Stop With the “Money Printing” Madness

I never stop seeing the term “money printing” all over the place.  It has to be the most abused term in all of economics and finance.  The madness must end!  So let’s try to make this so simple that a 6 year old could understand it.

1)  Banks create most of the money in our system.  Loans create deposits and deposits are, by far, the most dominant form of money in the economy.  So, if you want to say someone “prints money” you would be most accurate saying that banks print money.

2)  The government is a user of bank money.  When the government taxes Paul they take Paul’s bank money and redistribute it to Peter when they spend.

3)  If the government runs a budget deficit (taxes less than it spends) then Paul buys a bond from the government and the government gives Paul’s bank deposit (which he used to buy the bond with) to Peter.  Paul gets a bond which the government created in much the same way that a private corporation creates a bond when they issue corporate debt.   If you want to say these entities “print” financial assets then fine.  Corporations print stocks and bonds every day and you don’t hear the world exploding with hyperinflation rants because of it….

4)  When the Fed performs quantitative easing they perform open market operations (just like they have for decades) which involve a clean asset swap where the bank essentially exchanges reserves for t-bonds.  The private sector loses a financial asset (the t-bond) and gains another (the reserves or deposits).   The result is no change in private sector net financial assets.  QE is a lot like changing your savings account into a checking account and then claiming you have more “money”.  No, the composition of your savings changed, but you don’t have more savings.

5)  Cash notes like the ones you have in your wallet are created by the US Treasury and are issued to the Federal Reserve upon demand by member banks.  This cash is literally “printed” by the Treasury, but serves primarily as a way for banks to service their customers.  In other words, if you have a bank account you can exchange your bank deposit for cash from the ATM or the bank teller. Cash is preceded by the dominant form of money, bank money.  But it doesn’t get printed off the presses and fired into the economy as some would have us believe.

See, there’s no “money printing” in any of this unless you want to distort the role of cash in the economy or refer to lending and security issuance as money printing.  Yes, QE alters the composition of private financial assets, but that’s about it.  No real “money printing” there either.   So, next time someone goes off on a “money printing” rant just point them in the direction of these 5 easy to understand steps.

* Confused?  See the following pieces:

1.  Understanding The Modern Monetary System

2.  Understanding Inside & Outside Money

3.  Understanding Moneyness

4.  Where Does Cash Come From?  


Got a comment or question about this post? Feel free to use the Ask Cullen section or leave a comment in the forum.
Cullen Roche

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. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  1. This is very clear as relates to LSAPs of treasury securities. But doesn’t it need some modification for central bank MBS purchases?

  2. Cullen –

    Re: #4 – Would it be fair to say that the Fed’s open market operations of today are the same as always (operationally) but not really the same (size and scope)?…and that by enabling the Federal government to run huge deficits, the Fed is allowing for goods and services to be “bought” that otherwise wouldn’t have been? It’s not “money-printing” per se but its the reason for record profit margins that otherwise wouldn’t have existed…interested in your thoughts…


  3. You know Cullen, in #3 you mention corporations and other private institutions issue financial assets every day and no one screams hyperinflation… yet those “out of thin air” loans from the banking system to the private sector are exactly what creates money, no?

    The Federal Reserve game of QE (in the MBS market) has been to swap bad assets for good ones. The money was already printed (to fund the loans making up the bad assets). This has been going on at a rate of about $1.3billion / day in the MBS market last I looked.

    What I am getting at is that the quality of financial assets is being changed, while trying to hold level the quantity of financial assets (reducing loan losses) in the system. The still dying assets continue to put disinflationary pressure on the whole.

    Agree? Disagree?

  4. Cullen

    Keen has a post that fleshes out your item 4

    But he does find it is possible that QE can have a quantitiative effect on the money supply and it “comes down to net buying by banks of shares (and other assets) from the public”.

    He goes on to conclude that “If this logic is in the ballpark of what banks are actually doing, then this puts flesh on economist Michael Hudson’s remark that “Bernanke’s helicopter is dropping money on Wall Street, not Main Street”, and on fears that QE is helping drive a stock market bubble. The reaction of the stock market to fears that Bernanke might start to unwind QE this year could therefore be well founded.”

  5. Cullen,
    I’d love to get you to expand on the following:
    Prior to QE the Treasury ran deficits. They raised money by collecting taxes and spent money on social security, medicare, salaries, etc. Money in (taxes) came out of bank accounts and money spent went back into bank accounts. Deficits were funded by issuing bonds (money out of our bank accounts into the Treasury’s account). No money printing, just money moving around. But when the Fed buys bonds, isn’t it essentially putting money into the Treasury’s bank account that didn’t exist in the system? Isn’t this different from the loan/deposit money creation?

  6. Steve

    This is a good question that has puzzeled me. Why would the private sector swap HQC MBS that pays a income stream for banking deposits which pay nothing.

    I can think of three reasons.

    1. They are swapping LQC which have a lower leverage ratio due to higher haircuts for banking deposits which can be REPO for HQC and Rehypothecated at a higher leverage ratio.

    2. They are selling HQC MBS due to liquidity concerns.

    3. All of the above.

  7. Cullen, Will you respond to the Keen post at naked capitalism.
    Keen says…”But he does find it is possible that QE can have a quantitiative effect on the money supply and it “comes down to net buying by banks of shares (and other assets) from the public”.

    Whether the Fed is printing money or not may be irrelevant. The point is the Fed is juicing stocks with QE…or do you disagree???

    Koo says the same thing: Koo: As more and more people began to realize that increases in monetary base via QE during balance sheet recessions do not mean equivalent increases in money supply, the hype over QEs in the FX market is likely to calm down. At the moment, however, that is not yet the case, as the sharp fall of the yen following the announcement of Abenomics with its commitment to monetary easing amply demonstrates….The only way quantitative easing can have a positive impact on economic activity is if the authorities’ purchase of assets from the private sector boosts asset prices, making people feel wealthier and thereby encouraging them to consume more. This is the wealth effect, often referred to by the Fed chairman Bernanke as the portfolio rebalancing effect, but even he has acknowledged that it has a very limitmued impact.
    In a sense, quantitative easing is meant to benefit the wealthy. After all, it can contribute to GDP only by making those with assets feel wealthier and encouraging them to consume more.”

    Your thoughts???

  8. This entire article is riddled with errors. We can start with you using the term money to describe currency. It is important to teach a 6 yo the difference.

  9. Yeap, super brilliant, Print all you want and it’s no printing. Then why even work? Just print money give to everyone, tax them, they will spend it, tax those also & that be it, no need for jobs. Just print money, that’s it.

  10. Currency is cash and reserves. Cullen calls this outside money. See the MR articles at the bottom.

  11. “By keeping interest rates at record lows…”

    If the goverment can always conjure up dollars to pay its debts, why should they care about interest rates in making spending decisions.

  12. Other Question would be. What FED going to do with ballooning Balance shit so far approaching 4 Trillion $. You can count that as a loss, cause there is no Market for it, as FED is the Market, they only elephant in the room. Whom they going to sell those assets to? Aliens?

  13. The government can’t ‘conjure up dollars’ — it must issue bonds and pay interest on those bonds. So it has to keep interest rates low or the budget will be taken up by interest payments.

  14. Mark,

    Why do they need to sell them? They can just hold them until they expire.

  15. I could go into much more detail on QE. For instance, most of QE is done with non-banks where deposit balances actually increase, but net financial assets still remain the same. It’s a minor accounting change in the story, but the overall message is still basically the same.

  16. I don’t like to say the Fed is enabling govt spending. That implies that there would be no demand for t-bonds without QE and we know that’s wrong because QE2’s end resulted in RISING bond prices. Ie, demand was higher when QE2 ended….

    But, the deficit is definitely adding to corporate profits as that flow of spending from Paul to Peter ultimately results in higher revenues, incomes, etc.

  17. Yeah, I think it’s fair to say that the quality of private financially held assets has improved since MBS is inferior in quality to t-bonds. So, when the Fed takes MBS out of the pvt sector and exchanges it for reserves or deposits I think you could say that the quality of the pvt sector’s assets has improved. This is one reason why I say QE1 was quite effective. It made MBS much higher quality via implicit Fed backstop.

  18. It’s not right to say that banks lend out their deposits. It’s better to think of banks as extending loans and finding reserves later if they need to do so. Banking is a spread business where the bank essentially makes a profit by having assets that are less expensive than its liabilities. A bank needs to remain solvent to be allowed to legally operate, but that doesn’t mean it necessarily needs deposits to make loans. But banks like to obtain deposits because they’re a rather inexpensive liability.

  19. Keen’s post is very wrong. Anyone who describes QE as a repo is misunderstanding how open market operations work at a very basic level.

  20. If we’re talking about MBS, by holding them, the Fed has essentially printed the money to buy them in the first place. The ones with some value might still be unwound, the worthless ones will simply disappear.
    As for the Treasuries, the Fed will keep rolling them over.
    The Fed’s balance sheet is limitless.
    Note: There’s nothing inherently wrong about ‘printing’ money, provided you a) get it to the right people and b) don’t trigger inflation. So far we have failed on the first count and up to now succeeded on the second count.

  21. “There’s nothing inherently wrong about ‘printing’ money” No problem until demand for $USD falls through the floor.

  22. QE can function in two ways. It can work via a direct purchase from a bank where reserves are swapped for t-bonds. Or it can work via a non-bank where the bank is an intermediary. In the latter case it results in more deposits being held. Grandma sells her t-bond, the bank credits her with a deposit, and the bank on-sells the bond to the Fed. The accounting is a bit more complex, but the result is the same from the perspective of net financial assets. Grandma gets a deposit, the bank gets a reserve and a deposit liability and the Fed gets a t-bond.

    QE results in the supply of t-bonds essentially steadying because the Tsy is still issuing t-bonds via the deficit, but QE is removing t-bonds. So there is some portfolio rebalancing effect as the private sector is likely feeling the safe asset shortage. But I think a lot of it is psychological. The general public really thinks the Fed is printing huge amounts of money and that QE has a massive impact on the economy.

    I would definitely never say QE has no impact, but I think it’s far less powerful than most presume.

  23. Currency is a form of money. Currency includes cash, coins and reserves. I call this “outside money” because it comes from outside the pvt sector.

  24. “The govt isn’t printing money.” Fed is not printing money, IF they sell t-bonds to somebody else, that’s Market. If FED issue T-bond and buy them at the same time as it’s doing right now, then with one hand FED issing the t-bond with the other, print money (or just adding Zeros in the comp. system) which is the same thing. T-bond has to be bought with the $$$ If FED is the buyer, then FED printing money to buy T-bond.

  25. Well, I didn’t mean to imply that there would be no demand for treasuries, but that raises the question:

    If demand is strong enough (or even stronger!) without QE, then the point of QE is…..???

  26. In 2007, the Fed’s balance sheet footed to less than $1 trillion. Now it is over $3 trillion. Doesn’t this indicate that some money has been added to the system? Did someone else’s balance sheet shrink to make up for this?

    When I “change my savings account to a checking account” my balance sheet totals don’t change.

  27. QE is monetary policy, not fiscal policy. They’re trying to drive long rates lower and influence the pvt sector in other ways such as the “wealth effect” via the portfolo rebalancing.

  28. Not sure how creating debt( T-bond) is a zero sum transaction. And open market transaction free up the money supply which can lead to risk-on appetites which is what most people call “printing money”

  29. The Fed doesn’t issue t-bonds. The US Tsy does. QE2 already proved that the US govt doesn’t need the Fed to buy bonds in order to auction them all.

