will have imagined – very last the fed and the government.
    That’s why we should assume the worst case scenario will happen from QE… sorry TPC.

  • http://www.pragcap.com TPC

    That’t an interesting question. The dollar is backed by US output and the US govts ability to tax that output. The dollar gives you the ability to purchase some of this output.

  • http://www.pragcap.com TPC

    Don’t be sorry. I entirely agree that there are unintended consequences of QE and constant Fed intervention.

  • Chris

    The tipping point isn’t the FED asset swap…its the government spending $10,000 trillion in deficit spending. Bernanke is just trying to clean up the mess made by the banks/congress. There are giant holes in the balance sheets so he is going to buy treasuries to try and ease credit and create growth. If the economy doesn’t grow then we have to do what we should have done in the first place. Recognize the rampant fraud in MBS, determine which banks are insolvent, put them in receivership, and sell their assets at below face to the surviving banks. If needed issue more charters to create banks to take the place of those put in receivership.

  • http://www.pragcap.com TPC

    Yes, deficit spending is inflation. Not necessarily monetary policy. But look at the mass misconception that is occurring due to QE2. If $600B can scare people into commodities like this then I don’t even want to imagine what $10,000B would do.

    There’s a very dangerous psychological impact here and that, unfortunately, is what the economists generally ignore. It’s a market of humans after all. Not just a market of numbers and products.

  • Johnny

    Where is Hyman Minsky when you need him?

  • http://www.pragcap.com TPC

    Probably shaking his head somewhere.

  • Obsvr-1

    Another interesting perspective on the QE subject

    Debt Bubble Chronicles: Does Bernanke REALLY Think QE Will Boost Home Prices… Or is He Simply Trying to Hide an Even Bigger Problem?


  • Chris

    I do feel for those that didn’t specialize in business or economics. The system is geared to take money from those without financial knowledge and give it to the sharpest traders.

    Those who are getting scared into commodities are probably going to buy and “take delivery” and have difficulty exiting. The commodity bubble can make you a lot of money, but as we saw in the close today there are some really big traders that are going to have some fun pushing around these tiny markets. I’d advise people to buy on dips using options and have an exit strategy ahead of the end of QE 2. The one thing QE 2 guarantees is no rate hikes before mid 2011…and rate hikes are what can destroy speculators.

    A 0% curve across all treasuries…I shudder. We already have mexican 100 year bonds selling in single digit yields and railroads issuing 100 year bonds at 6%. The folks holding these are going to be in for a rude awakening, but how can you feel sorry for someone who chooses to buy a 100 year bond on a country near civil war?

  • http://NONE PETEY PETE

    As a layperson to the economic scene I’d like to ask one question. When the Federal Reserve buys the bank’s long term bill (saving a/c) and then credit their reserve account(checking a/c), what happens to the bought treasury bills? Are they destroyed?

  • http://www.pragcap.com TPC

    No, the bonds sit at the Fed as an asset. They will earn interest on this and then at the end of the year the press will tell you how much money the Fed makes and how it’s such a smart and profitable bank. I’ve talked about this before. It’s a bunch of nonsense. When the govt is making money the pvt sector is losing it.


  • roger erickson

    a “sovereign debt market as a check for spending” is more correctly called a “crude, arbitrary check on rapid changes in public spending”. That’s good in some contexts, where there’s little selective demand, but life threatening for a nation when contexts demand rapid, flexible action. That’s why public purpose demanded freedom from the cumbersome gold std – like it or not.

    What we’re always left with is group RESPONSIBILITY for group coordination. A nation has to find common purpose, set common policies, support all delegated strategies, and stay the hell out of most private tactics.

    As an extension of the reality that “loans create currency reserves”, you have to also accept that “public initiative creates currency supply”, REGARDLESS of the size of that currency supply. After that, we still have the responsibility to select public purpose wisely, but our public initiative can never be constrained, only directed.

    The one thing that Dallas Fed Chief Fisher had right was that the Fed has little to do with currency supply, only pricing of currency movements throughout the country – and that managing our output gap is a responsibility entirely delegated to the Treasury, Congress and Administration, and hence ultimately to the electorate.

  • remcoxyii

    TPC, I would really appreciate it if you could answer my question, because I’m struggling with it….

    In essence Q.E. is an open market operation, no? So, the Fed swaps treasuries for reserve balances. But if the treasuries are acquired from the private sector (through the primary dealers), deposits will increase (and so will M1). So, although no net financial assets are added, the money supply will increase, no?

  • Chris

    Yep, its definitely all the Democrats fault…


    Wake up…the republicans run even bigger deficits then the Democrats. Both parties have failed to fix the problem since the mid 60s. The reason we keep flip flopping every election is we want something different, but have to chose between dumb and dumber.

    Ross Perot totally destroyed Gore in the NAFTA debate…the US trade deals have all been terrible for the bottom 80% of the US population. If you allow businesses access to cheap labor and no environmental laws its no mystery where the jobs went. Republicans and Democrats have both consistently pushed really bad trade deals. This dust up with China would have never happened if we would have had sound trade deals. You trade goods for goods…instead we traded IOUs for goods and surprise, surprise blew a serious of huge bubbles on cheap credit/deregulation. Since the majority of America works in either Finance, Service, or Govt jobs its going to real fun if we manage to break global trade trying to save a bunch of insolvent banks.

  • tradeking13

    I found this blog post which explains how loans create deposits, not the other way around.

    Loans Create Deposits — how banks actually work [winterspeak.com]

  • http://www.iAssuranceVie.com Lafleur


    I think you are missing the point of the inflationist and the gold bugs. The argument is that the Fed, in order to maintain long-term interest at record low, will have to pursue its QE program forever…consequently, treasury has no incentive to keep a balanced budget or reduce its debt but to increase it, effectively monetizing the debt through the Fed. In your argument banks buy from treasury, Fed buys from banks is a pure illusion of an independant Fed and a free market in order to transfer fees to the banks.
    your argument that QE is an asset transfer is absolutely right, if the Fed announced this is a one time deal…

  • Chris

    They always have a choice in FED open market operations. The FED simply says if they want to buy or sell treasuries and then primary dealers name their price. The fed takes the best bids at the auction. If you don’t want to give up your treasuries you could offer to sell at a very high price and you will keep your treasuries.

  • http://www.pragcap.com TPC

    That’s a very risky bet in my opinion. If QE2 does not “work” then the political opposition to further Fed intervention will be intolerable in my opinion. Especially if it ends up just causing distortions in markets and has no real positive impact on the economy.

  • SS

    The monetary base increases. Not the net financial assets.

  • http://fridayinvegas.blogspot.com Kid Dynamite

    I swear, I’m not getting involved in this again, but that’s nonsense TPC. Dave is right. A dollar cannot be redeemed for anything. It’s not debt anymore – although at one point it was. Debt is redeemed for dollars. They clearly cannot be the same thing, or your excel spreadsheet will get a “CIRCULAR REFERENCE” error.

    a dollar doesn’t entitle you to a fractional share of output, GDP, or anything else.

  • http://www.covel.com Michael Covel

    It feels like we are due for an ‘event’…

  • troll

    So if the gvt. buys $1.2 T of “paper assets” that are probably worthless, and places $1.2 T of gvt-backed money(or bills or whatever) into the vaults of the big banks, the public is out a helluva lot more than $47.5 B in interest. We have to pay for the worthless assets, too. I see a lot of money that has to be raised somehow to cover these losses. More money = ? (inflation?).

  • http://www.iAssuranceVie.com Lafleur

    What political opposition? I haven’t heard any complaints about QE from any politicians except a few like Ron Paul. The only critics are foreign politicians.
    Off course there will be no real impact on the economy and the argument in six months will be is that QE2 wasn’t big enough. Have you been reading Krugman at all recently?

  • Z

    I am happy to keep your asset-swap model, but let us use it dynamically and focus on the very process of swapping, as it could have been devised to, indeed, increase the money supply.

    Mx = money in circulation + PROPENSITY TO USE IT.

    Initially, no new money is created. However, as the banks, businesses, and ultimately households are forced/incited/deluded/herded into restructuring their assets and reach for risk, the utopians would hope the money would find its way, through productive lending, into productive operations and increase employment along the way. The psychological trick played on the participants – well described in most of the posts above – would provide the initial kick to the process, after which economic fundamentals should take over. Well, the QE2 and similar attempt at kicking-off the economy, are doomed to failure within their own paradigm: heavily reliant on psychology, the process will never progress beyond its asset-bubbling, superficial, ephemeral stage. The players keep building up assets prices, as it – psychologically! – looks as the easier and less risky solution. Meet Charles Ponzi, the father of the paradigm!

  • Cy Hailow

    Simple yet Complex?

    Simple: The Fed is acting to push down longer duration interest rates,hoping against hope to prop up overvalued assets and a flagging economy thereby buying time while “things” resolve themselves.
    The alternative is unthinkable, politically unacceptable yet possibly necessary; all those grossly overvalued assets still lurking on the Banks’ and Fed’s (or is it Treasury’s?) balance sheets would come crashing down in value driving the world into a major recession and the Bankers to the stocks (and I don’t mean equities).

    Complex: From all I’ve read, no-one at all knows the likely impact of the QE2 path, not one of the so called experts or the local amateurs on this site. Hence the quantity of “fact free” postulation here on various topics such as inflationary effects is risible. For example, last time I checked the data showed inflation and forward expectations still to be subued, 18 months after the massive QE1. Why should QE2 be different?

    Let’s not forget it was the Fed (AG)and naked greed that got the US into the whole rotten mess in the first place. Rightly or wrongly, it’s now adding more low interest punch to the bowl saying “come on buy more risk assets, they’re cheap, really they are” as it’s cure.

    Thanks TPC, a useful summary

  • bns

    I was reading up on mmt and come across something confusing. In the chart below it shows that vertical money creation/destruction can be conducted by either the treasury (spend/tax) or the fed (buy/sell treasuries) which would indicate that QE isn’t a simple asset swap. Could you explain how the 2 are different?


  • TPC

    Our currency is not backed by any tangible hard asset such as gold. It is backed by our output.

