Before QE2 began, I was one of a handful of people who said it would do nothing for the economy and could in fact cause a margin squeeze as cost push inflation generated lower real GDP.  This was exactly what happened and for a brief moment, the mainstream media appeared to accept this reality, but they have more recently reverted back to believing the standard myths that surround the policy of quantitative easing.  Clearly, the misunderstandings continue and they continue even at the very highest levels.  Even Goldman Sachs appears to believe QE could fix the economy if it’s just tried harder (never mind that they were fantastically wrong about QE2 as the program added exactly no growth compared to their 0.5% estimate)…..

One of the few firms who has maintained a fairly sound understanding of the program’s effects is Hoisington Management.  In their latest economic outlook Hoisington elaborates on the recent effects of monetary policy:

“Although many measures of economic performance worsened during QE2, the Fed might argue that the recent M2 acceleration may eventually contribute to an improvement in economic growth as deposit growth fuels income expansion. In our opinion, such an optimistic assessment is not warranted.

In the past three months, M2 increased at a rapid annualized pace of more than 20%, and the annual increase in M2 is about 10%, well above the post 1900 average annual increase of 6.6%. This rise in M2, however, appears to reflect a massive balance sheet shift of assets, not a net creation of new assets. Theoretically, if funds are switched from non-M2 assets into M2 assets, M2 velocity would decline and bank loans plus commercial paper would be stable.

This is exactly what has been happening. After peaking at 1.69 in the second quarter of 2010, M2 velocity declined for four consecutive quarters, and we estimate that a major contraction in velocity to 1.59 is likely for the third quarter (Chart 3). Also supporting this idea of asset shifting, bank loans plus commercial paper in September totaled $7.845 trillion, down from $7.906 trillion in June 2010.

In an environment where short-term interest rates are close to zero, commercial paper has become an increasingly unattractive investment since the low interest rates do not cover the risk premium. As commercial paper has rolled off, issuers have been forced to meet funding requirements from bank loans. However, there are other balance sheet changes taking place along with the shift away from commercial paper. With the credit rating of major European banks sliding, companies operating globally may have moved euro-based deposits into dollar-based ones. Supporting this hypothesis, the dollar strengthened during this surge in M2. Economic stresses and uncertainty are responsible for the increased level of M2, not QE2. The real impact of QE2 was that inflation was boosted and real economic growth stunted.”

It amazes me that QE3 is still a viable policy option despite the clear cut evidence that it did nothing to help the economy.  If it’s such a panacea then why are we even bothering with this discussion in the midst of a downturn in growth?  Nonetheless, momentum builds for the QE3.   I hope you enjoy my mundane QE posts.  There’s a good chance I will have to regurgitate and vomit up a lot of my past work…..Bad myths are hard to kill…..


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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  • goodfriend

    nnooo QE back again…i remember the daily flow from you about QE…well always look at the brigth side: Should QE the writings for be launched that the articles have already be written !

  • goodfriend

    oppps corect english (i hope): Should QE be launched that you have the articles already written (actually replace 2 by 3)

  • Lite-Brite Template Maker

    Ok, where is the ‘One click download’ on this paper?

  • Captain Obvious

    Never mind, I found it. Just SHUT UP. I’m not the most patient person.

  • karl

    Hi everyone!

    What are the concrete differences between the Eurozone monetary system and the US one? According to the MMT, I understand that in the US the government spends first and then taxes and issues bonds to drain excess liquidity. So the money comes from the FED, goes to the US Gov, then into the economy, comes back to the Gov from banks with bonds.

    How about in the Eurozone? Who gives the money at the first time to the European governments? It is said that Eurozone governments cannot borrow from the ECB, but only from the private banks, but where does the money come from? The ECB?

  • But What Do I Know?

    Never underestimate the power of magical thinking. . .

  • http://binaryoptiontutor.wordpress.com/ Options Trader

    Personally I am a big fan of the mundane QE posts. I think alot of people love using big words without having a clue about the real impact.