  30. An innocuous change in nomenclature and simple enough, but why then do some observers like Jim Grant describe the current fed balance sheet as “grotesque”?

  31. Right, but if the demand from the private sector is there anyways to drive bond prices higher and rates lower (like after QE2, per your example), then the “wealth effect” should happen on its own, even without the Fed.

  32. There are more people out there who understand QE than you think. But yes, anyone who has been worried about high inflation due to QE has a very flawed understanding of modern banking.

  33. Yeah, I don’t disagree. Frankly, I think it’s flawed to try to induce a wealth effect by jamming private assets higher through policy like QE. We’re seeing that rollercoaster ride play out in Japan right now. I have zero doubt that a central bank can set a particular price for a stock market, but I think it’s dangerous policy to try to steer the madness of crowds into pvt assets like equities. You tend to get more disruptions than you’d otherwise have. I contend that QE with a stock market “wealth effect” target tends to drive prices much higher than they otherwise would be which creates the risk that they’ll eventually correct (which creates a poverty effect equal in size to the wealth effect). But who knows – I am willing to admit that that position is wrong if we see ample evidence that proves it wrong at some point.

  34. But I also wonder if indeed a free market solution is best, why do we need a 4T$ client distorting the market…?

  35. Why is Cash and T-bills considerd equal assets when cash has more moneyness, does the interest rate paid bring them to par?

  36. Remember, when I refer to something’s “moneyness” I am referring to its ability to meet the primary function of money as a final means of payment. A t-bill has lower moneyness than something like a bank deposit because most people won’t accept t-bonds as a final means of payment. Refer to the moneyness article and the scale of moneyness that I show there.

  37. Markets, in my opinion, are always being distorted to some degree. There’s no such thing as a stable equilibrium in the economy. Think of a stable equilibrium as being a pen resting on a table. If you touch it it will return to its original state. The economy doesn’t exist like that. It’s non-linear and dynamic. So, it’s more like a pen that’s been thrown through the air in the middle of a pouding thunderstorm. Unfortunately, the Fed and other institutions (even private institutions) can act like a thunderbolt at times and send the system into shock. I personally think QE creates this risk and generates more risk to the system than it’s probably worth.

  38. Cullen, what I can’t help but point out about swapping around financial assets with varying prices and risks essentially avoiding deflation since the less attractive assets are being sopped up and exchanged for more useful liquid assets to protect balance sheets.

    While that isn’t explicitly printing money, doesn’t it affect the economy by distorting institutional and market incentives as essentially another form of price control?

    Have those ever worked long term and how is it going to be different this time? Sounds a lot like buying time rearranging the chairs before the music stops and the deflationary cascade of levered assets high risk investment schemes begins in earnest as would’ve been the result of the liquidity lockup in ’07.

    Isn’t that why everyone implies that the Fed is printing money? Money that should have disappeared as bad investments cratered?

    Paul is taking it on the chin here and Peter is making out like a bandit if that’s the case. Big time.

    Thanks. This is a great site you have here.

  39. Hi Praxis,

    I think that’s a pretty fair statement. QE and the govt’s intervention in 2008 was DEFINITELY inflationary in that it avoided deflation. But I’d argue that it was the Fed’s lending programs, the deficit and the bailouts that were much more supportive here than QE was. QE1 had a huge impact because it corrected the problem where MBS was selling for 30 cents on the dollar. Remember though, these were pseudo govt guaranteed assets so they never should have traded at 30 cents on the dollar to begin with in my opinion. So, personally, I don’t have a big problem with the govt setting the price of assets it issues (assuming it has the power to do so). If the govt wants to set the price of its bonds at something and it can sell those bonds at that price then go for it. MBS falls into that category in my opinion because it’s mostly GSE assets.

    But QE2, QE3, etc are doing far less now that the MBS problem has been resolved.

    More importantly, I would have liked to see more of the big banks crammed down in 2009. Instead, we bailed them out and now the Fed continues to do what it does best – support private bankers.

  40. I’ve illustrated a version of Cullen’s 1., 3. and 4. (in his post here) on simplified balance sheets if anybody’s interested:


    3. (I usually go w/ x & y, but I’d identified them as Peter and Paul here too now)


    Also, here’s an bit oversimplified version of what happens when the Fed holds Treasury bonds to maturity (again, in balance sheets):

  41. Johnny

    “So it has to keep interest rates low or the budget will be taken up by interest payments.”

    If the budget includes interest payments on debt how does interest payments consume the budget. Your statement would imply the goverments budget is fixed year to year and never grows.

    The government can’t ‘conjure up dollars’

    Sure it can. The goverment can always spend more than it takes in (deficit spending by definition) the treasury is required by law to sell treasuries to balance the accounts.

  42. Johnny is probably referring to the reality that all govt spending is actually a redistribution of existing bank money. So, the govt doesn’t actually just conjure up dollars and fire them into the economy. They conjure up bonds and sell them. And yes, the govt can always sell its bonds, but it can’t always sell them to the public necessarily. In a hyperinflation the pvt sector would definitely stop buying bonds. Of course, that’s an inflation constraint so it’s very different than the typical solvency constraint like Greece has, but it’s an important distinction to make.

    You can print money, but you can’t necessarily print output. The USA is very fortunate to have an enormous productive base and a sizable aggregate demand problem at present. So we have to be careful about implying that a nation with a printing press cannot cause problems for itself by running that press (not that you did, but for other readers it’s important to point out). It very well could cause massive problems by diluting the quality of its output (malinvestment) or by spending in excess of productive capacity. The prior is like injecting yourself with lard on a daily basis and it’s going to kill you if continued. The latter is like nibbling on chocolate after a delicious dinner. It’s bad, but there are far worse things that could happen to an economy than having high inflation because your economy is super strong.

  43. Actually other balance sheets (specifically commercial bank balance sheets) grew! This happens when the Fed buys from non-banks during QE:

    But notice that nobody’s equity changed. Yes, money has been added to the system, but so have liabilities.

    What I didn’t illustrate here was the case where banks are the entities that provide the Treasuries to the Fed during QE. In that case only the Fed’s balance sheet grows. The private sector balance sheets (bank and non-bank) do not. Banks account for about 20% of Treasury holdings… does this mean they are responsible for about 20% of sales of Treasuries to the Fed? I’m not sure… but it’s mostly non-banks that sell to the Fed (I believe the Fed uses banks to make these purchases for them… the Fed doesn’t directly purchase from non-banks… I’ve glossed over this bit in my example, but it doesn’t change my balance sheets)

  44. Hello Cullen,

    Would you please elaborate on that ? I read the article from Keen, and I wasn’t able to see if that was simply a confusion bewteen repo and omo, or if something more fishy was in play.

    Good day and thinks !

  45. I can appreciate your answer, but in my opinion things have gone FAR beyond “distorted to some degree”. Multiple central banks have overreached their scope, selectively creating indemnity and highly beneficial rewards for some. But perhaps for someone like Bernanke who was staring at a 50% market collapse this was the only way out. Fisher has said “this thing will not go on forever”. Maybe central banks should step aside and try a bit of laissez faire pragmatic capitalism. (No charge for the plug:)

  46. Well, it’s just fundamentally incorrect to call these open market operations repos. A repurchase agreement implies that the seller of the bond will buy the bonds back at some later date. This is absolutely false. The Fed does not enter into repos. It is an open market operation and the Fed buys on the open market and has no need to sell the bonds back at any point. In fact, as I’ve repeatedly stated over the years, the Fed is unlikely to ever sell their holdings and is more likely to let them mature and roll off over time.

    Honestly, it’s a frightening mistake from someone who should know the difference between a repo and a OMO.

    Also, when he says:

    “For money to really be created, QE would have to go directly to the Deposits of the public in the private banks, and that’s not what QE does.”

    He is definitely wrong. QE works primarily via non-banks. So it does definitely alter the composition of private deposits. If people want to call that change in composition “money printing” then be my guest. But I don’t think it’s quite fair without also pointing out that the pvt sector’s t-bond gets “unprinted”.

  47. Cullen you’ve stated that banks hold about 20% of Tsy debt.

    1. Do they also contribute about 20% of all sales of Treasuries to the Fed during QE (with non-banks making up the other 80%)?

    2. Is that 20%, 20% of private sector held Tsy debt, or 20% of ALL Tsy debt (Social Security holds a lot and sot do GSEs, don’t they? Plus foreign central banks, etc).

  48. I wouldn’t make that kind of flat statement — that the government can ‘always’ borrow whatever it wants.
    MR is pretty clear that there are limits.
    There are also a great many known unknowns — like what will be the long-term consequences of such low rates if they must be permanant, or what happens if interest payments take up more and more of GDP, as well an ‘unknown unknowns.’

  49. NOW FED buying 80% of all t-bonds, what demand you are talking about? No Market for them, Printing and buying, yes, Treasury Dept issue them, Fed printing money and buying them. Fed+Treasury = US Gov. Need to make payment issue more T-bonds, It called barrowing money from future generation. Technically is broke by any definition. If that was .corp it would filing for chapter 11 long time ago.

  50. What kind of deficit would be possible in a true emergency — let’s say a nuclear attack on a couple of U.S. cities and sabotage of Middle East oil fields, precipitating World War III.
    If you take money from Peter to pay Paul and give Peter a bond, how much money do the Peters of the world have available? How many trillion?

  51. All Bank needs it’s leverage. They took $1 in deposit and loan out $30 at 4% simple as that. Same with GOLD every GOLD ETF claim it on their balance sheet and in reality it’s not there or much less than supposed to. Scam everywhere. To understand FED QE you can look and learn about Madoff operation, I think he might be elected as next FED chairman. :)))

  52. Thanks for the reply Cullen, I wholeheartedly agree, especially with the MBS panic. People are so high strung now-a-days.

    I think the system really shot themselves in the foot leaving everyone even less prepared to weather the next cyclical decline.

    It also seems like the ebb and flow cycles are compressing with the speed of information.

    This looks very dangerous like a deafening silence waiting for a pin to drop and start the crowd roaring, much like some sub sectors of Europe. Though the situation is obviously different, people are still people and react thusly and usually on an abysmal level of intelligence and foresight a-la Gustav’s “The Crowd”.

    Cheers mate!

  53. Cullen – What might help some people understand is if you cited examples of what DOES constitute “money printing” in the 21st century in a nation with its own currency (i.e. not Zimbabwe or Weimar). Something like “if Bernanke and the FOMC were to do [such-and-such], that would be money printing, but instead they’re doing [such-and-such]” might help people understand. Or “[first world country] tried money printing when they did [such-and-such], but we’re not doing that now and here’s the difference.”

    Thanks as always for your thoughts.

  54. You’re working from a gold standard-like concept of money I think. Money in our fiat system… the world’s system for the most part, is created via debt. It’s not like there’s a pile of indestructible money out there that gets leveraged up. If all money were confiscated and then used to pay all debts, they’d cancel. No debt, no money.

    When the bank gives you a loan, it’s not that they are leveraging up some pile of gold or paper bills somewhere… it’s much more similar to exchanging IOUs: You agree to pay the bank w/ interest, and the bank creates a deposit which can be used to pay anybody and which can be transferred infinitely. As non-banks are to banks, banks are to the Fed. Same idea, except instead of inside money, it’s outside money involved.

    They don’t even need that $1 in deposit!

  55. Also, a bit off topic but IMHO the real bubble in the financial markets these days is in…bubbles. People are so affected by 2008 – either because they thought they were smart and didn’t see it coming or because they DID see it coming and NOW think they’re smart – that they’re searching for the “next big one” everywhere. It’s like post-9/11 here in NYC: every time you saw a low flying plane or heard a fire alarm go off, it meant something vastly different than it meant before.