    If you don’t believe me then go to the Treasury tomorrow and demand that they give you something in exchange for your dollars. They’ll escort you out and tell you go to do something productive with your money.

    You can make the technical argument that the “debt” or treasuries back up our currency, but that’s just semantics.

  • B Ferro

    I still don’t get it…the Fed can buy Treasuries or MBS (or any asset if Congress allows it) in any amount it wants out of thin air, for as long as it wants, and that is not inflationary???

    I just don’t understand no matter how much we go through this…

  • Eric

    would much rather be leveraged up on gold silver and apple than tpc spy 1180 short.

    TPC – Basis is 1200 :-)

  • Chris

    The government deficit spending is inflationary. What really matters is whether congress raises the debt ceiling. That the fed is moping up some treasuries with a swap for dollars mechanically has no effect on inflation (treasuries are taken out of circulation, dollars are given to the banks but held at the FED)

    If you think that QE 2 increases the chance the US debt ceiling is raised then you have your case for inflation.

  • Eric

    The market has been arguing with TPC and winning, us on the other side of the boat love it.

    TPC – Did you think I won every trade I ever placed? Let the cards fall in a few months….

  • Chris


    Daily moves exceeding margin requirements…very exciting times in commodities.

    Increasing margin seems to have an effect on price…interesting.

  • Eric Jackson

    PragCap, I have to disagree, although I know you know 100x more about this subject than I do.

    I look at it from a more fundamental, basic point of view. The bottom line is that the Fed has magically created almost $2 trillion dollars worth of USD in the last 2 years. Can that really have no effect? If $2 trillion isn’t inflationary, then why not create $10 trillion? Let’s put $10 trillion into the reserves of the banks and then there won’t be anything to worry about. What is the dividing line between the QE actions and what constitutes as inflationary? Why not $100 trillion? If none of this increases money supply, then why not just keep creating these excess reserves until the banks are completely saved by them?

    Why did Ben Bernanke stop at only $600 billion this time?

    There must be a negative consequence to all this ex-nihilo reserve creation. What is it?

    TPC – The downside here is tremendous. There is moral hazard like you wouldn’t believe. Even worse, there is misinreptetation of the operation which has now created enormous distortions, etc. The dollar has been slammed for little reason. Europe now suffers as we gain. We could go on and on. The problems that arise from this sort of a govt program are enormous and I think outweigh the benefits. But this does not create any real sort of inflation problem. That is unless they were to literally scare us all into sending oil to $200 at which point we’d likely suffer the greatest deflationary collapse known to man and then we’d all turn around and point fingers at the Fed for causing a bubble in commodities. Don’t get me wrong. There are unintended consequences here….

  • Tom Hickey

    US currency is considered to be a liability of the US government in the sense that the government accepts its own liabilities and only its own liabilities in satisfaction of nongovernment liabilities to it, e.g., taxes, fees and fines. Everyone who pays taxes needs to have the government’s liabilities in the form of cash or a bank’s liabilities in a checking account to pay their taxes. If one sends a check drawn on one’s deposit account, then one’s deposit account is debited and the when the check clears, the bank’s reserve account is debited at the Fed and the Treasury’s account is credited. The only thing that the government accepts as legal tender in payment of liabilities to it are cash or reserves, which are equivalent government liabilities denominated in the currency of issue. According to Chartalism or the state theory of money, it is this that gives state money its value causally. That is to say, the need for state money to satisfy one’s liabilities to the government necessitates obtaining state money for this purpose. There are other factors involved in the value of money but satisfaction of one’s liabilities to the state with state liabilities is causal.

  • fed

    Bernanke’s Failed CNBC Predictions


    Marvin Barth Says QE2 Won’t Fix `Underlying Problems’


  • Teddy


    You didn’t get mad when we gave people who had more money than they could spend, the top 5%, over a trillion dollars in tax breaks.

    You didn’t get mad when those tax cuts failed to create any American jobs.

    You didn’t get mad when we were asleep at the wheel on 9/11, despite warning after warning.

    You didn’t get mad when in 2003, Bush passed The Medicare Prescription Drug, Improvement, and Modernization Act, a 600 billion dollar shell game that lined the pockets of The Pharmaceutical companies.

    You didn’t get mad when lack of oversight and regulations from the Bush Administration caused US Citizens to lose 12 trillion dollars in investments, retirement, and home values.

    You didn’t get mad when we didn’t catch Bin Laden.

    You didn’t get mad when Bush rang up 10 trillion dollars in combined budget and current account deficits.

    You didn’t get mad when we let a major US city, New Orleans, drown.

    You didn’t get mad when the Supreme Court stopped a legal recount and appointed a President.

    You didn’t get mad when Cheney allowed Energy company officials to dictate Energy policy and push us to invade Iraq.

    You didn’t get mad when a covert CIA operative got outed.

    You didn’t get mad when the Patriot Act got passed.

    You didn’t get mad when we illegally invaded a country that posed no threat to us.

    You didn’t get mad when we spent over 800 billion (and counting) on said illegal war.

    You didn’t get mad when all the reasons for invading Iraq were found to be lies.

    You didn’t get mad when Bush borrowed more money from foreign sources than the previous 42 Presidents combined.

    You didn’t get mad when over 10 billion dollars in cash just disappeared in Iraq .

    You didn’t get mad when you found out we were torturing people!!!!

    You didn’t get mad when you saw the horrible conditions at Walter Reed.

    You didn’t get mad when Bush embraced trade and outsourcing policies that shipped 6 million American jobs out of the country, causing a loss of 26% of our American manufacturing jobs.

    You didn’t get mad when the government was illegally wiretapping Americans.

    You didn’t get mad when over 200,000 US Citizens lost their lives because they had no health insurance.

    No…..You finally got mad when a black man was elected President and decided that people in America deserved the right to see a doctor if they are sick!

    The foreign owned and operated Fox News has you wrapped around it’s finger…Reply


    Palin, whose monetary policy credentials could not be deduced.” Really, because she doesn’t have any credentials, NONE!
    She couldn’t even finish her term as governor. The more she speaks about anything, the more people realize she is an idiot.
    The tide is changing against Palin as a leader by Republicans. She endorsed Christine O’Donnell and Sharon Angle who are both crackpots like Palin. Carl Rove was right when he spoke out against her not being presidential because of her reality TV show but he reversed himself to please the party before the election.

    People are starting to see the real Palin, not the sharpest knive in the draw. And look who she associates with that other crackpot, Glenn Beck or Rodeo Clown and Snake Oil Salesman for over priced Gold coins and other useless products that he hocks!

  • MJM

    So would it be correct to say that BB w/ his use of QE is enabling the Gov’t. to create inflation themselves through deficit spending via treasury issuance at very low rates?

    TPC – no

  • gf


    You will not get an argument from me.

    They will not be happy until they get their quota of Americans in poverty.

    Will 50 million , 75 million or 100 million be enough??

    This country needs a very sharp turn to the left before real recovery has a chance. There are no widely rich nations without balance between labor and capital.

    The end result of their endless push can only be a banana republic or police state. Neither results in a widely rich state.

  • Tea Bag A Dem

    Was Teddy complaining about Republican Policies when the Dow was over 14,000 and the S&P over 1500?

  • Tom Hickey

    Ask Tyler how that trade worked for him last year when the folks are ZH were betting on hyperinflation resulting from QE1.

  • http://www.pragcap.com TPC

    The great thing about economics is that it makes R’s and D’s look equally stupid. Lets ignore the political bickering and focus on the real problem. The more fact based information we help promote the closer we can all come to actually fixing the problem as opposed to bickering about whose strategies work and whose strategies don’t work. The last 15 years prove that both strategies stink. So get over it and lets start finding a solution.

  • Tea Bag A Dem

    MJM, I don’t think so because the Gubment raises the debt ceiling and just spends.

  • Cowpoke

    True dat TPC, It’s called Human nature.. We Humans are a nasty species..

    But there are a few good eggs like yourself willing to take the time to help edumicate the masses.

    You are a Fiscal Saint…

  • Chris

    I posted this earlier to respond to a partisan and I’m not going to bother writing a long rant about the DEM shortcomings…here is a summary for you.

    1. Stress Test was the opportunity to clean up the banks…instead we went with “fair value” accounting and papered over the problem.
    2. HAMP is a disgrace…the banks should either make deals with underwater borrowers or be forced to mark past due loans to current house prices.
    3. Obama election NAFTA lie…real progress on reforming international labor and environmental standards.
    4. Financial Reform…incredibly weak, the laws from the 30s should have been updated and reinstated. You can be a deposit bank, investment bank, or a hedge fund…but you got to chose one.
    5. Securities/Contract Enforcement…so you really think none of the bankers committed fraud. I’d argue Mr. Mozilo belongs in a cell right next to Mr. Madoff, but instead BAC pays his fine which is less then the money he made at Countrywide. When fraud pays how do you expect have a working market?

    How about we have a a new party that is for the rule of law, for putting obviously insolvent banks in receivership, and limiting speculators to risking their own money…just a thought.


    Yep, its definitely all the Democrats fault…


    Wake up…the republicans run even bigger deficits then the Democrats. Both parties have failed to fix the problem since the mid 60s. The reason we keep flip flopping every election is we want something different, but have to chose between dumb and dumber.

    Ross Perot totally destroyed Gore in the NAFTA debate…the US trade deals have all been terrible for the bottom 80% of the US population. If you allow businesses access to cheap labor and no environmental laws its no mystery where the jobs went. Republicans and Democrats have both consistently pushed really bad trade deals. This dust up with China would have never happened if we would have had sound trade deals. You trade goods for goods…instead we traded IOUs for goods and surprise, surprise blew a serious of huge bubbles on cheap credit/deregulation. Since the majority of America works in either Finance, Service, or Govt jobs its going to real fun if we manage to break global trade trying to save a bunch of insolvent banks.

  • Cowpoke

    Chris, The banks are gun shy because they fear a Mortgage Modification gives the home owner and upper hand IF valuation comes back.

    that sorta pisses me off because the Baksters have been made whole and they want to gank Joe Home owner and share NO culpability.