  • RobertM

    re: “…the mainstream media appeared to accept this reality, but they have more recently reverted back to believing the standard myths”.

    Sort of like them believing “paying off” the national debt by converting Grandma’s savings bonds back into cash will somehow help the economy.

  • pebird

    There was a correlation of commodity asset speculation with QE 1/2. Does not mean causation, but is there an explanation as to how a change in asset composition might result in more short term asset speculation? Or was it just a coincidence?

  • gaius marius

    cullen, i’d love for you to get a break from QE and instead deal with NGDP targeting — but in truth that isn’t much of a break, is it?

  • http://www.pragcap.com Cullen Roche

    Been meaning to get around to the NGDP stuff, but haven’t found the time to read it all. What are your thoughts on it? Sounds to me like they just want mega QE.

    Market monetarism all seems to be based on a rebranded form of monetarism which they’ve pulled off quite brilliantly. Still based on the same EMH nonsense though…..

  • John12

    I think you are right. QE2 hurts the world economic, not just US.

    Please delete the upper one.


  • Adam1

    Operationally the FED (Central Bank) sits at the top of the banking system. The FED is the monopoly issuer of reserves and the currency (coins aside). The commercial banks hold accounts at the FED to house their reserves. The sum of these reserve accounts constitutes the Federal Funds Market. The FED’s primary job is to insure the stability of the payment system which is dependent on the volume of reserves available to clear & settle payments between banks. To do this job the FED selects a target interest rate and then adds or removes reserves to keep its interest rates. The US Treasury also has its accounts with the FED. Operationally when the Treasury sells bonds it drains reserves from the banking system causing upward pressure to be exerted on the FED’s target interest rate. The FED then responds with an Open Market Operation to inject/replace the drained reserves.

    The fact that the US Treasury issues bonds and then the FED injects reserves is irrelevant. The same outcome would have happened had the FED just given the Treasury the reserves and issued bonds later. As long as the FED is doing its job it must fund the treasury either directly or indirectly. If the FED stopped adding reserves, eventually we could find our selves in the situation where the payment system becomes unstable and then we need to ask why we have a FED (therefore it is not likely that the FED won’t stop issuing reserves).

    The Greek government (for example) also has an account at the Greek Central Bank (GCB) as do all the Greek commercial banks. However the GCB is not the monopoly issuer of Euro’s, that job belongs to the European Central Bank (ECB). The GCB and the Greek government in effect have become currency users just like an US State governments.

  • VII

    QE is simply the federal reserves foot when the CAN kicking game starts.
    There are many Feet in this game…when the QE foot comes in everyone gets into a tizzy. But when did this game really start? Let’s fix that. So we don’t have to debate QE.

    For me theres no debate. QE is a laughable heroin hit to an addict. Only the addicts and those who sponsor his behavior argue for more.

    Thats what I think. Don’t bother discussin this with me…you’ll be talking to a wall on this one. I won’t even trust you if you defend QE or try and sell me on why something that needs a 3 after it works.

  • VII

    “How cool is it that we live in a world where complicated financial engineering in a radically overleveraged system forms the conerstone of the solution to these debts problems”
    David Rosenberg this morning discussing EFSF.

    “Now we se the German Finance Minister Schauble saying that the EFSF firepower will be expanded to 1 not 2 trillion euros. Go figure”

    You want QE fine…I’ll buy Gold and commidities and help drive your oil up. I’ll play your game and hurt the economy as much as I can. That’s my job..
    TO KEEP YOUR STUPID MOVES IN CHECK BEN. Someone will be out of a job I’m going to make sure it’s you Ben.

  • gaius marius

    that’s right. whole premise of either concept based on same misunderstanding of the banking system and what the Fed can do within it.

  • LRM


    Could you recommend a reading source that would be a Reserve/Clearing 101 or for Dummies. I think I may be a visual learner and need some diagrams on how this all flows. This is an area I need to understand better. The Bank of Canada had a piece on clearing but I did not really understand the reserve side well enough
    Thanks for any rx.