    So IMHO when people say the Fed is “printing money”, what they’re really doing is giving voice to inner fears (which they didn’t have before 2008) that the Fed doesn’t know what they’re doing.

  56. You imply that rates are “unnaturally low” if the fed is pushing them lower (and prices higher).

    What do you think a “natural” rate floor should be on short-term and long-term debt?

    To me, rates may be slightly “unnaturally low,” but not to a huge degree. The demand for loanable funds is low as hell. We’re deleveraging. One would expect very low rates.

  57. Depends on the rate we’re discussing. The overnight rate is naturally zero because that’s the base case for a reserve system. A reserve system without Fed intervention forces the overnight rate to zero. So the question becomes – what should the rest of the curve look like. I think the govt should offer risk free assets above the rate of inflation at all times. This achieves a few things. It provides savers with a decent way to protect their savings from purchasing power loss and it also maintains the yield curve in a position where banks can make a reasonable profit.

  58. Positive real yields on risk-free assets is subsidizing savers. In a world without fiat currency, people have to take risk to obtain a real rate of return.

    Also, if we want positive real yield that would cause rates to be 2-3% on short-term treasury debt. This is going to significantly tighten people towards spending their money in a balance sheet recession. Seems like a recipe for disaster unless government starts spending lots of money to stimulate demand.

    Further, if rates were “unnaturally low,” wouldn’t we see lots of borrowing and inflation? Also, as you say, after QE ends we wouldn’t see bond prices rise. We see neither. You seem to be contridicting yourself when it comes to QE, interest rates, and the wealth effect.

  59. Say there was only $1T (I don’t actually know how many there are, but I think the real answer is between $10T and about $65T… I’d favor the high end of this range). The fact is this $1T can be “recycled” many times over with Treasury deficit spending, each time producing $1T in bonds. Imagine, that this $1T were recycled every two weeks with heavy deficit spending… then in a year that’s $26T in spending. Also, as we know, this base of inside money can expand and contract due to private sector lending and loan repayment. Is that an unrealistic level of spending? Perhaps… but you did mention nuclear attack… seems we might have other problems to contemplate in that situation!

  60. Cullen,

    If you’re asserting that the fed is trying to push rates “too low” to create an artificial “wealth effect,” I’m taking that to mean you think they’re “unnaturally low,” but maybe we’re talking different terms here.

    I guess I’d ask, if you were fed chairman, what would Cullen do?

  61. “Not sure how creating debt( T-bond) is a zero sum transaction.”

    Pretty much everything is a “zero sum transaction” if you consolidate ALL balance sheets: Tsy, Fed, banks, non-banks. Take a look at this example:

    If you consolidate all balance sheets together you get $0. That’s the case with a fiat system like ours. Now in a different system, the Treasury might be able to simply issue money w/ no liability to itself (i.e. it creates itself an asset). But in our system, it all consolidates to zero. Of course, that’s just money and debt I’m talking about… real assets would still exist… houses, piles of gold, etc.

    Actually, even in our system, the way in which coins (as opposed to paper money) are treated is a little different… I think the Treasury essentially does create itself an asset in that case, but I believe there are legal limits to the extent to which this can be done. However, does it really get a 1 cent asset every time it mints a penny? You have to factor in cost of production there. On pennies it might be a net loss…. does anybody know?

  62. The cleanup bill would be steep!
    That’s interesting if you say that there is potentially $10 to $65 trillion out there just waiting to be invested.
    How would the circulation work? If I buy a bond, does that mean the spending comes back to me and I buy another bond?

  63. “If I buy a bond, does that mean the spending comes back to me and I buy another bond?”

    Not necessarily: it *could* come back to you, but would probably be redistributed to a lot of different people (maybe partly to you too). The point it it comes back to the private non-bank sector through gov spending but then gets circulated more, etc.

    Again, I don’t really know what the actual amount of money is out there, let alone that part available to invest in bonds, but that’s just an example. This chart seems to indicate that perhaps about $9T in bank deposits are out there:

    But I think I’ve seen that $65T figure somewhere (maybe here on pragcap) too. If you simply google “how many dollar are there?” you can find all kinds of answers.

    Don’t take my numbers too seriously! If somebody has some better info I’d love to know. My point was more the concept that money can be recycled to support gov spending.

  64. I agree on the technicalities of QE, but then it seems that the Fed is very confused itself. Bernanke has stated over and over again that he is trying to generate inflation to spur the economy (which is a pretty bogus concept to begin with).

  65. “Bernanke has stated over and over again that he is trying to generate inflation to spur the economy (which is a pretty bogus concept to begin with)”

    What kind of inflation are you referring to? CPI? Not saying I agree, but a lot of economists think that might be a good idea (modestly raising the CPI inflation rate). Even if the Fed were able to hit its 2% CPI target that would be better than what we’re doing now (I guess they’ve been undershooting). Krugman tosses out 4%. He’s an new Keynsesian (NKer). Market Monetarists (MMers like Scott Sumner) (which I think of as generally on the right… libertarian types), also would like to see a higher inflation rate, but of course prefer their idea of NGDPLT (a 5% annual growth in NGDP) which is the sum of real growth and inflation (real GDP + inflation). Both NKers and MMers are upset with Bernanke for not even hitting 2%! … although I think the NKers think Bernanke is correct to state that fiscal policy is a better tool at the ZLB (liquidity trap conditions), whereas the MMers don’t believe in the liquidity trap and think the Fed can do more on its own. Traditional monetarists (John Cochrane) are not convinced that NGDPLT or higher inflation rates are a good idea to begin with… nor are most Austrians (both of these schools tend to be right wing also).

    David Glasner (an MM sympathizer) has a pretty good response to folks that think that deflation or disinflation is good. He said (to one disinflation/deflation advocate) “would you mind explaining why transferring wealth from creditors by price inflation (actually by inflation greater than expected) is theft, but transferring it from debtors by price deflation (actually by inflation less than expected) is not theft?”

    So there’s lots of views here: Inflation (with current economic conditions) good or bad? Can the Fed get there by itself or not? So I’m not sure what you’re calling a “bogus concept”… the idea that the Fed can hit its inflation target, or that it should try to do that in the first place? We had a good discussion about this yesterday in the comments to Frances Coppola’s piece:

    I think her take is that more CPI type inflation might be good, but that she’s doubting the Fed only approach (monetary policy) has a functioning “transmission mechanism” to get us there… especially if it’s just QE that’s the tool. People like Glasner and Sumner are critical of QE the way it’s currently done. Glasner, for example, thinks that the Fed should announce that it’s willing to do what it takes to hit 2% (or whatever target) and then INCREASE asset purchases (he doesn’t care what the assets are) every month until it gets there, and then it should level off and stick with that level of purchases for a fixed period of time. Instead, we have a fixed $85B in purchases every month, and Bernanke is hinting that it might be time to stop doing that… both the idea that it’s fixed (not really adjusting to a target) and the unclear plan and Fed announcements are disturbing to MMers. Coppola though doubts even if this revised MM type QE strategy would even work w/o a coordinated fiscal stimulus to go with it.

  66. If you were correct about QE or high deficits or cash or M3 growing, then it wouldn’t be money printing.

    Inflation is not as low as the BLS would like us to believe.

  67. It doesn’t matter that assets stay the same, it’s still money printing, just like the Fed buying MBSs or Treasuries increases total money in the system.

  68. So it’s merely more unwanted and unnecessary lending and security
    issuance, aka, credit creation, not money printing.
    We should all be much more comfortable-when did excessive credit
    creation ever turn out to have a downside?

  69. If the governments’ trying to avoid it, it must be
    what’s in the best long term interests of the nation
    and the vast majority of citizens.
    Debt deflation is what we need. there’s too much of
    it and we need to shrink it-and hold responsible those who created it for the accompanying costs.

  70. “the Fed buys on the open market and has no need to sell the bonds back at any point.”

    False in the case of both Securities Lending and TOMOs. And on POMOs, the Fed did sell them from the SOMA in large quantities in 2008 and early 2009, and during other periods. POMOs are not permanent, ipso facto.

    “QE works primarily via non-banks.”

    Primary Dealers *are* banks.

  71. Cullen has his own measure… but it’s about the same order of magnitude as the CPI. I don’t know if it’s higher or lower currently. Plus there’s a broad swath of people, right and left, that think that inflation is very low. Krugman on the left, Bernanke, the Market Monetarists and traditional monetarists on the right, as well as some Austrians like Mish Shedlock and David Stockman. The Republican party thinks that CPI is too high of an estimate and wants to replace it with the lower Chained CPI (CCPI) which they think is more accurate and more realistic for adjusting social security benefits. Obama has made some indications that he’s willing to put that on the table (so I guess there’s some buy in from his admin too).

    The shadow stats guy (John Williams aka Walter J. Williams) says otherwise, but he’s gotten a lot of push back on that. Williams states the following on his shadowstats homepage:

    “…and my results led to front page stories in 1989 in the New York Times and Investors Daily (now Investors Business Daily), considerable coverage in the broadcast media and a joint meeting with representatives of all the government’s statistical agencies.”

    Just to check him out, I tried finding those “front page stories” in the archives for the NYT (which are freely available online), but I couldn’t find anything. Nor anything about these “joint meetings.” I used both names he gives: John and Walter J. as well as other variations. I didn’t check Investors Business Daily. All I found was an article by a SF bay area paper.

  72. QE produces liabilities on the Fed’s BS (and offsetting assets: the assets purchased). But if those reserves just sit there as assets on bank BSs (with new offsetting deposit liabilities, BTW), earning the banks a small IOR, then is this kind of credit creation really comparable to credit creation used to buy and speculate on houses? There’s only three places reserves can go:

    1. To an entity with a Fed deposit (banks, GSEs, foreign CBs, etc)
    2. Withdrawn as paper notes from non-bank bank accounts (at which point it stops being “reserves” but it’s still “outside money” and a liability of the Fed).
    3. Back to the Fed where it’s destroyed (i.e. the liability is erased from the Fed BS)

    They can’t go to individuals and non-bank private businesses, neither of which have Fed deposits.

  73. BTW, number 2 on my list just amounts to a matter of convenience: pre-existing bank deposits are exchanged for cash and back again. I don’t think there’s any evidence that QE has increased the amount of cash in circulation.

  74. MR should become #1, if for no other reason than your willingness to answer so as :, ***** “Believe nothing merely because you have been told it…But whatsoever, after due examination and analysis,you find to be kind, conducive to the good, the benefit,the welfare of all beings – that doctrine believe and cling to,and take it as your guide.”- Buddha
    May you reach a million subscriptions before years end.

  75. Quote” So we have to be careful about implying that a nation with a printing press cannot cause problems for itself by running that press (not that you did, but for other readers it’s important to point out). It very well could cause massive problems by diluting the quality of its output (malinvestment) or by spending in excess of productive capacity.”
    May I ask,” So who is there that is a safeguard for the control of the quality and quantity of the currency in the interest OF the People”?
    We have a central bank ‘owned and operated to benefit the Private For Profit Banks (PFPB). Banks created for the purpose of maximizing profits for their owners. Is this perhaps the “flaw” (as admitted by many that “the system is flawed”)?
    Why not Amend the Fed: Make the Federal Reserve Bank work FOR the People, to function as the controller of the quality and quantity of the currency while at the same time being the “good faith and credit” for the redemption of that currency-that is the exchangeable wealth of the nation?