    I did hear of an Idea thet may pass muster though.

    let me try and describe the best I can:

    Home Owner x owes 200G’s on a house worth 130G’s. The Bank writes down the principle and loan to 130G’s. If the value when sold is above 130 when sold, the bank and home owner split the diff up to 200. Anything above 2 Hondo, the home owner keeps.

    make sense?

  • Obsvr-1

    QE has nothing to do with the debt ceiling, that is a congressional action and congress can do that as well as appropriate and spend virtually unlimited … the FED has to ensure that there is a monetary base that supports the money demand, GDP growth and turnover of real dollars, using interest rates to achieve money supply expansion and contraction — using monetary policy to influence/control the interest rates and/or corollary amount of monetary base to impact supply/demand of real dollars vs deposited dollars.

    What is occurring is an end around of the “The FED can not monetize the deficit” statute of the FRA to monetize the deficit as well as cover up the crimes and mass transfer of wealth from the middle and lower class (essentially any class that is not part of the elite bankster club) by expanding the monetary base in an attempt to inflate the deflating economy and deleveraging that is underway.

    Questions still unanswered
    1. If QE is just an asset swap NON-EVENT than why do it … perhaps to fill the banks reserve accounts in preparation for buying the toxic MBS back in the forced put back — something is scaring Ben B.

    TPC – Part prep for downturn in banks B/S. Part interest rate reduction.

    2. Why would the commercial banks agree to swap interest bearing treasuries for reserve cash or accounting entry.

    TPC – As primary dealers they do the Fed’s bidding.

    3. Why discourage saving in favor of inducing speculative (high risk) investing

    TPC – Because the Fed is concerned that a deflationary debacle will turn into a depression. So they’re trying to induce more credit creation.

    4. Why force fixed income investors for retirees and/or close to retirement asset diversification towards high risk speculative investments.

    TPC – Good question. The Japanese have been asking this for 10 years.

    The FED is out of bullets and is trying a hail mary hoping that the economy will turn so the empty chamber is not discovered … because the next move will be more nuclear instead of conventional in the analogy of using bullets.

    TPC – They are out of bullets in terms of stimulating the economy. Not out of bullets in saving the banks.

  • http://fridayinvegas.blogspot.com Kid Dynamite

    FAITH in our currency is backed by our output. there’s a big difference.

    TPC: Certainly. It’s faith based system. But any market is.

  • Obsvr-1

    So Saving the banks is the objective — that’s what everyone is afraid of, another bank bailout…

    Let them fail, use the new powers of FinReg to wind them down, have the federal reserve system handle money markets, liquidity needs and utility banking while the new era (distributed banking) takes hold.

  • http://www.pragcap.com TPC
  • http://goodrichardsalmanac.com Richard

    How convenient for you that Obama’s deficits weren’t included in that chart.

  • http://goodrichardsalmanac.com Richard

    Can you back that up with a reference? Aren’t you simply saying there is no reserve requirement?

  • http://www.pragcap.com TPC

    It’s like saying that 2 comes after 1. It just is the way it is. This is why Canada has no reserve requirements.

  • Obsvr-1

    and here …

    Emac’s Bottom Line
    Is the Fed’s Debt-Buying Unconstitutional?


    TPC – This article is misleading. The Fed ops are not helping tsy to fund anything.

  • Obsvr-1

    @TPC – See here:


    100% agree with your assessment here — now to just get a majority of the 99% in the land of obliviousness to understand, then perhaps a few letters, calls, emails to their senators and reps instead of tweeting and facebooking would send a message of outrage into the politicos

  • Roger Ingalls

    Great work TPC, loved the short and sweet summary.

    Minor observation.

    If one of the goals of QE2 is to drive down interest rates (including mortgage rates, I am assuming ), why has there not been a decrease in mortgage rates?

    Perhaps it was already baked in…, but there has not been a significant move downward in rates since the actual plan was announced.

    Is it because the asset swaps have not occurred yet?

    I’m watching sadly as commodities trades I bailed on earlier have soared higher (silver and gold mining, mostly). Hoping it’s the right choice, I suppose it’s better to have a little profit than a big loss.

    TPC – This is one of my biggest problems with QE and why I think it is not necessarily intended to help Main Street. The purchases are focused on the short end of the curve and not the long end where most loans occur. For instance, 30 year mortgages have barely budged in the last few months. I am more baffled by the Fed’s actions every day.

  • SS

    Hi Roger,

    Where can a lay person get a good chart of mortgage rates?

    TPC: SS – Try BB: http://www.bloomberg.com/apps/quote?ticker=NMCMFUS:IND

  • http://www.pragcap.com TPC


    You’re probably a good person to ask about this. Do you know the average duration of a home loan in the USA? I can’t seem to find a good answer on this.



  • Roger Ingalls

    This is what I’ve used to answer the question in the past. It’s probably missing some element (like excluding those that never refi), and possibly overstating the churn, but it has been measured in a consistent way over a number of years.


    Not very darn long.

    And here’s decent reference for rates


    Glad to be of some use.

  • http://www.pragcap.com TPC

    Am I missing something or is that showing the average age of the loan? I was curious if you have any idea what the average American mtg duration is? I would guess its 20 years or so, but that’s a guess….Thanks and sorry if I missed something. If you can’t find it then no big deal. I’ve looked all over….

  • Roger Ingalls

    That’s a decent and handy chart…missing the average costs. Freddie charts do a better job of that, but only comes out weekly.


    You can poke around that site and mine interesting data.

    The short look: rates are ridiculously cheap. Might go lower, but many will be knocked out of qualifying, or pay higher rates by lower home values to come.

    Fewer borrowers qualify. Loads are stuck in crap loans that HARP/HAMP won’t/can’t help. It was a big mistake not to open the HARP program to non-Fannie Freddie loans. MANY would have qualified, got in more stable fixed loans, and went right on paying, EVEN if the asset was overvalued.

    While I’m opining, I wanted to defend appraisers, who were maligned here by a respected commentator (Chris, maybe?) on another thread.

    You won’t hear me argue there were no crooked appraisers, it’s just that I never encountered any, and never had the need or desire to ask an appraiser to be crooked. I never had the impression they would have complied, had I asked.

    Rapidly increasing home prices did not require that crooked appraisers supply “inflated” values. Appraisers use comparable sales. If something sells higher down the block, then the appraised values rise. It can happen incrementally.

    Rapidly inflated values came about because of looser guidelines, and exotic products, both offered by banks. The banks took the risks, because they could profit handsomely, and most of the folks that benefitted the most, made off with most of the money, even if many banks failed, and thus never paid full price for the risks they took.

  • Roger Ingalls

    I understand the chart to show the average length a mortgage is held before it is refinanced.

    If you are looking for what the average product mix is at origination….hmmm… probably around somewhere. I’ll bet it’s somewhere between 20 and 25, since the 30 yr fixed is so popular. With all of the cash in refis, and low rates, the 15 and even 10 yr have made a bit of a comeback recently.

    What would be more difficult to come up with is “what is the average remaining duration of all the residential mortgages in America?”. My direct experience and impression would be biased, since most of the people I talk to self select as “freqent traders”.

    I can tell you this.

    Only one time, in over 7 yrs of doing this, and talking to many thousands of borrowers, have I encountered anyone in the last 12 months of their loan. That borrower had remained at 9% the whole time.

    It is indeed rare to talk with anyone that is in their current loan more than 7 yrs. Typical is probably 3 to 4 yrs.

    Tell me specifically what you are looking for, and I may be able to poke around for an answer.

  • http://www.pragcap.com TPC

    That basically answers the question. I am curious which product is the most widely used and what is the average mix. I think you’re probably right that it’s 20-25 with the 30 being the most popular at origination.

    It’s interesting for this debate because 74% of household debt is mtg debt so you’d think that Bernanke would target the longer end of the curve if he was trying to make housing and refis more attractive. Who knows what the hell they’re doing. I’d like to think they’re not prepping for another bank bailout, but that’s the only logical answer I can keep coming back to.

    Thanks a lot Roger.

  • Chris

    /repeat post/

    I’m not going to bother writing a long rant about the DEM shortcomings…here is a summary for you.

    1. Stress Test was the opportunity to clean up the banks…instead we went with “fair value” accounting and papered over the problem.
    2. HAMP is a disgrace…the banks should either make deals with underwater borrowers or be forced to mark past due loans to current house prices.
    3. Obama election NAFTA lie…real progress on reforming international labor and environmental standards.
    4. Financial Reform…incredibly weak, the laws from the 30s should have been updated and reinstated. You can be a deposit bank, investment bank, or a hedge fund…but you got to choose one.
    5. Securities/Contract Enforcement…so you really think none of the bankers committed fraud. I’d argue Mr. Mozilo belongs in a cell right next to Mr. Madoff, but instead BAC pays his fine which is less then the money he made at Countrywide. When fraud pays how do you expect to have a working market?

    How about we have a a new party that is for the rule of law, for putting obviously insolvent banks in receivership, and limiting speculators to risking their own money…just a thought.

  • Chris

    Sounds like a plan to me…the lower mortgage payments would fix a large numbers of home owners balance sheets and allow them to do something other than just pay their mortgage. Would definitely boost the consumer, eliminate some of the housing backlog, and eliminate foreclosure loses (court costs, vandalism, abandonment). All good in my view

    There really is no best solution, some of the loans during the bubble years are NINJA and liar loans that no modification can fix. The key here is to clean up the chain of title, get the foreclosure through the system, and take the loss on the bank balance sheet. Prosecuting those who made huge money creating these fraudulent loans would be great for market confidence.

  • remcoxyii

    Yes, the monetary base increases, but that is due to increased reserves (and doesn’t matter too much if there is no demand for loans). But if treasuries are bought from the private sector (through the primary dealers) then M1 increases as well. And that is inflationary.