  • http://www.pragcap.com Cullen Roche

    I am working on a big piece on this. I think you’ll like it. The market monetarists will have a big problem with it…..

  • perpetual neophyte

    Cullen (or any other commenter) – I am struggling with the operational aspect of the asset swap not creating new money. Can anyone help with where I am understanding this incorrectly?

    1) Member bank has $100 billion in 2-year Treasuries yielding 0.30%.
    2) Fed swaps those Treasuries for $100 billion of excess(?) reserves yielding 0.25%

    Where did the $100 billion of reserves come from? Were they already on the Fed’s balance sheet or were they keystroked in to existence? If the latter, is that not vertical money creation?

    I am sure there is a simple step I am misunderstanding…

  • Colin, S.Toe

    1) The Fed can loan to banks needing additional reserves.
    2) The Fed can buy (or sell) treasuries.
    3) The Fed can buy (or sell) other assets from the ‘horizontal’ sector.
    (QE involves 2 and 3 – correct anything wrong here.)

    Question: are there other ways the Fed can inject (or drain)reserves – ie other forms of OMO? (Does the latter also include ‘swaps’ eg with the ECB?)

  • Tickle Duster


    I think you’ll find that most Austrians said QE would damage the economy, it’s not exactly rocket science.

  • http://www.pragcap.com Cullen Roche

    Too bad they got the analysis totally dead wrong. They said the increase in the money supply would cause the problem. But the money supply is barely growing according to our friends at Shadow Stats.

  • Adam1

    Sadly I don’t know of any specific books. I’ve done my learning by reading and re-reading a lot of stuff. And I’ve had some phenominal help from operations folks at the bank I work at and from Cullen, Bill Mitchel and Scott Fullwiler with many specific questions.

    A great read on check clearing and specifically correspondence check clearing and how if help cause the banking panics of the 1930’s

    Operational realities of MMT (FED & Treasury)

    And my own distilled explanation on bank lending which relies on the payment system…
    To be clear, banks do not accept deposits in order to make loans! That is a mischaracterization of how a bank operates. Banks accept deposits in order to make investments. How do they get you to deposit money with them? They offer to pay you interest on large deposits AND they operate a payment system which you can utilize. You deposit money into a checking account; the bank gives you checks (or other PAYMENT instruments) and promises to settle these payments from your account as they come due. Now when you deposit money into your checking account the bank doesn’t put it into the vault and wait for the payment requests to come in, it uses those deposits to make investments and keeps only enough liquidity to clear those payments as they are needed. Deposits are just cheap ways of funding payment requests. If a bank needs additional liquidity there are other ways of obtaining it (sell bonds, borrow from Federal Funds market, etc…)

    Loans… Loans only require deposits (or other forms of liquidity) to fund payment requests generated by the loans. When you receive a loan from a bank you do not receive money! It is better to think about what you need and what the bank is really promising. When you need a “loan” what you really need is to make a payment (or series of payments) that exceed your current ability to finance. So when you go to the bank you are really asking the bank to make one BIG payment (or a series of payments) for you in exchange a series of smaller payments plus interest. The bank is really only promising you to make a payment. This is why you typically get a loan check when you leave the bank – it’s a payment instrument – the bank is promising to make good on this payment.

    So operationally when you get a loan you get a check – a payment promise. The check is going to get deposited in an account. If the check gets deposited at the same bank the bank just credits the account – the deposit comes out of thin air. The bank doesn’t take money out of the vault to make the payment it just creates the deposit. Funds or liquidity is only needed when a payment request is made.

    Alternatively that loan check could have been deposited at another institution that is now going to make a payment request to the originating institution. When that payment request comes in the originating bank only needs funds to settle that payment request. If the bank does not have sufficient liquidity at the time it will have to source the funds elsewhere. Most likely it will borrow from the overnight Federal Funds Market.