  76. Do you not even realize that the term quantitaive easing by definition means to increase the monetary base, as is happening exponentially? See wikipedia since evidently you have no other education in economics, at least none that sunk in. You fail to mention when describing the exchange of reserves from the Fed to the bond seller those reserves are created out of nothing. Is your point that since the Fed creates money using a digital computer entry and not a printing press that this is an important economic distinction?

  77. 2 points;

    1 – It is customary to say that one “robs Peter to pay Paul”. If Paul is the taxpayer, you have it backwards.

    2 – “Paul gets a bond which the government created in much the same way that a private corporation creates a bond when they issue corporate debt.”

    That is assuming that when a private corporation issues debt, it backs that debt with property which it does not own, promising to seize that property by force at a later date.

    I suppose you are correct that, from the standpoint of the paper-and-ink supply, this isn’t “printing money”. But it certainly is creating dollars out of thin air, which expands the money supply.

  78. Cullen,
    In discussing QE and “printing money” I was challenged with data ( FRED) showing a dramatic increase in M1 2010 -which makes it appear that QE does contribute to the monetary supply? I understand that reserves aren’t part of M1 but is there a cause and effect?

  79. If Fed QE actions lower yields relative to what they would be without QE (or any open market operation) then the asset swap is NOT zero change in private sector financial net financial assets! At the point of transaction, it increases the private sector balance by the difference between PV_noQE and PV_QE. The Tsy market is about $500 B/day. In other words, it’s about as liquid a market as has ever existed. Every day, around 4% of the publicly held Tsy securities change hands. In a month of trading, an amount equal to the entire public outstanding holdings changes hands. Under current QE, on average every day the Fed buys and net holds about 0.45% of the daily trade. It’s hard to believe that people think the 99.55% of the other market participants every day have no impact on prices. So beyond the printing money fallacy, there is the Fed is setting the yields low and controlling the market fallacy.

    But there is temporarily an effect of “printing money” in the sense that people who choose to sell get a slight bit more money now than they would get if there was no QE. And, if the economy improves and rates move higher (as they have recently) then if the Fed sells the bond back into the market it takes a loss. Over this time frame, people could sell to the Fed and buy back later when the economy and rates improve and have both the bond and more money. I expect there is a lot of smart money that has done the first half of this. Of course you have to consider the whole TVM calculation at every point and decide if it’s net better to do.

    I think that if you work through it from first principles, temporary money creation can only occur through entities that are connected through the Fed clearing process. A real bank can create a loan without any reserve money. But other entities (shadow banks) can only do this indirectly. They have to have actual money to make a loan, which through a sequence of flows, must originate from a real bank. This can involve a complex web of collateralized transactions, but ultimately there is a bank with access to the Fed system.

    Also, if you work through it from first principles, it is evident that money creation a transient phenomena, or more accurately the integrated difference between the birth and death rates of credit creation (parameterized by interest rates). Recent data should make this evident to anyone willing to work through it. “excess credit creation” has to be countered at some point by inflation (which can be asset inflation), economic growth, or credit destruction. But that feedback can start and end at any point along the long, long curve where we live, far from fundamental equilibrium.

  80. Comment on your point 2: The US certainly has a lot property! National parks, BLM land, forests, coastal waters, military bases, military hardware, government buildings, rights over the electromagnetic spectrum, etc. There’s no shortage of real, tangible assets the US government actually owns outright.

    Also, Treasuries certainly have a certain “moneyness” but not to the extent that bank deposits, paper cash, or reserves do.

    Also, when a private bank corporation creates a loan, it’s creating money out of thin air (ex-nihilo) very much like the Fed does (note that the Fed is not the same as Treasury). There is a difference: When banks do this they need to maintain acceptable CAMELS scores (i.e. meet capital and other requirements and demonstrate acceptable risk and solvency, etc), whereas the Fed is not nearly as restricted (i.e. the Fed’s pocket is very nearly bottomless).

    One of Cullen’s points is that vast bulk of this ex-nihilo money creation is done by private sector banks rather than the government. In other words, since ALL our money is based on debt (including inside bank created money), the private sector has a lot bigger effect on expanding and contracting the money supply than the government does. At least I think that’s Cullen’s point! ;)

  81. There’s this:

    and this (from wikipedia):

    “M1: The total amount of M0 (cash/coin) outside of the private banking system plus the amount of demand deposits, travelers checks and other checkable deposits”

    I think Cullen has provided an explanation for why bank deposits grow with QE: because the Fed ends up buying most of its assets from private non-banks. I demonstrate how bank deposits (and thus bank balance sheets) can grow even though bank equity stays constant here:

    So non-banks exchange Tsy debt for deposits. Nobody’s equity changes: not the banks, the Fed, or the non-banks. However, bank balance sheets grow, and thus M1 grows. Banks get offsetting reserves (assets) and deposits (liabilities) growing their balance sheets.

  82. Fed reserves are indeed created out of nothing, just as bank deposits are. All our money is created out of nothing! It’s all a matter of exchanging IOUs: The bank creates an IOU for you (your deposit… which has the advantage that it’s infinitely transferable and accepted as payment everywhere) and you hand the bank an IOU (the loan papers or your credit card agreement). One of Cullen’s points is that this latter private bank “out of nothing” money creation is really the dominant one.

    But due to double entry accounting, all that money created out of nothing has equal and offsetting debts… even the government money. No debts = no money.

    That fact that anything is happening “exponentially” is not shocking: anything promising a moderate annual growth rate, such as inflation (2%) or return on stocks, etc, represents “exponential growth.”

    “Is your point that since the Fed creates money using a digital computer entry and not a printing press that this is an important economic distinction?”

    I doubt that’s his point! Let’s say that instead of electronic bank reserves the Fed used a special red paper money…. but only certain entities were allowed to use this red money: banks, Treasury, GSEs, etc, and only amongst themselves. We’d have exactly the same situation: that red money wouldn’t somehow “leak” out into the real economy…. it would remain a facilitator to clear payments, etc, which is what reserves are. The fact that there’s more reserves in the system doesn’t increase the chances of bank deposits being created through the lending process… that’s the old “money multiplier” concept associated with the gold-standard … back when the concept of “base money” had some significance.

  83. Do you even know the actual growth rate of the monetary base? Hint: its not 2%. What is the point of arguing that 2% is exponential when you know very well its more than 10x that? Or maybe you don’t know that, just look it up. You’re just like the original author, arguing semantics like printing vs digital, which no kidding who thinks most money is in printed form, instead of substance?

  84. Yes I skimmed through it. I know most folks round here jap and joke at ZH but I do think it’s good to have contrarian views on things. This part is what I took at the end:

    Financial intermediaries should provide sufficient disclosure to clients when collateral assets posted by them are rehypothecated; rehypothecation should be allowed only for the purpose of financing the long position of clients and not for financing the own-account activities of the intermediary; and only entities subject to adequate regulation of liquidity risk should be allowed to engage in the rehypothecation of client assets.
    Ironically, using rehypothecation for the purposes of financing the own-account activities of the intermediary, is precisely what happens every single day in every single, and certainly TBTF large (see JPM) bank.”

    We know that nothing has really changed and that the whole Frank Dodd deal was a joke nothing has really changed.

    So we must be fiscally ever vigilant keeping our ear pressed to the ground in hopes of understanding the thunder of the heard of pragmatic capitalist stampeding in a direction which they have not yet understood but yet we already knew. :)

  85. Thanks bart, so that looks like about $1.9T currently? I’m not sure what % is Tsy vs “agency” but assuming it’s all Tsy, then that gives 1.9/16 = 12%.

  86. But if a non-bank sells its Tsy debt on the open market, and the Fed is purchasing Tsy debt on the open market through a PD intermediary, the effect really is as if the Fed purchased it directly from the non-bank. I think that’s what he’s getting at (minus a commission probably… paid to the PD).

  87. I’m saying if that monetary base money has very limited ways to leak into the real economy, it might as well be printed in vast quantities, exponentially even, and sent to the moon! It doesn’t necessarily increase bank lending and thus bank deposits, which is the only money that individuals and non-bank businesses use!

    There’s only three places that reserves can go, and non-banks are not one of them:

    I think the historical significance of the phrase “monetary base” is how it related to an entirely different system of money based on a more or less fixed amount of gold. The idea was there that the fractional reserve ratio (r: typically around 10%) produced an upper bound on the amount of lending banks could in theory do: If they re-loaned out that gold (or claims on the gold) an infinite number of times, the the money multiplier said the upper bound on bank deposits (backed by gold) created from this “base money” is (base gold money) / r, so working from 10%, about 10x as much in deposits as gold. None of that applies any longer! Banks create deposits w/o regard to reserve requirements… those reserves are also created ex-nihilo and they can always be obtained to meet the requirement: if not, the Fed couldn’t achieve it’s FFR target and it couldn’t achieve a smooth payment clearing system (as it must!). The whole concept of fractional reserve banking, the money multiplier, and base money has gone out the window since we left the gold standard in 1971. Sure the definition still remains (of base money), but it’s lost its significance.

  88. I should also say that pretty much the only significance to there being excess reserves (ER) in the system (in ANY amount!) is that with ER > 0 the Fed must set the FFR through the IOR rate rather than through OMOs (it used OMOs prior to 2008).

  89. Tom, how would the Dog Leash analogy (Bond Vigilantes)work in regards to the ” ER > 0 the Fed must set the FFR through the IOR rate “?

  90. Cowpoke, I searched on this page for “Dog Leash” and “Vigilantes” on this page and didn’t see it. I know what bond vigilantes are (I think!) but I don’t know what they have to do with dog leashes! Please explain.

    But briefly, when ER > 0, then reserves are always available on the interbank market, which tends to drive the interest rate for them the IOR rate: a bank can keep its reserves and earn IOR or it can lend them out and earn IOR. If the Fed loans reserves for a higher rate, nobody would use the Fed, and the Fed’s rate would be meaningless. However when ER = 0, then the Fed can set a rate and back it up: if the rate starts to drift higher it performs OMSs, and if lower, if performes OMPs. I don’t know if that answers your question or not.

  91. Here’s a much better explanation:

    Which Cullen linked to here:

    “For the real wonks, Scott Fullwiler has the only post up on all of this that displays a total understanding of the concepts at hand, but I’m not sure he’s deep enough in the dream sequence….”

  92. I don’t know why no one has addressed this question, previously asked by others. If the Treasury issues debt to finance deficit spending and the Fed buys 80% of the issue, the Fed has created money (money printing). It is as if the Treasury issued the dollars directly, out of thin air, to pay it’s bills. That is much of what is happening. The Fed is monetizing the debt. The Fed is monetizing most all of the debt issued by the Treasury. If the Fed wasn’t doing this the government would have to actually borrow money.

  93. Tom, See Here:

    “Bond traders try to front-run Fed policy and economic expectations in an attempt to generate a profit. I describe this whole process like a person walking a dog through traffic. The Fed is the person walking the dog. The dog is the bond market. And the traffic is the economy.”

    So my question in regards again to what you said:

    “I should also say that pretty much the only significance to there being excess reserves (ER) in the system (in ANY amount!) is that with ER > 0 the Fed must set the FFR through the IOR rate rather than through OMOs (it used OMOs prior to 2008).”
    So, if the FED sets the tone, why is it that they “MUST” set the IOR through the IOR?
    Tom, why MUST they do it this way?

    See#3 here:
    3. Why is the payment of interest on reserve balances, and on excess balances in particular, especially important under current conditions?