  • DTC

    I think FED is essentailly buying time for the banks. Banks need steep curve, otherwise they are not in position to make money. This is why FED will not buy long end. But long end will not collapse, as Baby boomers are retiring and they need income. With rates as low as now you need twice as much savings to generate income or more. Actually the whole world needs income, because people got burned in stocks and real estate and are not willing to commit to that stuff again. They simply haven’t saved enough…The world becomes Japan.
    Banks can not aggressively lend because regulators are telling them to get their capital ratios in order. So whatever politicians tell them to do is for general public ears. Also, banks can not ramp up assets, as there are not enough willing or qualifying borrowers.
    Business cycle becomes short (as it used to be), as there is no more credit smoothing mechanism. So markets will remain very volatile, with large 40-50% swings.
    $ debasement – doesn’t make sense. US world dominance to significant extent is built on it’s currency and financial infrastructure. More so, US firms are the largest investors in EM accross the globe. Other countries, in particular EM, are not in position to build such infrastructure in the immidiate future. I doubt that people who run USA are prepared to kill the goose which brings golden eggs. Are they playing it on the edge? May be…Essentially US authorities are trying to create growth, as hard as they can. But it will probaly fail and impact all markets, because in the absence of new ideas, industries, technologies and new growth drivers, markets try to evolve around same old story.

    Another thought, world press is becoming hysterical about $ printing, but DXY seem to be bottoming at higher low (75-77 level), relative to 2008 low of 71.4 and 2009 low of 74.25. Chances are high that market is setting up itself for large unwind which will make $ rally either late this year or some time after usual January exuberance next year.

    TPC – thank you for great site!

  • Victor

    The Fed and the Treasury are two different arms of the government. They are not the same.

    A bond is an obligation of the Treasury used to fund government spending. Cash is a note from the Fed not backed by any hard asset except the Fed’s good faith to replace one piece of cash with another piece of paper.

    There is nothing which says that the Fed is buying bonds from banks only. What they are doing is taking the bonds out of circulation and replacing it with cash. They might be going through the dealers but the bonds might be coming from anywhere.

    QE will reduce the number of bonds in the market, and hence increase their price and reduce the interest rate. This will allow the Treasury to fund deficit spending without the risk of failed auctions. The Fed is indeed printing cash to monetize the bonds.

  • Michael Cullen

    You say, and I quote, “If Bank A owned a 1.2% 5 year note and they sell that note to the Fed they receive reserves earnings 0.25%. Their savings account was changed to a checking account”. If what you say is true, what’s the incentive to participate in such a transaction? Why sell an investment earning 1.2% for one only paying 0.25%? There is no incentive unless you are altruistic, which banks are not. It makes no sense, and on the basis you describe, no one will sell to the Fed, and QE2 will be as big a failure as the Public/Private effort sponsored by the US Treasury was to buy MBS and CMBS from the banks was!

  • gaius marius

    right! this is why a fiat dollar is worth anything at all.

  • goodfriend

    Disagree, since i fell that a portion of household that is under trouble doesn’t pay that much tax so the efficiency of such a plan would be more limited in comparison with having govt spending and creating jobs for this class of the population…

    Now, lowering taxes could be indirectly efficient for unlevered corporates since margin increase could led them to hire people. BUT it has to be properly targetted (i.e. google and the likes doesn’t need tax cut given their use of “dutch sandwich”).

    Finally i think that lowering tax for high income people would be a waste. Idea is to target underwater/low income people and SME.

  • Andrea

    Your arguments are very interesting but I am missing something. I am looking to the Atlanta Fed graphs (http://www.frbatlanta.org/documents/research/highlights/finhighlights/fh_110310.pdf) of Federal Reserve Assets and Liabities. Assets increased because of QE1 (Agency Debt & MBS). On the liabilities side, Banks Reserve Balances increased and currency in circulation didn’t change. When you say “there is no new money creation”, are you referring to the fact that currency in circulation didn’t increase?Does this depend to the money multiplier “not creating more commercial bank money supply” because of the velocity of money is so low?You spoke about Fed and commercial banks…what about if horse starts drinking water again?What is your opinion about currency debasement?Is this another misunderstanding of QE?In a fiat money monetary system I think credibility of central banks is all you have…and actually, I think Fed is al least losing it.

  • WB

    If the Fed is increasing bank reserves, it is increasing the ability of banks to lend. New bank lending creates new check book money. There is no increase of government liabilities, but the balalnce sheets of the bank grow.

    TPC – This is not really correct. Banks don’t lend their reserves. This is not a supply side issue.

  • http://www.pragcap.com TPC

    Guys, adding to the monetary base is not inherently inflationary.

    “The nonbank public – nonfnancial
    corporations, state and local governments and
    households – cannot use deposits at the Federal
    Reserve Bank to effectuate transactions. Moreover,
    currency is not suffciently broad to be considered a
    temporary abode of purchasing power. For Friedman,
    high-powered money can be properly regarded as
    assets of some individuals and liabilities of none.
    So, let us be clear on this subject. In 2008, when the
    fed purchased all manner of securities, to the tune of
    about $1.2 trillion, the fed was not “printing money”.
    Bank deposits at the fed exploded to the upside, the
    monetary base rose from $800 billion to $2.1 trillion,
    yet no money was “printed”. Deposits did not rise,
    loans were not made, income was not lifted, and
    output did not surge. The fed could further “quantative
    ease” and purchase another $1 trillion in securities
    and lift the monetary base by a similar amount yet
    money would still not be “printed”. It is obvious the
    fed authorities would like to see money, income, and
    output rise, but they cannot control private sector borrowing. If banks were forced to recognize bad
    loans and get the depreciated assets into stronger
    more liquid hands, it could be debated on how much
    reserves should be in the banking system. Until that
    cleansing process is completed it will be a slow grind
    to cure the one factor which makes the fed “impotent”
    and unable to “print money”….overindebtedness.”


  • Octavio Richetta

    The FED via QE2 is buying this:


    Please note that these assets are the safest/lowest risk for every given maturity.

    The FED bid does several things:

    1. it provides a floor to the price of this bonds, thus lowers volatility accross the board (i.e., even for risky assets; i.e., the portion that is relatd to interest rate risk).

    2. It props up the price of these bonds making them less attractive in terms of yield. (part of the propping up of the price process has to do with the hoarding of the bonds. A regular market maker buys and sells. These guys only retire bonds)

    So the people who sold the treasuries have two options: Sit on cash making 0%. Or they may consider buying a riskier asset since the risk return relationship now looks nuch more attractive vis-via the no-default treasury rate of return for a given maturity. Moreover, the fed move even takes away duration risk to a certain extent (item 2 above).

    So there is no question many of the sellers of these bonds will go out and buy riskier assets increasing their price in process. The even applies for the folks who didn’t sell the t bonds to the fed but had some cash aside or like the big guys cab short gazillions amounts of T bills/notes to play leveraged carry trades.

    Is this inflationary? it depends on how you define inflation. For me, inflation is the increase in the prices of things I buy. And those have gone up a lot more than the headline numbers suggest.

    O! and I forgot! Those with cash may decide to go out and spend some of it (consumption investing etc.) if they see/perceive this activity as inflationary. There is no question QE2 floods the market with a greater amount of liquidity (i.e. more liquid assets( that it would have with no QE2

  • JH

    When you transfer money from saving to checking, it is usually because you are planning on purchasing something with that money.

    TPC – No, it’s called a savings account because it’s a place where you can put your cash and earn interest in an effort to avoid devaluation due to inflation over the long-term. The difference between a checking account and a savings account is JUST the interest and duration.

  • remcoxyii

    Adding to MB is not necessarily inflationary, adding to M1 is. And if the Fed purchases treasuries from the private sector (through the primary dealers), it adds to M1 due to increased deposits.

    The biggest part of Q.E.1 was used to get MBS from the bank’s balances, so then it primarily adds to the monetary base. But Q.E.2 might very well alter the balance sheet of the private sector (because primary dealers buy treasuries in the open market and then sell them to the Fed). And in that case Q.E. leads to an increase in M1, because it causes primary dealers to buy treasuries from the private sector.

    TPC – You’re missing the point of the article. The “deposits” were already in the system. They had already been “put to work”. They were sitting in a savings account and were then transferred to a checking account in the form of bank reserves. That’s all. There’s NOTHING inflationary about QE. NOTHING.

  • Zimmer


    Do you really see no connection between the Fed’s actions and the Treasury’s. Even Richard Fisher now acknowledges that the Fed is monetizing the debt. The size of the deficit and the amount of QE are similar. It is hard to believe it is simply a coincidence.

    Do you think that there is any chance that QE will ever reversed? I suspect that at some point down the road, they will come up with some reason to justify making permanent the larger size of the Fed balance sheet.

    I don’t see this being hugely inflationary yet because of amount of slack in the economy and the amount of deleveraging that needs to happen, but I can’t see it as a “non-event” either.

    I think the Fed is doing QE mainly becuase they feel they have to do something and this is all they have. But, they also know that it is a big help to the Treasury.

    TPC – You’re making the same mistake that everyone seems to be having trouble grasping. The money was already in the system. They are not adding new money. They are swapping the money (already in the system) from a savings account into a checking account). How would this help treasury in any way? The funds to buy bonds and “fund” the deficit (which they don’t) are already in the banking system so to argue that this somehow helps to “finance” the treasury is simply double counting the assets already in the banking system.

  • Jire Sekar

    I feel sorry for the readers who believe this posting, as it is terribly misleading. Your explanation of QE2 is only valid in a scenario where the bond purchases are not used to monetize national debt. Lets for example say that a country runs a debt of $100 a week, and bonds to finance this debt are purchased entirely by American individuals. In this case, QE would work as you explained as QE would be replacing existing bonds with cash. However, QE is being used to finance the huge current federal deficits, as evidenced by the growing share of government bond sales accounted for by the federal reserve. If we assume that the $100 a week in deficits is now financed entirely by the federal reserve, the QE thereby adds $100 per week in M-Zero (monetary base) to the system in new banking reserves. Those reserves do not sit idle. As the economy strengthens, bank lending increases. Through fractional reserve lending, there is a multiplier of deposits that is created which can be as high as 20x. But lets assume a conservative multiplier of 5x, the increase in money supply is $500 per week.

    TPC – I feel equally sorry for the people who believe that bonds and taxes finance govt spending. It’s quite clear from your comment that you have no idea how the US monetary system actually functions. The US govt is not a household. It is never revenue constrained. You are living in a fantasy world where the US tsy kindly calls up China and says: “good day sirs, mind if we take out another line of credit to the tune of $100B this month?” That’s so far from how it works that it’s not even funny. In reality, we spend the money whether China buys bonds or not. They don’t fund anything.