    The reason it can borrow from the Federal Funds M is because when the deposit hit the books at the other bank the deposit became “money”. That bank took a deposit and wants to make income off that deposit. It is ready for investment and if another bank needs liquidity it’s willing to pay interest to borrow from another bank with excess deposits. (note: a bank can invest money from a deposit the moment the teller hits enter on the key board. Yes the bank is taking a risk that the payment is rejected, but the bank is in the business of taking risks to make money).

    All said and done, banks use deposits as an inexpensive way to fund their payment system and while loans do generate payment needs they also generate their own deposits so they are self funding. (note: it is possible a loan does not generate a deposit. Example: a car dealer goes to his bank and CASHES a loan check he received from a customer. No deposit (at this time) is made. If there are no excess deposits in the banking system such as in this example then the FED will always make sure there is sufficient liquidity in the system. The FED’s primary role is to insure the payment system does not fail (hence the FED discount window). Reserve requirements are suppose to help protect the payment system and have nothing to do with the creation of loans.

  • Adam1

    “are there other ways the Fed can inject (or drain)reserves”

    Do you mean legal ones or operational ones? Operationally the FED could just had the reseves over to the Treasury to spend, but that would be a violation of current US law. Though I do believe it is how some countries operate in whole or in part.

  • Adam1

    Operationally the money was originally created when the bonds were issued and spent (see an earlier post of mine). So when the FED “swaps” the bonds for reserves there is no real net new “money” being created.

  • Colin, S.Toe

    I was referring to ‘Open Market Operations’, as in your original comment, which I assume means legal ones.

  • thepigman

    Even as QE2 choked and stalled the “real” economy with inflation,
    Wall Street praised and cheered its results as it was good for
    THEIR business, i.e. inflating risk assets and commodities
    and creating, YES INDEED, yet another mini-bubble.
    Economists like Goldman’s Hatzius ARE NOT laboring under any myth
    about the effectiveness of QE on the real economy. They simply couldn’t care less about the real economy. It’s all about what’s
    good for them.

  • Anonymous

    I can’t believe you said….”even Goldman Sachs”

    Similar too

    “Even Marlboro thinks smoking helps obesity.”

  • VII

    ANONYMOUS WAS VII..was logged out. Sorry TPC.

    I’d post a picture of myself but I wouldn’t want Trixie or what ever she calls herself to stalk me

  • LRM

    Thanks for your reply. I was away and did not notice your effort to help
    I have often heard that banks make loans out of thin air which I Guess is initially true
    But the banks check from the loan eventually has to clear and thus the bank ends up needing something in order to clear that check. I will check out your recommended readings.

  • Coolidge Low

    Looking forward to reading. I could be wrong (wouldn’t be the first time), but this is going to become the debate moving forward. The investment implications will be huge and we all need to position ahead of this one.


  • Adam1

    The key is the payment system that the bank operates. While “funds” are needed to clear and settle the loan checks, in reality it is a very special type of “funds” that are needed – reserves. Only reserves can be used to settle payments between banks, and the bank has several routes to obtain the reserves should they not have sufficent amounts on hand – including getting them directly from the FED. They don’t need them ahead of time to make the loan.

  • Oroboros
  • Adam1

    It dawned on me today that the FED lent to a lot of non-banks during the height of the crisis. How it operationally did it I don’t know, but it’s wasn’t likely done as an OMO, some special vehicle probably.

  • karl

    So it’s the ECB who loans money to the commercial banks who then loans to the government? The only difference between US and Eurozone is the fact that there’s one more intermediary (private banks) between the Central bank and the Government?
    Thanks for your reply

  • Adam1

    “So it’s the ECB who loans money to the commercial banks who then loans to the government?”

    The ECB provides Euro reserves for the Euro banking system, but reserves are not used to create loans.

    That aside, because the GCB and the Greek government sit below the ECB and the euro inter-bank lending market there is no “automatic” mechanism to force the ECB to fund their spending. Operationally the ECB could just hand over reserves to each nation as needed but I would assume that’s illegal and not likely to happen.

    Likewise if there was a central treasury or a Euro bond the likely design would operationally compel (though it would likely not be transparent which is why people think the US government borrows money) the ECB to fund the expenditures.