    Recently the Desk has encountered difficulty achieving the operating target for the federal funds rate set by the FOMC, because the expansion of the Federal Reserve’s various liquidity facilities has caused a large increase in excess balances. The expansion of excess reserves in turn has placed extraordinary downward pressure on the overnight federal funds rate. Paying interest on excess reserves will better enable the Desk to achieve the target for the federal funds rate, even if further use of Federal Reserve liquidity facilities, such as the recently announced increases in the amounts being offered through the Term Auction Facility, results in higher levels of excess balances.”

    Thanks Tom for your patience with me.

  94. Heck Tom, I just type a whole bunch of stuff that failed to appear so I am going to bed. Not sure what the deal is. Thanks anyways for all you do.

  95. Here’s one you might want to look at yourself:

    … also, I don’t know of any serious economists that think we’re in danger of hyperinflation: NKers, MMers, traditional monetarists, M M Ters, post-Keynesians, and even some Austrians (Mish Shedlock, David Stockman, Chris Whalen). Robert Murphy lost a bet about that so he probably won’t be sticking his neck out again anytime soon. Even ZeroHedge has given up on hyperinflation on their “bear porn” site haven’t they? It’s pretty much just Peter Schiff … and maybe this Cate fellow, right?

    I’m not saying hyperinflation is impossible… that would be way too bold of a statement, but unlike the author, I don’t think it’s likely. How do you explain Japan in relation to this statement, for example:

    “Hyperinflation happens after government debt is over 80% of GNP and the deficit is over 40% of government spending.”

    They’re struggling to get to 2% inflation (even Abe-nomics biggest cheerleaders, like Scott Sumner, don’t think they can get their inflation that high with current policies: policies which seem extreme in many ways!).

    Plus, there’s no lack of demand for US government bonds.

    There’s a lot of US production to back our currency, and the government owes dollars, not foreign denominated currency, nor are the dollars we owe pegged to foreign currency. All of those situations existed in Weimar, Russia (1998), Zimbabwe, etc BEFORE the hyperinflation (unlike the author states).

    Here’s another post you should look at:

  96. Ah, you’re the “Cate fellow” … hahaha! … well, hopefully you’ll get a response from Cullen. Hyperinflation is one of his specialties… he can do a much better job sparing with you than I can on the subject!

  97. It might be stuck in the “spam filter”… it happens to me all the time. It’ll show up eventually after Cullen releases it.

  98. Possibly, However, I only included a link to the FEds:
    “3. Why is the payment of interest on reserve balances, and on excess balances in particular, especially important under current conditions?

    Recently the Desk has encountered difficulty achieving the operating target for the federal funds rate set by the FOMC, because the expansion of the Federal Reserve’s various liquidity facilities has caused a large increase in excess balances. The expansion of excess reserves in turn has placed extraordinary downward pressure on the overnight federal funds rate. Paying interest on excess reserves will better enable the Desk to achieve the target for the federal funds rate, even if further use of Federal Reserve liquidity facilities, such as the recently announced increases in the amounts being offered through the Term Auction Facility, results in higher levels of excess balances.”

    And had other commentary but to tired to recall.. Have a nice evening..

  99. There doesn’t have to be a difference.

    Rehypothecation has not been taken into account as part of the area of “money printing”, and it exists. Or perhaps you don’t think it does?

  100. YEP, that’s what it is. Crazy because it was a link to A FED publication. Not sure why a FED Publication gets the censor flag but it does. These spam filters are crazy.
    OH Well check back Manyana!! Peace.. :)

  101. No, I never saw the ZH article. Rehypothecation has been around for many years, and some are learning about it recently and haven’t yet taken it into account.

    Perhaps someone else is confused by it’s effects on “money printing”.

  102. Do you seriously think that if QE were to stop tomorrow the Treasury would have an unsuccessful bond auction? Also, it’s not like the Fed is purchasing Tsy debt directly. That may seem insignificant to you, but that says there is underlying demand for it in the private sector.

    Also, keep in mind that the Treasury still has to pay the principal back on Fed held debt, even if the Fed holds it till maturity. The Fed and Treasury are separate entities and keep separate balance sheets. If Treasury were allowed to overdraft the TGA, or it could sell directly to the Fed, or the Fed were to forgive the principal, then that would be much more like “monetizing the debt.”

  103. looks like MR C or someone released it all but now it’s kinda convoluted. Hope ya can make sense of it.. Nighty Nite.. :)

  104. Cowpoke, perhaps I’m a little dense tonight… but I’m not getting the bond vigilante connection… that paragraph you quoted actually ties in with my attempt to paraphrase Scott Fullwiler on this! Again, Scott does a much better job of explaining it that me…

    I’ll check out the link, but we are talking about just the FFR (the overnight rate), not the rest of the yield curve, right? It seems bond vigilantes… er, scavengers, mostly come into play on up the maturity length, not necessarily so much regarding the overnight rate. Yes, I know there’s a connection, but seriously, what can bond traders do about that? That’s the one rate the Fed has always absolutely controlled and continues to control (it could theoretically control other rates, but hasn’t chosen to do that yet… instead it “influences” them… leaving room on the leash for the dog to pull rates one way or the other).

  105. Rehypothecation is nothing new. It just involves securitized lending. You’re acting like it’s something new. It’s not. And QE doesn’t allow a bank to rehypothecate more than it could before QE so you seem very confused. Maybe stop reading Zero Hedge. Theyve gotten EVERYTHING wrong for 5 years straight now.

  106. bart, sorry, but does this:

    “There doesn’t have to be a difference.”

    apply to my previous question:

    “Can you explain why rehypothecation is more of an issue with excess reserves than the Treasuries they were swapped for?”

    If so, then I guess I don’t understand that answer. My question was in response to this:

    “And no one has directly addressed the rehypothecation issue on excess reserves. It happens.”

    So lets say there’s no QE, and instead of excess reserves the banks hold more Tsy debt. So no QE means no “money printing” right? So can the Tsy debt be rehypothecated or not? What’s the concern with rehypothecation with reserves rather than Tsy debt?

    … or are you talking about QE involving non-bank Tsy debt sellers which has the effect of actually GROWING bank balance sheets (rather than just exchanging one asset for another on them) with offsetting excess reserve-assets and deposit-liabilities? In that case there are more assets (and liabilities) on the bank BS. However, they still have to maintain acceptable CAMELS scores.

    Are you saying that they can get away with rehypothecating these extra assets on their BS while doing this, even though their equity position remains unchanged? Can you give of an example of how this works?

    I seriously want to know… I’ve seen this rehypothecation concern raised before… and I don’t know much about it. I remain skeptical because Joe in Accounting has dismissed it several times now, and that guy knows his stuff… he’s a bank auditor by profession and I’ve learned a tremendous amount from him. This stuff certainly isn’t MY profession, but I’ve never been steered wrong by Joe yet. So ideally I’d like to see you explain this to Joe!

  107. SS, I don’t know too much about the subject however I’m inclined to agree with you. My only doubt really is in regards to bank balance sheets which have grown as a result of QE (due to the Fed purchasing from non-bank sellers). Those swollen bank balance sheets do not mean banks have any more equity… and anything they do is still subject to regulations (capital adequacy and the rest of CAMELS), but is there any way in which just having a larger balance sheet itself somehow allows more rehypothecation to take place?

  108. Regarding your QE angle of zero asset change, the fed does use newly created money to buy an asset ( be it a gov’t bond or a MBS). The is not asset neutral. The bond does not disappear, but instead now belongs to the fed. Also the money in the public hands is now increased and will drive it to invest in something else presumably riskier than a gov’t bond. How is that not money printing?

    A bank deposit / loan does create money, as you suggest, but only if it is done in a productive manner. At the end of the loan, the bank has its money back plus a little more, the depositor still has his money plus [very] little more, and the borrower has his car (or whatever).

  109. In Cullen’s point 4), he writes:

    “The result is no change in private sector net financial assets.”

    I maybe would have phrased it slightly differently saying instead there’s no change in “net equity” by any party. But what I think he means here is “asset change net of any change in liabilities”… i.e. I think he means essentially no change in equity. Here’s my simplified balance sheet illustration of this:

    In this case bank assets clearly increased by the same amount that bank liabilities did, and both are due to QE with a non-bank seller. If the bank was the seller, no balance sheet expansion occurs in the private sector at all: just a pure asset swap. In both cases, however, the Fed BS grows.

    “The bond does not disappear, but instead now belongs to the fed.”

    True, but the Fed’s liabilities have increased an equal amount, thus there’s no change in Fed equity.

    “Also the money in the public hands is now increased…”

    but again, public equity is unchanged since public liabilities have also increased by the same amount.

    “…and will drive it to invest in something else presumably riskier than a gov’t bond.”

    That’s the idea!… how well it works is debatable, but there is some evidence this happens. Also, even if it does happen, it doesn’t necessarily do much to decrease unemployment, etc.

    “How is that not money printing?”

    There is definitely money creation going on here, but in equal measure to debt creation in all cases, so there’s no net new equity for particular entity. That’s the sense that there’s no “money printing.”

  110. More MR madness & delusion.

    I agree, banks don’t “print money”. Banks don’t create money, they create credit & debt at the same time. But creating credit & debt is not limited to banks, EVERY ONE can do it. Any one who has a basic knowledge of accounting is able to understand that.

  111. Ya, I am that “Cate Fellow”. :-)

    It is not production that backs the currency, it is how much taxes compared to how much spending. Japan and the US are spending far more than they are taxing. If you are spending much more then in MR/MMT terms all the bonds issued are new money and the government is stuck making lots of new money till they get their budget under control. Budgets often don’t get under control till after hyperinflation.

    Japan had limits on how much money could be made but now they are ignoring these limits.

    The only way you can say there is no lack of demand for Japanese or US bonds is by counting the central bank as part of the demand. They are buying most of them. The central bank buying most of the bonds seems to be a key part of going into hyperinflation.

    Even Mish, a deflationist, is expecting a “currency crisis” in Japan that sounds a lot like hyperinflation to me.

    I don’t think Japan will have long now before they get past their 2% target.

    Yes, I am familiar with Cullen’s work and he and I seem to have an interesting debate about once a year. I am not sure if we are due for another yet. I would love for him to go through my Hyperinflation FAQ and argue against anything he disagrees with. A number of the comments/questions I respond to in that FAQ come from him.

  112. All money is credit. It all comes from being created in equal measure with debt (BTW, one entity’s debt is another entity’s money in the fiat system). Only the credit you or I create isn’t accepted as payment by everyone. That’s the enormous difference! I can’t send your credit (IOU) to pay my electric bill or to pay my property taxes, or use it to buy my groceries. The bank’s IOUs work for all that. The difference: you don’t have a banking charter and so unlike the bank, your IOUs aren’t dollars. So you’re right: anyone can create money. The trick is getting other people to accept it.

    Even paper money is really just an IOU from the Fed: it’s maintained as a liability on the Fed’s balance sheet… a liability that’s erased (like IOUs always are) once it’s returned to its originator (the Fed).

    This isn’t a concept unique to MR, BTW:

    Neo-classicists like Nick Rowe accept it:

    “banks do create money out of thin air”

    Market Monetarists like David Glasner:

    “banks can destroy, as well as create, money”

    Austrians like Jeremy Hammond:

    …and Murray Rothbard (who doesn’t like it, but agrees that’s what happens):

    ““Fractional reserve banks…create money out of thing [sic, ‘thin’] air. Essentially they do it in the same way as counterfeiters.”

    Free banker Hayek inspired economists like George Selgin:

    The Federal Reserve Bank of Chicago, (from their Modern Money Mechanics):

    “The actual process of money creation takes place primarily in banks”

    … and of course post-Keynsians, M M Ters, and yes… MRist too.