    Hey, nice post and interesting comments,i’m new in this world and need some help about this quote:

    “The logical question that most people ask is: “where did the Fed get the money to buy the bonds?” They didn’t get it from anywhere. It truly is ex nihilo. But it is not new money being injected into the private sector. It is merely being swapped with something that was already spent into existence.”

    It really was already spent into existence ?¿ From where, and since when ?¿
    And what happens about US Debt, i suppose it must increase
    about the currency, according to this post, QE has no effect on on making bucks weaker
    And finishing,total number of T-Bills gonna be the same or increase with the increase of debt.?¿

    Thanks you all !!!!

  • Jire Sekar

    Jack, you’re on the right track… see my post below… when asset purchases are used to monetize national debt, it is highly inflationary

  • remcoxyii

    “TPC – You’re missing the point of the article. The “deposits” were already in the system. They had already been “put to work”. They were sitting in a savings account and were then transferred to a checking account in the form of bank reserves. That’s all. There’s NOTHING inflationary about QE. NOTHING”

    I am really trying to understand it, so am I correct in saying the following:

    You basically say that treasuries are a form of money (only with a different duration and interest than for instance cash). So swapping treasuries for cash only alters the duration of the money supply; no net assets are created.

    But I still have to wrap my head around the concept of this form of money and whether it is inflationary. As I see it (and please point out where I go wrong): If the private sector buys treasuries from the government (or central bank) it decreases cash/checking accounts/deposits, which can chase goods. Selling those treasuries to other private sector participants doesn’t change the total amount of money (that can chase goods) in circulation. Only if a treasury matures, or is bought by the Fed, can the total amount of money that can chase goods increase again. So, swapping a treasury for cash by the Fed, does alter the money THAT CAN CHASE GOODS, and therefore is inflationary. Damn, I still don’t understand it because my logic brings me to the same point ;)

    I would really appreciate it if you could explain how treasuries can be used to DIRECTLY buy goods, because as I see it, only then would there be no difference in inflationary impact.

    TPC – You’re making the false cash on the sidelines argument. That cash is already in the system. The firepower to purchase other goods is there. If I own a tsy bill and I want to buy stocks I have that liquidity. I have to sell my bill and then buy stocks (someone gets my t bill and then I exchange my cash for equities and someone else gets my cash). Adding more cash doesn’t add more fuel to the marketplace. It just alter the duration of the paper.

  • Jire Sekar

    If taxes and bonds don’t finance government spending, than what does? is it magic?

    the government is revenue constrained by the taxes it can raise and the bonds it can issue, unless it resorts to printing money (e.g. QE2)

    where in my original posting do you find a flaw that would lead you to conclude i know nothing of monetary policy?

    TPC – A nation, sovereign, with a monopoly supply of currency has no limitation on what it can and can’t spend. Think of the US govt like an alchemist. What stops the alchemist from making gold? Nothing. He can make as much as he wants. The only thing he needs to be wary of is how much productive capacity he is purchasing with his gold. If he creates gold in excess of productive capacity it will result in inflation and devaluation of his gold. But he has no restraint on how much he can spend.

  • Jire Sekar

    TPC, I think you’ve just proven my point. The criticism of QE2 is that Ben Benanke is the “alchemist” whom you referenced. He can’t resort to creating gold because that technology is unavailable and moreover, the world economy is on a fiat paper money system. Thus, the only alchemy he knows is printing money which is exactly what QE2 is. As you further point out, this alchemy tends to lead to devaluation of his paper money (the dollar) and inflation of (the dollar).

    as i said in my original post, your analysis is not completely invalid – it would work in a scenario where asset purchases are not funding government deficits. Unfortunately, that’s not the scenario we are in.

    TPC – No, I haven’t proven your point at all. BB is the Wizard of Oz. Pushing lots of buttons and making lots of noise, but behind the curtain is a nobody. The Fed does not even have the ability to print money. Only the US treasury can do that via deficit spending. All the Fed does is alter the interest rate and try to play games with the banking system.

  • Roger Ingalls

    To make refis more attractive, they need to do a better job of selectively loosening guidelines, to allow more credit worthy borrowers to refinance.

    Low interest rates are not enough.

    The people that are benefitting most from these low rates are people who already have good terms and low rates. I’m generally refinancing people from low 5’s to low 4’s.

    Not purchasers, as they are not appearing in droves. Not enough new qualifiers, too much economic uncertainty (employment, income and future prices).

    Not the people in risky loans, as they were specifically excluded from HARP (loans for creditworthy borrowers who are now underwater).

    And not the people who own free and clear (about 1/3 of housing is debt free).

    Kind of far off topic, but I think if there is to be a recovery, housing is going to have to lead it, barring some deux ex machina, in technological invention. I cannot see that QE2 is propping up housing, or solving it, for that matter.

  • Zimmer


    I think you missed my point. I understand that the debt was issued first and that QE doesn’t change the amount of money in the system. I am suggesting that you have to look at the Fed spending/QE as a package deal. Much of the Treasury debt has been bought with the expectation of selling to the Fed at a profit. The Fed can’t buy the debt directly. Treasury has to issue the debt first, and the Fed buys it later. But the effect is the same as if the Fed bought the debt directly, or if no debt had ever been issued and the Fed simply printed the money.

    Do you think QE will ever be reversed?

    TPC – Here’s how it really works. Tsy spends money, sells bonds, money spent is used to buy bonds, now fed wants bonds back, banks get reserves, Fed gets tsys, tsy pays interest, interest gets turned over to tsy at end of year, bonds either get sold back to public or more likely mature and then get rolled over by tsy. End of story. This is really a big non-event despite all the hyperventilating over it.

  • Dave


    You claim bonds are government liabilities. In fact government liabilities are tax payer liabilities. So let’s suppose that ‘cash’ are government liabilities too (as you write in your post), which is in fact backed by the output of the economy (that you wrote later on a comment to my post). The output gets created by the working american people, which are in fact the tax payers.
    So do you still claim that there is no problem, if the fed buys bonds (which are in fact tax payers liabilities) with cash created ex nihilo (which are tax payers liabilities too)? As you can see the debt burden for the tax payer gets doubled if the fed buys bonds from the treasury. But because paper money is not backed anymore by hard assets, only the government will benefit from this death spiral of debt.

  • Dave


    You claim bonds are government liabilities. In fact government liabilities are taxpayers liabilities. So let’s suppose that ‘cash’ are government liabilities too (as you write in your post), which is in fact backed by the output of the economy (that you wrote later on a comment). The output gets created by the working american people, which are in fact the taxpayers.
    Do you still claim that there is no problem, if the fed buys bonds (which are taxpayers liabilities) with cash created ex nihilo (which are taxpayers liabilities too)? As you can see the debt burden for the tax payer gets doubled if the fed buys bonds from the treasury. But because paper money is not backed anymore by hard assets, only the government will benefit from this death spiral of debt.

    TPC – via Tom Hickey above:

    “US currency is considered to be a liability of the US government in the sense that the government accepts its own liabilities and only its own liabilities in satisfaction of nongovernment liabilities to it, e.g., taxes, fees and fines. Everyone who pays taxes needs to have the government’s liabilities in the form of cash or a bank’s liabilities in a checking account to pay their taxes. If one sends a check drawn on one’s deposit account, then one’s deposit account is debited and the when the check clears, the bank’s reserve account is debited at the Fed and the Treasury’s account is credited. The only thing that the government accepts as legal tender in payment of liabilities to it are cash or reserves, which are equivalent government liabilities denominated in the currency of issue. According to Chartalism or the state theory of money, it is this that gives state money its value causally. That is to say, the need for state money to satisfy one’s liabilities to the government necessitates obtaining state money for this purpose. There are other factors involved in the value of money but satisfaction of one’s liabilities to the state with state liabilities is causal.”

  • Zimmer

    Use whatever terminology you want, but the U.S. government has 3 choices when it wants to spend money – it can create the money out of thin air, it can collect taxes or it can borrow the money.

    The Treasury/Fed would like to create the money out of thin air, but current law doesn’t allow it do so. Also, explicitly creating a lot of money out of thin air would horrify much of the world. So, instead the Treasury sells bonds, a fews weeks later the Fed buys them back, and they call it QE.

    TPC – Actually, when the US govt wants to spend money they ALWAYS create it out of thin air. Taxes and bonds fund nothing.

  • Dave

    “The only thing that the government accepts as legal tender in payment of liabilities to it are cash or reserves, which are equivalent government liabilities denominated in the currency of issue. According to Chartalism or the state theory of money, it is this that gives state money its value causally.”
    You got it. It’s the government monopoly of central banks forcing people to use paper money without any value. So if you buy then more government liabilities (bonds) with paper money you should understand where this leads to.

    TPC – What else should we use as currency?

  • The Banker

    Sounds like a good plan to me goodfriend! I like you ideas as well. How about we compromise and do both!

  • Dave

    TPC, it’s not a matter of what you use (dollar, yen, euro…). It’s a matter of how the currency system works and how it is backed.

  • Zimmer

    I don’t think even most MMT proponents actually believe that MMT theory describes reality. They generally use it more as a means to an end to justify their desire/belief that government can bring about full employment by spending more money.

    At times, your comments suggest that you view monetary and fiscal policy as being run by a single entity as MMT theory favors. But other times, you want to look at the Fed’s activities in isolation without regard to what Treasury is doing.

    The Fed and the Treasury aren’t operated as a single entity under current US law. You may believe that they should be (I might even agree, but likely for different reasons), but current law says that are independant. My initial comments reflected my view that the Fed is using the terminology of QE to circumvent the current legal limits on Treasury’s ability to create money out of thin air.

    TPC – Well, technically, their operations are intertwined. One does not exist without the other. Trying to separate the two is silly. But that doesn’t mean that they don’t have particular functions. Fed controls monetary policy and the overnight rate. That’s just a fact of the matter.

    I think readers are trying to find some great injustice that has been imposed on them via inflation. But the facts don’t support that thinking. MMT really has nothing to do with any of that. It’s just a cleaner way of describing what the US govt is really doing when they implement a policy like QE.