    On the other side you have yourself… and John Tammy. Tamny somehow believes that fiat money is really only paper money, which he thinks of as a kind of irreducible physical object, which can only be an asset on anyone’s balance sheet (should they be lucky enough to have their “hands” on it at any one particular time):

    “About Rothbard’s assertion, underlying it is a fanciful belief that the alleged “money multiplier” is fact as opposed to fiction. It’s the latter. Indeed, wise minds should quickly understand that there’s no such thing as a money multiplier such that Bank A can take in $1,000,000 and lend out $900,000, Bank B can then lend out $810,000, then Bank C can lend out $729,000 such that $1 million in deposits miraculously turns into nearly $2.5 million.”

    “In truth, just as there are no sellers without buyers, there are no borrowers without savers; thus rendering the very notion of a money multiplier moot. $1 million doesn’t multiply into $10 million if it changes hands enough times; rather for someone to borrow someone else must be willing to cease using money in the near-term so that they can. That such an absurd bit of witchcraft has so long transfixed so many bright minds is one of life’s great mysteries”

    So while I (amazingly) agree with Tamny here that Rothbard is wrong about the money multiplier, I do so only because Tamny is so wrong that he happens to be right on that one score! If you read this bit carefully, he basically lays out Rothbard’s argument… and then asserts it’s wrong because “for someone to borrow someone else must be willing to cease using money in the near-term so that they can” which is completely preposterous! What he’s saying is money is (only) a physical object which is passed around and shared (hand to hand), and only one person can be using each dollar bill at a time! There’s no concept here of an electronic bank deposit. Using Tamny’s logic, if I put a dollar in my bank account (so now the bank has $1 in it) and then you borrow a dollar from the bank, then I’m out of luck! I have to wait until you put the dollar back before I can use it! Ha!

  113. Sure, but the bond is held in a balance sheet that has almost no impact at all on the real economy. The Fed does not buy goods and services from the private sector with its balance sheet. And its balance sheet only indirectly impacts the real govt balance sheet. So yes, the bonds don’t disappear, but they disappear from the pvt sector and having any real economic impact.

    For instance, you could say that the Fed has an infinite balance sheet since it is the reserve monopolist. Or, if you prefer, you could say their balance sheet is a void that is really rather meaningless (except from the income residual which goes to Tsy). Depends on how you want to view it. But its balance sheet is really rather meaningless as it pertains to everyday economic activity. Those bonds aren’t being used as collateral to shop at Wal-Mart after all…They’re just being held in a void where people rant and rave about them, but they have very little real impact on the economy….

  114. “When the government runs a budget deficit, then Paul buys a bond from the government and the government gives Paul’s bank deposit to Peter. Paul gets a bond…”

    5 milliseconds later – “When the Fed performs quantitative easing…which involves a clean asset swap.” Paul’s bond gets swapped out for deposits.

    So after 5 milliseconds, Paul nets out – he went from deposits – to a bond – back to deposits. The net effect is the Government swaps a bond for deposits with the FED (leaving out Paul, the intermediary). The Government gives these deposits to Peter.

    As long as the bond stays at the FED the private sector gains a financial asset: Peter’s deposit.

    From what (little) I understand, as long as the expectations are that these purchases will be reversed, i.e. not permanent (responsible), then inflation expectations will be anchored, and thus (in theory) no inflation.

    But in Japan, for example, if the expectations are that some of the purchases won’t be reversed, i.e. permanent (irresponsible), then inflation expectations can rise, and thus (in theory) inflation.

  115. A couple of observations on this. First, even before QE, the Fed has bought and sold Tsy debt. Likewise, the net Fed purchases during QE could be reversed by sales at some point. Secondly, even if Tsy debt is held by the Fed until maturity, Tsy still has to pay the principal to the Fed. I sketched out a simple example here of the Fed buying and holding Tsy debt to maturity, and then Tsy rolling over the debt, by selling more bonds to pay off the principal to the Fed, etc.:

    Look at the next to last set of balance sheets, preceded by the text:

    “Balance sheets after the first Treasury bond matures and Treasury repays the principal to the CB:”

    and compare them with this example at step 6 (the last set of BSs) where I illustrate Cullen’s point 3. above (i.e. deficit spending w/o QE):

    Do you see how similar they are? In other words in both cases, if we start from absolutely clear balance sheets, at a certain point in the process it’s as if Treasury had just issued debt directly to the non-bank public in exchange for services. No bank deposits or reserves exist at these points (these super simple examples are meant to illustrate, not to be realistic, BTW).

    One final point: in a simplified cashless world consisting only of the Tsy, the Fed, banks, and non-banks (i.e. ignoring GSEs, foreign central banks, foreign trade, etc) and w/o capital or reserve requirements then we could write the balance sheets like this:

    A: $D Fed deposit,
    L: $T T-bonds,
    NE: $(T-D)

    A: $F T-bonds,
    L: $F reserves,
    E: $0

    A: $L loans + $B T-bonds + $(F-D) reserves,
    L: $(L+B+F-D) deposits,
    E: $0

    A: $(L+B+F-D) deposits + $(T-B-F) T-bonds + $R other assets,
    L: $L loans,
    E: $(T-D+R)

    Where label “A:” means assets, “L:” means liabilities, “NE:” means negative equity, and “E:” means equity. “R” represents real assets such as cars, houses, etc owned by non-banks, and T > F+B (i.e. total Tsy debt is at least as much as Fed & bank held Tsy debt).

    What’s the point? To show how $D (the TGA balance) relates to other variables.

    It’s easy to add cash to the above. In fact, when you write:

    “isn’t it essentially putting money into the Treasury’s bank account that didn’t exist in the system?”

    You could go on to claim that

    non-bank held money (bank deposits & cash) = bank loans + Fed & bank held Tsy debt – TGA balance

    If the TGA is empty (all Tsy $ have been spent), then replace the last term with $0

    So, then all else being equal, as aggregate Fed & bank held Tsy debt, goes up, then non-bank money goes up. But in terms of non-bank financial equity (ignoring the real assets term, R), that’s always just

    non-bank equity = total Tsy debt (T) – the TGA balance (D)

    regardless of what Tsy debt anybody (Fed, banks or non-banks) holds. This shouldn’t be surprising since I’m ignoring foreign trade… and by assumption my “banks” sector always has equity = 0: thus it’s a simplified “sectoral balances” result: when Tsy runs a deficit, private sector financial equity goes up, and vice versa.

  116. Interesting thought… but if you think in terms of equity, QE (or reverse QE) contributed nothing. Only the deficit spending process did. Regarding “irresponsible” … I think the Japanese are TRYING to raise their inflation rate to 2% (and they may not do it!).

  117. Cullen As usual, an excellent post. I am not clear on one point. You say “Paul gets a bond which the government created in much the same way that a private corporation creates a bond when they issue corporate debt”. However, isn’t it true that ultimately the government bond is replaced at maturity by money created “ex-nihilo”. In contrast, the corporate bond must be “paid off” with “inside money”.
    Corporations can’t create net financial assets. So it perhaps was not your point, but don’t these transactions differ in this respect? Thanks much for any thoughts.

  118. “However, isn’t it true that ultimately the government bond is replaced at maturity by money created “ex-nihilo”.”

    Say for example, the government raised the bond payoff money through taxes. Then bank deposits would disappear from the tax payer and be used to pay the bond holder. Or the government could sell another bond, in which cases much the same thing happens, except an NFA is added to the private sector. Perhaps the confusing part is that technically the inside money gets converted to outside money (deposit disappears and bank raises then transfers reserves to Tsy) and then back again (Tsy pays bond holder by crediting his bank w/ outside money, and the bank credits bond holder’s deposit with inside money).

    “Corporations can’t create net financial assets”

    What about a commercial bank deposit? Or a corporate bond? Or stock? Or do you mean “net of any liabilities?” Nothing does that in our system*. There’s a liability created for every asset created somewhere.

    *except for coins, which are created by Treasury as assets.

  119. I think we’re jumping through all kinds of hoops to avoid the obvious — that Treasury bonds will eventually be replaced by the Fed’s powers of creating money. (Heck we’re seeing it with QE.)
    I thought that was one of the main thrusts of MR — to reassure us that a currency issuer can’t default. We are not going to ‘pay down’ the debt in the example you used of the taxpayer paying the bond holder. We can issue as many bonds as we wish (barring the inflation constraint) because the Fed can buy them.
    And your other example — adding new bonds to replace the maturing bonds — just punts the date of money creation down the road.

  120. “We are not going to ‘pay down’ the debt in the example you used of the taxpayer paying the bond holder.”

    I don’t agree. Say we start from all clear balance sheets. Now Paul take a loan, buys a bond, the gov spends the proceeds on Paul, and then taxes Paul 100% to pay off the bond. We’re left with

    1. No more gov debt (bond paid off)
    2. Paul has a deposit equal to his loan from the bank

    If Paul pays off his loan, we’re back to the beginning: all the balance sheets are again clear.

    It’s be similar to step 5. here:

    except that Tsy now taxes Person x $100k, and uses it to pay the principal on the bond held by Person y, and then Person y paid off Person x’s mortgage (unfortunately there’s the complication of a house and two people in my Example 8: say they got married), but if those steps were performed, we’d be back to step 1 (with just the house as an asset, but otherwise all balance sheets clear).

    There’s nothing inherent in the system that forces the Fed the replace Tsy debt held by the public with reserves. That may in fact happen, but there’s nothing structural to force it. That was my point.

  121. “And your other example — adding new bonds to replace the maturing bonds — just punts the date of money creation down the road.”

    Yes, w/o any taxation or revenue generation, THAT’S the case in which we’re not going to pay down the gov debt.

  122. The weird thing is that actually the “wealth” increases as a result of QE, because the amount of debt increases. Again, any one with basic knowledge of accounting can understand this.

  123. This is the weak point of MR — sometimes it gets slippy on what the outcome will be.
    If a Treasury is a corporate bond, then it must be paid off by taxpayers. But a Treasury can always be redeemed by the Fed, so let’s stop making that comparison.
    So, in theory, the Fed can pay off the bond using newly created money. In reality, we certainly know this will be the case.
    Your two examples are so far outside the realm of possiblity that it weakens the MR argument.
    1. If you issue a bond to Peter and pay Paul, do you really imagine we’re going to tax Paul to pay back Peter. You’re going to send Paul a Social Security check and then take it back?1
    2. You say that without taxation or revenue generation ‘that’s the case in which we’re not going to pay down the gov debt.’ AGain, obviously this is not going to happen.

  124. Cullen, I was surprised to see this today on Sumner’s site, especially after his article some months back entitled “Keep banks out of macro.”

    Ha! he’s actually addressing the “loans create deposits” idea… but in a classic Sumner strategy he says such questions are useless, and causality is hard to tell (though it may well be more one way than the other). My guess (it’s hard to tell because he’s so non-committal): he’s actually come around to that way of thinking, but refuses to acknowledge that it has any significance! ;)

    He warns his readers about asking bankers for an explanation!

    Well, now he can at least dip his toe in the water with some of his more prominent co-MMists who’ve acknowledged this long ago.

  125. Right, the deficit spending created the net financial asset. The difference, if I understand it correctly, is the difference between the bond being in the private sector vs being at the FED.

    1. Paul (private sector) doesn’t have the bond, so he’s forced to do something else with his money (buy riskier assets, for example).

    2. Interest on the bond gets rebated back to the Government.

    So, while the Government has the liability on its books, it doesn’t cost anything.

    If it’s temporary, i.e. sold back to Paul (private sector), net interest expense goes up and future tax increases may be necessary (tax Cullen to pay interest on Paul’s bond).