    If your textbooks and orthodox beliefs were correct then QE1 would have been horribly horribly inflationary. I’m not asking anyone to take my word as gospel. I just call things like I see them.

  • Obsvr-1

    if bonds don’t fund the deficit, then what funds the deficit ?

    TPC – Technically, the enter button on a computer in Washington DC.

  • Obsvr-1

    which if is not a printing press (which only a small % is) then the majority has to be backed by a bond

  • http://deleted Don Levit

    Does the Fed have a balance sheet?
    If so, what are their assets and what are their liabilities?
    Do the assets exceed the liabilities?
    I gather the Fed is not a department of the government. It is its own entity, right?
    Don Levit

  • Obsvr-1

    see http://www.federalreserve.gov and http://www.newyorkfed.org/index.html

    this will answer many questions and provide insight into the Federal Reserve System a.k.a. The FED

  • Anonymouse

    The downside is that it increases input costs, which compress margins as end demand remains weak.

    TPC already said that “It actually might be the greatest economic destruction plan since the bank bailouts.”


  • Obsvr-1

    balance sheet found under the press release


  • Zimmer

    My beliefs aren’t very orthodox and certainly weren’t derived from the textbooks I read in college.

    If you look back at my initial comments, I didn’t suggest that QE was going to cause a lot of inflation. In fact, I agree with you that we aren’t likley to see much inflation in the next few years.

    You have argued that QE can’t cause inflation and that it is a non-event. I agree that QE won’t do much for the economy, but I think it is a big event because I see it as the Fed monetizing the US government debt. That is a legislative choice, not monetary policy, and the Fed shouldn’t be doing it.

    I don’t think we are likely to see a lot of inflation over the next few years because the amount of develeraging that needs to take place is much larger than the size of the deficit/QE, at least as currently planned.

    You have rightly pointed out that the US government’s ability to spend isn’t limited because it controls its currency. But under current law, if the US government wants to run a big fiscal deficit, it has to either borrow the money or get the Fed to print it, because the Treasury doesn’t have the power to do so on its own. That is not a question of orthodox belief, it is just current US law and practice. So there is a point at which the US government’s ability to spend is limited by its ability to get the Fed to go along, and I think that is one of the roles of QE.

    TPC – Well, I think it’s a big MONETARY and economic non-event. That doesn’t mean it won’t have any impact on anything. A lot of people are talking about market prices as if they reflect future economic performance correctly. That’s not necessarily true. I think the fed is impotent in a balance sheet recession. That doesn’t mean they can’t move markets.

  • http://deleted Don Levit

    Wow, this is a lot to go over.
    I appreciate the material, but I am overwhelmed, and unable to respond.
    Don Levit

  • Obsvr-1

    should be required reading for the masses (99% that has its wealth transferred to the plutocracy)… as well as combing through the FCIC.org site to read/watch/listen to the material presented to the Financial Crisis Inquiry Commission

  • roger erickson

    Sheesh! So much discussion about the creation of currency, with so little attention to operations.

    Reality: Sovereign groups decide at some point to create a currency, ex nihilo, as TCP says
    see here: Public initiative and the beginning of US currency: A confused electorate can end up pretending to borrow it’s own currency, instead of creating it?

    After that, there’s a fundamental difference between a currency “issuer” and currency “users”.

    Currency Issuers manage real-goods budgets (food, shelter, national security, etc, etc)
    (and use currency primarily as internal bookkeeping, for accurate mgt of delegated tasks)
    (small groups do this through affinity bonds; past some population size, they do it through an invented currency, or things like RFID chips; either way, it’s bookkeeping)

    Currency Users manage currency budgets as accurate proxies for local real-goods budgets.

    This is not rocket science.

    Our particular case is distorted a bit by external demands, since the $US is used as a reserve currency for many currency users outside the USA. Nevertheless, the simple truth holds. Any currency, even a reserve currency, is 95%-100% bookkeeping, and 0%-5% tangible value.
    What kind of fool attempts to save “fiat”?

    It’s best to invest in your kids, your community, your citizenship for protection, not in arbitrary bookkeeping metrics. An NFL team, for instance, derives no long term benefit for points scored over the course of a season. Contexts change, meaning meaning-of-currency rules change. Get over it, and get back to planning real outcomes instead of trying to stabilize nominal currency metrics.

    All this discussion is rather moot. Big picture is that too many charlatans were allowed to cheat on various contract processes (liar’s loans, etc). Recovery paths are through re-establishment of honest transactions, not ONLY currency valuation. The one thing that’s coming to the fore, from both Bernanke & Dallas Fed Chief Fisher, is that this was always beyond the Fed’s domain to fix – it really depends on Treasury, Administration, Congress & electorate initiative, expressed through prosecution, control of fraud rates, adequate regulatory tolerance limits, adequate currency supply, and adequate expression of public purpose. Bernanke is tasked with a narrow role, preserving the banking system. It’s the SEC and FDIC that should be closing down big banks, not Bernanke. Granted, he’s reluctant to speak outside his narrow mandate, but so is the Pentagon.
    The bigger failure is the failure of an electorate to speak out. Every electorate gets what they deserve. Either speak out more, or emigrate. There are some tough choices looming.

  • Anonymouse

    Even if QE2 fails, the resulting opposition (in Congress) is unlikely to stop QE3, because the Fed is set up as an independent agency. The only means of stopping QE3 must arise internally within the Fed. I doubt the new members in Federal Reserve Board (FRB) next year have sufficient votes to stop QE3.

    I suspect we will eventually have QE4, QE5 and so on up to Q33, in order to keep asset price “higher than they otherwise would be”.

    When valuations diverge from fundamentals, value investors give up – Klarman is returning cash to his investors …


  • roger erickson

    chief perp either now has a new employer, or …. is old enough to finally get over his insecurity?

    maybe found out he has terminal cancer? finally free to speak honestly? nothing to lose?)

    this from the guy who said what he was paid to say; for ~ 50 years straight!

    finally speaking out on a basic truth: it’s the SEC that should be prosecuting, and the FDIC that should be closing down big banks, not Bernanke. Granted, he’s reluctant to speak outside his narrow mandate, but so is the Pentagon.

    The bigger failure is the failure of an electorate to speak out. Every electorate gets what they deserve. Either speak out more, or emigrate. There are some tough choices looming.

    very reminiscent of Eddie O’Hare – Greenspan’s days may be numbered; maybe he hope’s an airport will be named after him


  • http://goodrichardsalmanac.com Richard
  • Obsvr-1

    SEC and DOJ should be prosecuting the miscreants from the big banks however it is the OCC (Treasury) that should utilize the new powers from FinREG to restructure, wind down or close the big banks – but there is no will from the FED, Treasury or Politico’s to do the right thing in shutting them down — instead they are throwing $T’s to save them, including the Multi-B$ bonuses to protect the plutocracy.

    The power of the people, the electorate, could be quickly brought to bear if everyone would just withdraw their funds from the big multi-national banks and move the money to their local banks — can you just imagine the sphincter slam that would cause. Second stage get new CC issued from local/state banks and transfer all balances from the big bank issued cards — sphincter pucker #2.
    Start voting with their dollars to punish the banksters and the Multi-National Corp (MNCs) that have no loyalty to the USA or society…

  • RkD

    But where did those reserves come from in the first place. They were created just around 2008, where the Fed extended a line of credit to the ailing banks. They have since failed to generate any loans, so thus we have QE2. But those reserves were lines of credit from the Fed!! Sure he did not physically print money, but he is using reserves that he himself created a few years ago – no?

  • http://mercenarytrader.com Jack Sparrow

    TPC, what say you to this inflation explanation from John Hussman, which, while not directly contradicting MMT, places emphasis on another aspect entirely?


  • http://www.pragcap.com TPC

    Hussman is making the case that I often make. That inflation will come one day in the form of increased demand and economic recovery. I don’t disagree with that and I am confident that the ensuing inflation (his timing probably isn’t far off) would not turn into hyperinflation.

  • bluebare

    You’re right. I have a very difficult time wrapping my head around bullshit like this.

  • chrisc

    I read about half way thru the comments and kept seeing the same explanations over and over so just for the sake of clarity i’d like to ask if i got this right.

    The fed is essentially parking (temporarily taking t-bills out of circulation) by buying them on the open market and throwing them on their balance sheet. Net effect, there are less bonds in circulation and a greater proportion of cash wasting away in peoples accounts and looking for a “home”. This cash burns a hole in your wallet and cannot earn due to low rates so it chases riskier assets and we see all equities/commodities bid up as more cash finds a home in the casino (what else am i gonna do with it). Net amount of injected cash in the system is still zero (doesnt this mean the Govt is saving money in its interest payments to the fed? anyhow…). All the fed is doing is prodding people to spend their cash via low interest rates and “confiscating” bonds on the open market. The NOMINAL (not actual) returns on risky assets increase and gain momentum, confidence is restored because lemmings love it when their investments always go up (just like houses! lol), the “smart” economists see the market flying up in the face of no fundamentals and start screaming about money printing and inflation, and the currency traders fall for the rumors and sell off their USD. This gentle prodding by BB ingeniously tips the balance from China to the USA with a passive currency manipulation even though nothing has fundamentally changed. That’s the point, since nothing has changed, all the imbalances still remain… perhaps procrastinating the problem into the future just as most people do day to day with all this easy credit. They mortgage their future and live for today, make promises for health and pensions that are totally unrealistic and pretend like all the systemic inequalities and inefficiencies in the system (compensation, poverty, taxation, etc) don’t exist.

    The solution to all this is to live within your means. Invest in education. Invest in science and technology and stop putting people to work building SUVs and giant McMansions instead of devoting their effort to more meaningful endeavors that benefit humanity. Holy crap this turned into a sermon, i’m sorry…

  • BK

    TPC im sorry if this question has been asked, but the reserves on the banks balance sheet that has now been effectively swapped via a QE transaction – who is the end owner? the banks or the banks customers?