    If it’s permanent – it’s debt monetization. No need to worry about future tax increases to pay for it. Party – free money.

  126. My all Paul (no Peter) verbal example above was meant to have Paul fill in for all of the non-bank private sector, so of course it’s not realistic. It’s not so outlandish to imagine that we could be in a situation where the gov is actually generating more revenue from the non-bank private sector than it’s spending… and thus paying down the debt (late 90s for example, prior to any QE). Of course it wouldn’t happen all at once (taxing Paul 100%), but that was just meant to illustrate the mechanism.

    More broadly, I was trying to address CharlesD’s questions, and that there’s really not such a huge difference between money used to pay down corporate debt vs gov debt. Yes, it’s ALL created ex-nihilo ultimately. That’s how our system works… no way around that. But I think he was imagining that it HAD to be “freshly” created somehow… when in fact it could be done with recycled (through taxation or bond issuance) existing ex-nihilo inside money.

    As to your point 2.: I guess I should have left that as “I agree” because that’s what I was trying to do with you. ;)

    Again, as to the specifics of our situation right now, you may well be correct that the Fed will end up holding on to a lot of Tsy debt until maturity. I’m agnostic on that… just pointing out that there’s nothing inherent in the system that forces it…. and in fact we can look to the not so distant past for examples that prove that can happen.

  127. You and I are mostly in agreement here I think. Just a couple of quibbles: On you point 1., Paul COULD just leave his money as cash: maybe he thinks that’s the best way to preserve capital given the risk environment.

    “If it’s permanent – it’s debt monetization” … I agree it’s similar, but not quite there. I’d agree if the Fed actually purchased directly from Tsy… and coordinated w/ Tsy: Thus Tsy would be free to fall into further and further debt (to the subordinate Fed) because it knows the Fed will buy no matter what. As it stands, though the interest is free (as you point out), but the fact that it has to pay back the principal, and it MUST turn to the private sector for the funds, means (even though the Fed MAY step in to purchase that debt later — and perhaps sell it again later: who knows!) it’s not outright “monetization” in my book. But that’s just my opinion. I see what you are saying though.

  128. It’s still a pointless difference between rehypothecation of Treasuries or excess reserves, and you have not addressed the overall issue but have rather obfuscated it.

    If you don’t believe that rehypothecation of excess reserves or Treasuries doesn’t affect money supply or money printing or bank leverage or even the derivative picture, then there’s nothing I can say.

    Perhaps you may even believe that rehypothecation chains are not a danger to the monetary or banking system, and don’t matter?

  129. I’m not saying either way! I was hoping you’d give me a very concrete SIMPLE (as possible) balance sheet type example of “rehypothecation chains” of “excess reserves or Treasuries” becoming a “danger to the monetary or banking system” or affecting the “derivative picture.”

    That all sounds very abstract to me.

  130. All you have to do SS is to look at my post above the one you responded that very definitely notes that rehypothecation is not new. That’s a fail.

    And the ZH comment seems to be nothing other than an attack that proves you have little clue what I’m talking about, or what the rehypothecation and their chains of excess reserves (which MR asserts doesn’t mean much in the inflation area) has to do with a stable monetary system and balance sheet stability, etc.

    Almost every time someone attacks, the assertion is made about some ZH view that I supposedly have gotten there. MR aficionados are apparently quite scared and worried about what facts get posted on ZH, whether I hold that view or not. Please try and stick to the facts about rehypothecation and the related chains.

  131. Ok then, you’re apparently not concerned about multiple parties using the exact same collateral to back some other financial instrument. Please look up Ponzi again and reflect on its dangers across the balance sheets of multiple banks or other financial institutions.

    It happens with excess reserves like it does with Treasuries, which makes excess reserves much more of an issue than MR asserts or holds.

  132. How does asking for a concrete, simple yet detailed example mean I’m “not concerned?”

    If it happens with “excess reserves like it does with Treasuries,” what do you propose? Eliminating both? It sounds like QE doesn’t matter too much in this regard then, since it swaps one for the other and both are an equal danger. True or not?

  133. Actually nobody’s equity changes with QE, although balance sheets *might* grow: with equal measures of assets and liabilities.

  134. Hehe. Looks like Sumner’s been stung.

    He doesn’t seem to understand the different roles played by capital requirements and reserve requirements. And nowhere is there any mention of the risk vs reward dynamic that is actually the principal driver of bank lending decisions. But then I was a banker, so what do I know?

  135. According to Sumner we’re not supposed to talk to people like you! (bankers!) … so please go away before you corrupt our thoughts! hahaha!

  136. As I noted above as an answer, reread about Ponzi and apply it to rehypothecation. All I see from your answers is a failure to look and take into account the very real dangers of rehypothecation and the chains.
    If you don’t or can’t see how Ponzi can affect balance sheets, all the examples in the world won’t help.

    All I’ve been talking about is that MR (and MMT for all I know) severely undervalue or even ignore that rehypothecation issues affect excess reserves and inflation, and that it’s not wise to underestimate their dangers or effects on money printing and actual inflation via QE.

    All I’ve seen is efforts to avoid those points, as in the super odd question about eliminating both excess reserves and Treasuries.

  137. I’ve never avoided the topic of rehypothecation. I am extremely aware that it exists and I understand shadow banking perfectly well. It was a central component of the crisis. I have no idea why anyone would think I don’t emphasize its importance. I emphasize banking quite a bit and this all falls under the umbrella of modern banking. No need to use scary terms or recreate the wheel to make banking sound more complex than it really is. Capital problems have long been a problem with banking and when we discuss that issue the concepts you discuss simply fall under that broader umbrella….Just because I don’t scream about it on the internet doesn’t mean I ignore it.

  138. Cullen, can you explain “the very real dangers of rehypothecation and the chains” bart is referring to, and what that has to do with “Ponzi?”

  139. Rehypothecation is just using collateral multiple times. It’s basically a form of leverage. The whole banking system is one big leveraged entity. There’s nothing new here except that the leverage has evolved over time to include more sophistication. Of course it’s dangerous if it’s abused, but that could be said about lots of things. I posted a bunch of papers on shadow banking the other day that touch on the risks of rehypothecation. It’s worth perusing to better understand.

  140. Cullen, I’ve personally never seen you write about or mention rehypothecation. Perhaps there’s a link available where it is mentioned and covered?

    I still believe that rehypothecation and the related chains are underestimated and undervalued (in virtually all the main economic schools) as both an inflation source and a danger to the banking & monetary system.

    Using the same collateral to back multiple other financial instruments or products is just plain fraudulent to me, and can be compared to the “tactics” used by Lehman or Bear. I have no desire to scream about it nor to scare people, but also think it’s unwise to not mention it in the context of QE money printing.

  141. Thanks Tom and others for your comments. What I meant to say was that I think a Treasury bond COULD be paid with money created “ex-nihilo”, unlike a corporate bond. As you point out, when a T-bond matures, our current accounting pays it with tax money or additional borrowing.
    But,as said, it COULD be paid for with money created “ex-nihilo”, as his happening with “QE”.

  142. Cullen, thanks. Does QE add any extra dangers to rehypothecation? … for example, does the fact that QE can expand bank balance sheets due to bond purchases from non-banks magnify the potential for the abuse of rehypothecation?

  143. I see… but bank deposits are created ex-nihilo (inside money), and that’s really the only money it can get paid with “directly” (which is kind of a strange concept, since ultimately it’s actually gets paid “indirectly” through the bank with outside money as I described above).

    What I’m saying is there’s *perhaps* even less of a straight line between the Fed creating money ex-nihilo money and paying down the principal of a maturing bond, regardless of where it’s held.

    Check the balance sheets part of this comment:

    It’s kind of a long rambling msg on my part… I fell asleep writing it and didn’t actually post it till the morning! Ha!

    But it *might* help to answer you question somewhat. Keep in mind I’m not trying to track the history of every dollar, but this equation is an OK approximation for this purpose:

    non-bank held money (bank deposits & cash) = bank loans + Fed & bank held Tsy debt – TGA balance

    So in other words, this gives you a rough breakdown on the “components” of private non-sector bank “money” available to be taxed or borrowed from (through Tsy auction) with which to pay off the principal of any maturing Tsy debt, including those held at the Fed until maturity. To make it simpler, just assume that the TGA balance (Tsy’s Fed balance of outside money) is zero. So that gives you a breakdown of private money in terms of corresponding pools of debt. However, I’m not claiming that this money is somehow “backed by” these categories of debt. Still, perhaps you could say something to the effect that the following fraction of private non-bank money used to pay (anything) resulted from (in some sense) the Fed’s Tsy debt purchases (i.e. Fed ex-nihilo money creation):

    (Fed held Tsy debt) / (bank loans + Fed & bank held Tsy debt)

    So, if this ration turns out to be 0.3, for example (It’ll always be between 0 and 1), can you say that 30% of dollars used to pay the principal on maturing Tsy bonds (on average) came form ex-nihilo Fed money? I’m not sure, but maybe!

  144. Tom, notice this part: “On-balance sheet data do not “churn,” where churning means the re-use of an asset. If an
    item is listed as an asset or liability at one bank, then it cannot be listed as an asset or liability
    of another bank by definition; this is not true for pledged collateral. Since on-balance sheet
    items are the snapshot of a firm’s assets and liabilities on a given day, these cannot be the
    assets or liabilities of another firm on that day. However, off-balance sheet item(s) like
    ‘pledged-collateral that is permitted to be re-used’, are shown in footnotes simultaneously by
    several entities, i.e., the pledged collateral is not owned by these firms, but due to
    rehypothecation rights, these firms are legally allowed to use the collateral in their own

    So this is probably why Rehypothecation will not fit in your ” concrete SIMPLE (as possible) balance sheet type example of “rehypothecation chains” ”
    Because these things appear (to me anyhow) happen OFF Balance Sheet.

  145. Great, thanks! But perhaps there’s another way to make a simple example? I’m kind of fuzzy on how items get “off balance sheet” in the 1st place. I guess I need to do some more homework here.

  146. well that’s the whole kicker of it all. Repo, Off balance Sheet, Rehypoth, etc.. I think individuals should have the same abilities as corps do with this stuff.
    For example, look at:

    I Would LOVE to go around my house and take inventory, garden Hose, Lawn Mower, Bird Feeder, etc and bundle them into a “House Hold Security” and then pledge that at my local bank as collateral for x dollar amount loan at a deeply discounted interest rate compared to apwn shop.

  147. Regarding the phrase “money printing”: my take is it’s a way to shut down a conversation by trying to cause a negative gut reaction in those that hear it. This is done all the time, regardless of justification. Here are some other favorite phrases used like this: “central planning,” “central planners,” “collectivists,” “class warfare,” “legalized counterfeiting” (for fractional reserve banking), “helicopter money,” “government bureaucrats,” “government ,” “redistribution of wealth” (or just “redistribution”), “Keynesian” (for anything involving any kind of stimulus or deficit spending), “taking property by force” or “by gunpoint” or “legalized theft” (for taxation), “socialism” (used for anything involving gov spending), “government regulations,” “red tape,” “nanny state,” “statist,” “social engineering,” “pork barrel,” “waste fraud and abuse,” etc. Those are some favorites on the libertarian or right wing side of things anyway. The left wing has some favorites as well: “rentiers,” “rent taking,” “financial capitalism” (as opposed to “industrial capitalism” which is more noble), “the 1%,” vs “the 99%,” “banksters,” “neo-liberal” (believe it or not, that’s become a bad word in some quarters.. along with “privatization”), “plutocrats,” “oligarchs,” “too big to fail/jail” etc. “Corporate welfare” is used by both sides, and more frequently “crony capitalism.” These are more or less center left and center right gut-reaction phrases, but of course there’s even scarier ones on the extremes: “bourgeois,” “counter-revolutionary,” “class struggle,” “imperialist,” “oppressor,” “lackey,” “capitalist” (for anything even slightly right of radical left), “Zionist,” “bolshevik,” “Marxist” (for anything slightly left of the extreme right), “fascist” (for either slightly right or left of the favored extreme position). And then of course a few social ones too “Bible thumper,” “fundamentalist,” “reactionary,” “sharia law,” “wingnut,” “teabagger,” “illegal immigrant” (or just “illegal”), “secularist,” “welfare queen,” “food stamps,” “racist” (for even the slightest deviation from PC… both sides use it too), “community organizer,” “elitist,” “redneck,” “gun nut,” “media elite,” etc. Then there’s a couple of ones used w/in a group: “RINO” and “firebagger.” You ever hear of “firebagger?”… it’s for fans of “fire dog lake” which is considered a little too left purist for others on the left. That was a new one to me.