  • torquemada

    1 Do these plethoric reserves on banks balance sheets allow them to technically lend more money as opposed to a situation of holding treasuries ?
    2 Are Bnaks obliged to swap their bonds and hold the proceeds in reserves ?
    3 In absence of main street demand for credit ( existing over indebtedness & lack of projects ); aren’t financial institutions rather funding the carry trade at almost zero rates ? In which case USD’s are “created”

  • troll

    I need answers because I am economically ignorant.

    1. I always hear that because the public sector isn’t borrowing, the economy won’t go. Since one can’t borrrow endlessly, isn’t it illogical to assume that borrowing fuels the economy? (I understand the term “enhancement”, but I also understand the word “finality”.)

    2. Since, in finality, something is only worth what somebody else will give for it, isn’t the entire economy actually based on a “communal” type belief system? If that is so, what if a large sector of the populace decides to “commune” elsewhere?

  • OTS

    prescient could you expand on this

    “The banks are in the casino with a boatload of cash. And guess who they are prying the money from, CHINA, et al. IT’S A BRILLIANT FRIGGING MOVE”

  • http://mercenarytrader.com Jack Sparrow

    But wouldn’t you concede there is a more timely aspect to his argument based on marginal utility considerations?

    Namely, “just an asset swap” can still have short-term inflationary impacts by way of the Fed impacting marginal utility considerations through a short-term increase in the supply of dollars versus bonds. The net liabilities / total size of the pie may not change, but if Hussman is correct, then QE impacts can be short-term inflationary by dint of changing people’s marginal utility preferences whether or not “more” money is added to the system.

  • http://mercenarytrader.com Jack Sparrow

    p.s. In other words, we can’t necessarily say whether the impact of a monetary policy event will be until we understand the impact on marginal utility preferences for one type of liability or asset over another — which takes us back to psychology as a legitimate and meaningful input of the inflation equation (as opposed to an assumed non-variable or extraneous factor).

  • http://www.pragcap.com TPC

    I think you have to put this in context however. We are in a balance sheet recession and this is core in my argument. Investors are increasingly indifferent between 1% paper and 0% paper. For instance, I have gotten used to the fact that my cash doesn’t earn 3% anymore so I don’t feel inclined to reach for risk in this environment.

    That will change with time because we wont be in this environment forever, but interestingly, in many ways what Bernanke is doing to making everything less attractive as investors become psychologically immune to holding cash. The people holding these bills and notes aren’t just doing so for fun. They’re doing it because they want to save. Not because they want to be herded into an asset that will give them principal risk. We’re all becoming indifferent to cash vs bills because the difference is practically nil.

  • http://www.pragcap.com TPC

    Here’s a timely response from Warren Mosler:

    “the question is whether lower rates in general cause what were investors to become consumers.

    there isn’t much evidence of this happening anywhere, including Japan, so the next question is why not.

    my guess is the interest income channel- lower rates mean less income for the economy in general because the govt. sector is a net payer of interest. and QE directly reduces govt interest payments as the fed earns the interest on the securities it buys, rather than the private sector.

    so rates are lower, which might encourage consumption, and might encourage borrowing to consume, but income over all is lower as well.

    And, of course, without real asset prices rising lenders are less inclined to lend as they don’t have rising collateral values to bail them out. A 70,000 mtg on a 100,000 condo or house can easily turn into a loss if the borrower defaults, for example, just from fees, commissions, closing costs, depreciation due to neglect.”

    I like the description of trying to turn investors into consumers. Or even better, trying to turn SAVERS into investors. The point is, these people want to save. They don’t want to consume. They’re holding bills and notes for a reason. Not because they want to be herded into an asset that gives them principal risk….

  • http://none JKC1967

    Dear TPC: I love your blog and have learned a great deal. It seems to me that the FED and the big banks and the Treasury are essentially all kind of scratching each other’s backs through zero bound rates and QE2. Please let me know if the idea that follows is in any way accurate:

    1) Banks borrow from FED at near 0%
    2) Banks then invest a nice chunk of that money in Treasury bonds to earn the spread, helping the Treasury’s sales (and also by the way one more reason why its silly to worry about whether China or anyone else will buy Treasury bonds–plenty of US investors are)
    3) This allows banks to slowly repair their balance sheets in a risk free way
    4) QE then replaces the Treasury bonds with cash on the banks balance sheets, and the whole thing starts all over again.

    I think much of this is a back door way to help the big banks recover, with a side benefit for Treasury sales. I’d really appreciate TPC’s feedback if any of this makes sense of if I am out in left field? Josh

    Josh – US investors don’t fund the USA’s spending. The US govt spends before it borrows. Not vice versa. Please see here:


  • http://mercenarytrader.com Jack Sparrow

    Ok — this response makes sense to me, as I hold similar views. With that said, my understanding is that your argument here is situational rather than theoretical. That is to say, there is a difference between

    a) QE is not inflationary b/c the correctness of MMT is misunderstood, and

    b) QE is not inflationary in this particular instance b/c of XYZ dynamics

    There is a subtle but meaningful gap between the two, not unlike the very important difference between claiming markets are 100% efficient vs. “mostly” or “generally” efficient.

    Re, QE effects on asset prices via adjustment in marginal utility preference, one could further argue the asset effects were mostly pre-baked into the cake — though Bernanke’s WaPo op-ed certainly fueled an increased appetite for commodity speculation.

    With all that said, I agree it’s quite possible the market experiences a letdown upon realizing QE in truth 1) hasn’t caused long-term inflation in and of itself and 2) hasn’t helped much of anything at all…

    TPC – Well, if we weren’t in a balance sheet recession and we cut rates to zero borrowing would go through the roof so we’d never even get to the point of implementing QE. The whole reason we’re here is due to the B/S recession….

  • http://deleted Don Levit

    Could the Fed buy Treasuries to relieve us of the debt held by the public and intragovernmental debt, which is over $13 trillion.
    Seems like a neat way to absolve ourselves and our descendants.
    Any drawbacks?
    Don Levit

  • Obsvr-1

    If they just retired the bonds it would then effectively be just printing money and the value of the dollar would plummet and ignite hyperinflation.

  • Andrew P

    The Fed is buying its T-bonds directly from the US Treasury


    In essence, they are just financing the Federal Defecit. The Treasury spends the same amount of money it was going to spend anyway because that is controlled by Congress. The only difference is that the Treasury pays the Fed a lower interest rate than it would have had to pay the private sector, and the Fed’s profits eventually get paid back to the Treasury. The net effect is to lower the amount of interest income going to the private sector from the government.

  • Andrew P

    Actually they ARE monetizing the defecit. Here is the schedule.


    TPC – This is not accurate. Tsys don’t “fund” anything in the USA to begin with so there is really nothing to be monetized. You think tsy needs the Fed to buy these bonds? Absolutely not. The key point here being that Fed is buying bonds that represent money already spent into existence. This doesn’t give tsy any more power to spend than it had before. It simply means they’re debiting the pvt sector of an interest bearing asset and crediting them with a lower int bearing asset. The early evidence is showing that it’s quite a stupid operation on the whole.

  • Andrew P

    There will be QE forever as long as the Congress is running record defecits. It is the only way to have record and increasing government defecits simultaneously with low interest rates.

    TPC – That’s not true. QE doesn’t give them any ability to spend more money….

  • Andrew P

    Oil will go to $200 when supply constraints really bite. It is a simple matter of supply and demand.

  • Andrew P

    There is no need “to monetize all the Treasury bonds in China”. Those bonds will eventually pay off anyway. All the Fed needs to do is buy up all new issuance to finance the Federal Defecit. If they do this forever, they will eventually own all Treasury bonds issued. And that is just about what they are doing.

  • Tycoon

    Though QE itself may not be DIRECTLY inflationary, the effects of QE taking place in our fractional banking system will be inflationary. For instance, if the Fed replaces $100 of Treasury Bonds with $100 of reserves, then those reserves will very likely be lent out, redeposited, lent out again, etc, until the $100 bond has been turned into hundreds of dollars of loans, deposits, interest, etc. This seems to me to be an increase in the money supply and tthis inflationary.

    Saying that QE does not cause inflation seems to be like saying that gravity, and not the wings falling off, is the reason a plane crashed. Sure, replacing the wings with air didn’t directly cause the crash, but the natural result of that change did.

    TPC – Incorrect. Banks don’t lend out reserves. Your theory is the same one many worked under during QE1. There was a massive decline in borrowing durring QE1 as the chart in this post shows.

  • Alice


    First and foremost, this site is a blessing who I wished I had stumbled upon sooner–just picking concepts here and there has been rewarding. As a high school student who admittedly doesn’t have a strong grasp on this whole banking system, and equally monetary and fiscal policies associate with it, I was wondering if you can help me understand the difference between the “reserve” and “deposit” items as they are defined on the balancing sheet of banks.

    Obviously, the deposit is what the bank’s customers keep for whatever reason. Where does this “reserve” accounting item come from? Is it some sort of equalizing liability-vs-asset, created on the balance sheet by the bank to balance out T-bond it purchases, reflexively through Fed, from government’s Treasury?

  • Steven

    Banks loan Bank Credit (so Bank of America lends you Bank of America credit) and promise to exchange that for bank reserve (or USD cash) upon demand.

    You can walk into BoA and borrow $100 and then transfer that to IRS account at the Fed. BoA first lend you BoA credit which is worth $100, then you take the $100 to exchange it for bank reserve and then send it to the IRS (which only in effect only accepts base money as payment).

    So, it kind of lending bank reserve.

  • Steven

    Until foreign vendors who do the vendor financing have enough of these ‘gold’ and says we will only accept RMB/EUR/AUD/CAD etc branded silver as payment.
    Then the US Government will be constrained to only have access to resources within its own border.

  • Obsvr-1

    Another twist on the QE operations of the FED w.r.t. back door bank bailout/assist
    This makes your blood boil when you understand that the banks are in deep trouble, yet pay out $B’s in compensation(plus ups) and bonuses funded by taxpayer money.

    Is QE2 A Stealthy $90 Billion Gifting Scheme To The Primary Dealers?

  • Obsvr-1

    Quantitative Easing Explained — not sure if I should laugh or cry …


  • gv

    Aren’t you ruling out the possibility that increased spending in the economy (as a result of QE) will lead to improved fundamentals?

  • Anonymous

    Adding on to what Tycoon was mentioning earlier and TPC’s response to that, the reserves are the % of deposits that FED requires the banks to hold with the FED. Now say a bank has the following Balance Sheet
    Assets Liab+Equity
    ——- ———–
    Reserves – 20 Deposits 180
    Loans – 100 Equity 20
    10Y Bonds – 80

    In this case FED has mandated a 20% reserve. The reserves are to ensure that the banks have the ability to service a % of their depositors who might withdraw the money suddenly. Now when the FED buys the 10Y Bonds from the bank, like TPC says, it will just take out the 80 from 10Y Bonds on the bank’s assets and will increase the reserves from 20 to 100. What this has also meant though is that banks now have 80 more in reserves to support their deposit base. In theory that means the bank could attract more deposits (retail or wholesale) of 400 which is what the 80 in reserves could support (80/0.2). This is cash that the bank can then lend out to its customers. Now this is 400 that has gone into the system. Let us say it goes out as loan to a business, who then buys machines etc and then that 400 will land as deposit at another bank, who can then lend out 320 (400*0.8). That customer then uses it for something else and the money then ends up at another bank who can then lend out 256 (320*0.8). It goes on until the amount becomes close to 0. Basically the fractional banking system will ensure that there is about 2000 more $$ put in movement with a 400 buy. (400/0.2).

    Reserve %, payment on excess reserves, short term fed funds rate, purchase of securities are all part of FED’s tools to manage the twin mandates of FED, namely stable employment, and low manageable inflation.

    Now for the caveats….The key question that nobody probably even Mr. Bernanke has an answer is how the QE will play out, because nobody has any experience in this segment. Putting on Mr. BB’s shoes he is expecting that QE2 will give an immediate boost to asset prices, thus infusing confidence for consumers to spend..and that companies might be able to borrow cheap or use the excess cash to invest etc etc.

    But that all depends on “demand”. As TPC has rightly pointed out, this does not seem like a supply issue anymore, but demand issue. Consumers are very very wary about spending, and unless data points move in the right direction firms are also weary of overspending. So the best that Mr. But I do believe that once consumers de-leverage their debts to a manageable levels, they will once again start spending. What that level of sustainable debt level is debatable but I would say it is around 100-110% debt/disposable income. Currently as a nation we are at 120% with a high of 128% two years back. Long run avg is around 100%. So I say another 2-3 years of de-leveraging. The best that Mr. BB can hope is that QE measures will give enough time for consumers to pay down their debt before they can start spending again. QE measures may or may not hit all the right targets, but without it a rise in rates will be absolutely catastrophic for the debt ridden consumer trying to pare down their debts to manageable levels.

  • Jimmy

    TPC you are wrong on many things.

    1) Demand for fiat currency does not come from government tax collection. It comes from interest on debt. Commercial banks create 90%(roughly not using precises figures) of money outstanding through loans. The borrower recieves a loan(created by the bank using fractional reserve). It becomes an asset for the bank and a liability for the borrower. So the balance sheet is square right? WRONG. Because the borrower must now enter the economy to obtain the “interest” on the loan. This ensures there is always a DEMAND for the currency in which the loan is issued through scarcity.(Not enough $$ to pay debt + interest) Someone is always extracting cash to pay the interest. This means that someone must also always be borrowing and spending to make that cash available. When that system breaks down, there is a sudden SHORTAGE of liquidity since there is not enough “cash” to obtain to pay principal + interest. This leads to “debt deflation”. Demand falls off a cliff and into a recession we go.

    This is where the Fed comes in. They attempt to mitigate this by giving the borrowers more breathing room to continue to borrow(lowering interest rates etc) At some point it is just impossible for borrowers to take on new debt, creating a shortage of cash to cover old debts. The highly leveraged system begins to break down. Capital is destroyed through initial credit missallocations.

    Once the initial attempt fails, government steps in and begins increasing its own debt load in order to keep the cycle going. The Fed merely ensures the government(spending debt mechanism) can continue indefinetly. OR SO THEY THINK.

    TPC – People don’t pay back their debts all the time. Big deal. They file bk and start clean. What happens when you don’t pay your taxes? Men with badges knock on your door. Big difference.

  • Jimmy

    The government and the fed believe by them continueing the debt process, they can stimulate private demand enough where the private sector can return to borrowing again. They can continue this ponzi scheme until either the government overwhelms itself in debt whereby

    1) By now the government is such a large % of the economy and carries such a debt burden that default is inevitable. However this would mean a massive deflationary collapse and all banking becomes insolvent. Total chaos, rioting looting. However the currency remains intact because of the liquidity shortage due to loans being called in at a large scale(panic).

    2) The government unable to continue borrowing monetizes its own debt until a political crisis leads to hyperinflation. Argentina, Weimar, Soviet Union Republics.

    TPC – The tsy market doesn’t fund anything in the USA….

  • Jimmy

    TPC – People don’t pay back their debts all the time. Big deal. They file bk and start clean. What happens when you don’t pay your taxes? Men with badges knock on your door. Big difference.

    But not on a large scale, when its large scale as in 07-08, system collapses period.

    TPC – The system didn’t collapse….

  • Jimmy

    An FRN note and a US government bond ARE NOT the same thing. This is an absurd claim. A bond is a claim on the US government to deliver FRN notes sometime in the future. An FRN note is a claim on the assets of the central bank which are usually DEBT instruments. This is why FRN notes are “liabilities”. Essentially you are correct that both are debt instruments but they are NOT equal to each other. Both are completely seperate “commodities”. Both are governed by the same supply-demand laws. The Fed and the US government are NOT the same entities.

    Final point. You claim that the role of the government is to essentially nurse the private sector? This notion is totally false and merely attempts to allocate a role to the state. This makes the assumption that the state is able to not only allocate resources more efficiently then the marketplace but also liquidate them better.

    TPC – Govt exists to serve the pvt sector. Not to “nurse” it. All currency is a debt to the govt. Read the writing on the top left of your dollars…..

  • Jimmy

    Final point again.

    The Federal Reserve by law is not allowed to purchase US debt directly from the treasury. This is why they must purchase from private banks and dealers. It is essentially a “stealth” bailout and monetization of the treasury. Some of you need to read the Fed Reserve Act.

    The most successful period in US history was actually the 1800’s during which prices were in a constant deflation and the value of money rose. This led to savings becoming more valuable and quality of living exploding higher. Goods became cheaper from productivity gains. All of this became backward when the Fed was introduced and Nixon turned debt into money.

    TPC – Monetization doesn’t happen in the current system. Bonds don’t fund anything….

  • Jimmy

    TPC – The system didn’t collapse….

    It didn’t? Thats only because the Fed stepped in along with mass scale government spending to keep the debt train going AS I EXPLAINED PREVIOUSLY. You are once again assuming the Federal Reserve and US gov are the SAME THING. This is completely false.

    TPC – Yes, the system remained intact because the govt provided stimulus and the lender of last resort made a market in credit markets….That’s the role of govt and the entire reason the central bank was created…..

  • Jimmy

    TPC – Govt exists to serve the pvt sector. Not to “nurse” it. All currency is a debt to the govt. Read the writing on the top left of your dollars…..

    This maybe true in theory. You should read the top of your dollars. FEDERAL RESERVE NOTE.

    Government does not serve the private sector. The number one goal of the state is SELF SURVIVAL. All other goals are secondary. Remember that concept.

    TPC – Self survival? I don’t even know what that means. Govt is not a living and breathing entity….

  • Jimmy

    “TPC – Yes, the system remained intact because the govt provided stimulus and the lender of last resort made a market in credit markets….That’s the role of govt and the entire reason the central bank was created…..”

    You don’t get it. Its a debt based monetary system. Someone must be constantly borrowing in order for it to work. At a given point the government itself will be unable to add debt. The central bank and GOV did nothing but kick the can down the road. At some point they will be powerless. Remember neither can create or allocate capital.

    “TPC – Self survival? I don’t even know what that means. Govt is not a living and breathing entity….”

    The role of the state is the same as any other corporation or individual. It is motivated and driven by self interests first and foremost. Survival is number one. State will do anything to keep a grasp on power. Study history.

    You state the government is here to serve the private sector. This sounds like someone who is merely attempting to justify the role of the state in the first place. For the government to “serve” the private sector it must be extremely dynamic and able to adapt to the ever changing needs of the marketplace. This is impossible because it violates rule number one that the government is motivated by its own self-interest first. Thereby how can it serve the private sector and itself at the same time? What you are attempting to justify is that central planning maybe used in certain circumstances and the government is able to allocate resources to the correct sectors. This has a documented history of being completely false.

    TPC – Okay. Let’s just agree to disagree.

  • http://deleted Don Levit

    TPC wrote:
    The Fed took on an asset (treasurys) and also accounted for a new liability (the reserves).
    So, it looks like the bank is more liquid than it was before (it has reserves instead of treasurys).
    And, the Fed’s balance sheet remained balanced – the asset increased the same amount as the liability).
    Is that correct?
    Don Levit

  • migluso


    Congratulations for your website.

    Can or cannot banks create new commercial bank money because now they hold deposits (excessive reserves) at the Fed?

    Could they create commercial bank money “backed” by treasuries (your analogy=savings account), like they are allowed to do with deposits at the Fed?

    Thank you in advance

  • Fed Bernake

    Your article has gotten the basic concept wrong! Fed is creating money since the Bank’s reserve money increase from 50 to 90. The excess reserve can result in multiplier effect (every student of 1 st year economics should know this concept).

    With the extra EXCESS RESERVE, the bank is given extra fire-power to lend. Whether the money supply will increase will depend on higher demand by consumer (which has good credit standing) for loans.

  • http://www.pragcap.com TPC

    Banks don’t lend their reserves…..

  • http://deleted Don Levit

    From an article I read, the excess reserves have increased exponentially compared to the required reserves.
    Banks are encouraged to maintain their excess reserves, and not make more loans, if the interest on these reserves is high enough.
    Is the interest on bank reserves paid by issuing additional Treasury securities?
    By the way, I bought the book “The Creature from Jekyll Island,” which deals with the Federal Reserve.
    Anyone read it?
    Don Levit