    Now some of those phrases can be perfectly legitimate and useful even, but when over used or used indiscriminately or obviously used to produce that gut level reaction, I always find it off putting…. except of course when I’m doing it… then it’s totally justified ;)

  148. EXACTLY, And So SO AS IT with the DEMOCRATS in Power. Look how they are strong arming all they can. hell Money, Finance politics… It’s ALL THE SAME METRIC when Human are involved.. :)

  149. I tried to parcel out blame in equal measures, you think I was too hard on the right?… or are you just demonstrating some of my logic in the final line? :)

  150. Yes & No. The FED buys MBS paper from banks. At the bank nothing changes. There e.g. MBS (credit to mortgagees) is changed for more deposits (credit to the FED) at the FED. At the bank the balance sheet doesn’t grow.

    But at the FED something different happens. But at the debit & credit side the amount of assets grow. And that an increase of “wealth”.

  151. Sorry, no one on this page has succeeded in explaining this in a way that a six-year old could understand. And sadly, that’s why rants about money printing will continue. But please keep trying. It’s a worthy goal.

  152. You did fine, Funny, just before you typed that I was having a conversation with a family member about stock values returning to a mean after extremes and comparing that to other events of human endeavors.
    Seems like most things we do go from one extreme to the other or sort of a regression toward the mean.

  153. Cirrus, it’s because there needs to be a chart for visual and then about a 6 to 10 word statement regardless if it’s factual. Then people will retain it.
    Case in point, I just heard this morning on ABC news business about how the FED is Jucing the DOW and they put up a chart just like this article on FOX News:

    So people need a visual and a one line statement I think, to make it adult proof. :)

  154. “4) When the Fed performs quantitative easing they perform open market operations (just like they have for decades) which involve a clean asset swap where the bank essentially exchanges reserves for t-bonds. The private sector loses a financial asset (the t-bond) and gains another (the reserves or deposits). The result is no change in private sector net financial assets. QE is a lot like changing your savings account into a checking account and then claiming you have more “money”. No, the composition of your savings changed, but you don’t have more savings.”

    It can be money printing eventually because the depositor can then request his cash and the bank will ask for more money printed. So you are playing with words here and that is not a good sign. QE is not direct money printing but a lot of money may be printed because of QE that would not have been printed should QE had not taken place. In other words, QE is an indirect means of facilitating money printing by replacing toxic assets with clean deposits.

    Get it or you need more explanations?

  155. Cullen, this is hard stuff for the layman to understand. I am one.

    Suppose I’m XYZ bank. I buy $10 billion of T bills which give me a small return which I keep in my reserves. The gov spends my $10 bn. Is it fair to say that the principal of the T bills is an inert financial asset whose value I cannot use to chase a return?

    Now, the Fed gives me $10 bn cash for my T bills. Where was that cash before the Fed gave it to me? It is my understanding that the Fed simply increases its balance sheet – in other words, they give me money that had not been previously loose in the economy being spent or chasing a return.

    So now, isn’t there the banks original $10 bn being spent by the gov, $10 bn in reserves that can now be used to buy more T bills or other qualifying assets (that couldn’t be purchased without QE), and the Fed holding a $10 bn claim against future revenues of the US gov?

    So if it’s not money printing, are we at least increasing the number of assets in the economy that chase return?

  156. “A 6 year old could understand it”?????

    Let this economic ignoramous give it a try:

    1. A bond is a fancy name for a loan (you have to pay the money back with interest).
    2. “Loans created deposits, and deposits are…the most dominant form of money…”
    3. This would mean the the U.S. is creating huge deposits with the selling of it’s bonds.
    4. How does the government intend on repaying these deposits/money?
    a. future income (taxes)
    b. the implied default of printing money

    Therefore, while the U.S. may not be printing money, it is guaranteeing it will do so if necessary.

    Cullen: What is the difference between printing money, and guaranteeing that you will do so as a last resort?

  157. It’s not ‘money printing’ but ‘net financial asset printing’, in the form of T-bonds, which have a scale of money-ness at something close to 100 percent.
    I’ve never understood the insistence in here that we’re not money printing.
    On one hand, MR has shown that we can print these net financial assets at the current rate without danger of inflation or default but then it won’t admit this is what we’re doing.
    If you say that a bond must be paid back by the taxpayer, you get hooted off the board, but in this debate the bonds are being described as similar to corporate bonds, in which they will be paid back by the taxpayers. Which is nonsense, because they are already being redeemed by the Fed in QE operations from electronically created money.
    I can’t quite figure out why the deception. What’s the long-term goal here? Promote the buildup of federal debt until the only way to finance spending is by directly issueing money?

  158. Tom, I’m Irish so be kind. I get the “no new FAs” in the system. but what is the fed “swapping”? they buy UST but with what? so USG debt has grown from $9T in late 07 to $16.4T end of Q1. I get the Fed “had to” step in(how and where is subject to debate) but at some point the economy has to start generating greater tax receipts right? And at a pace that can service the debt at higher rates, right? It seems these discussions get caught up in the trees without looking at the forest.

  159. Tom thanks that was very helpful in explaining where the money comes from to pay off the bonds. Which is very helpful in explaining the world as it is (reality). I was just saying that my understanding is that the Fed could, for example, hypothetically buy all of the T-bonds with “ex-nihilo” money and then “retire the debt” by writing all the bonds down to zero and putting a large debit in their capital account. This sounds bad but it would just be accounting and have no real world effect. And, as we know, the composition of private sector financial assets would change but not the amount. And the debt is gone! While I realize this is really a bit off topic, it is important to me in discussing with others because I believe it is one way of demonstrating that the “debt” is not a burden on the future – since it could be hypothetically be retired with no consequences for the economy. Understanding that this is true is important for discussing the “debt” with others so any disagreement welcome (I don’t want to be spreading false information). I’m not dogmatic about anything. I’m trying to understand. As we know, “dogmatic” thinking is part of the national problem. Thanks.

  160. Off topic perhaps but it has occurred to me that most “traditional” voices are worried about the Treasuries piling up on the asset side of the Fed’s balance sheet. Many of the same people are, of course, worried about the piling up of Treasury securities on the liability side of the Treasury’s balance sheet (the “National Debt”). For that portion of the Treasury debt which the Fed has purchased, haven’t both “worries” disappeared? That is, on a consolidated “government” basis, the Fed’s assets equal the Treasury’s liabilities and they would net to zero (for the portion of the debt owned
    by the Fed). Am I missing something? Thanks.

  161. I “believe” that Cullen has explained this to me: (1) Uncle Sam’s Deficit Spending increases net financial assets, (2) the Fed is a downstream process marketing the Treasury Bonds/Bills and Mortgage Backed Securities that have already been created, and (3) thus the Fed does not “create” or “print money”. What MR says is that the Bonds held by the Fed and others will be “paid off” or “rolled over”, because (I believe), that has been Monetary Reality so far. My understanding is that MR does not predict things that might happen in the future. MR explains how things work today. So… (my point): What will the Fed do with all those bonds (bought under QE), down the road is unknown therefore beyond the scope of MR, and thus in vacuum of speculation — which we are free to engage in until our air has been sucked out.

  162. As I understand it, when the Fed buys back a bond the bond no longer exists. So there is no “down the road”.

  163. Midas2, Thanks, Those bonds are effectively retired from the stock of assets circulating in the financial system (true, although perhaps only temporarily), but they have not expired. The Treasury pays interest, and the Fed sends some back minus expenses according to their published accounting. But the Bonds have not gone to maturity yet. That remains “down the road”. I think we are still in that vacuum of speculation.

  164. Bank loans create deposits… not ALL loans! If I loan you my car, or $10, that doesn’t create a deposit. In our system, only commercial banks and the Fed can create deposits ex-nihilo through the act of lending. The Fed creates outside money and the commercial banks inside money deposits. The Fed can go one further and create deposits through the act of buying stuff (as in QE). So Treasury doesn’t create net deposits when it sells bonds, nor do corporations. Treasury doesn’t have the ex-nihilo deposit creation ability.

    Check out a few of the examples here:

    Examples 8, 4, & 1.1 are a good place to start.

  165. Actually, the bond still exists, and the Treasury must pay the Fed the principal back (interest payments are remitted back to the Treasury). Plus the Fed could sell the bond later before it matures.

  166. I see… not sure if any laws would need to be changed to just “retire” debt like that. But I see what you’re getting at. The trillion dollar coin idea is a little different but perhaps has the advantage of actually being currently legal. Another idea is that we could allow (again a law change) the Tsy to overdraft the TGA. Or if the Fed & Tsy coordinated and the Tsy bought Tsy debt directly from the Fed… essentially making the Fed a desk in Tsy. Then retiring the debt would not even be necessary, but easier if we wanted to do that.

    You’re describing the M M T idea of state money. Cullen has written about that saying maybe it’s an OK concept, but emphasizing it’s not what we have.

  167. Thanks Tom Yes as I understand it, the law requires the debt to equal the cumulative deficit. It is a relic of gold standard days. I am not recommending to retire the debt. As Cullen has pointed out, it serves many useful putposes. It was just a way, with a hypothetical, to demonstrate that the “National Debt” is really just a private savings account and could hypothetically be converted to “cash” without changing the amount of financial assets in the system. And yes, this is a hypothetical not what actually is happening, which makes MR preferable to MMT in that sense.

  168. This is not a very realistic example (my link below): I’m making all kinds of simplifying assumptions, but I’m following through to the logical conclusion of what happens when the Fed buys Tsy debt and holds it until maturity, an then more Tsy debt is issued to pay the principal back to the Fed, and then more Tsy debt is issued to continue deficit spending, etc… I tried to conclude at a place which is similar to the start: The overall effect is not really different than just continued deficit spending. In my examples I like to start off with all zero or nearly zero balance sheets for everyone… and given that huge oversimplification, the effect of continued gov deficit spending, whether the Fed buys and hold the Treasury’s to maturity or not, is that the Treasury essentially issues more and more debt instruments and the public acquires more and more. So private sector equity goes up by the same amount that Treasury goes down… and you can always return to a place where there are no deposits present anywhere. So that’s how I like to see it: Fed holding to maturity or not, you can always stop and “sample” the process at a place where the private sector holds an ever growing pile of Tsy debt, and the Tsy likewise has an ever growing Tsy debt liability:

    Hope that helps! Also, you might check out my Example 8 too.

  169. Tom, I agree that you have described MR. “the Treasury must pay the Fed the principal back (interest payments are remitted back to the Treasury)” You’re describing how things have been going. But the situation we have now is unprecedented. You must agree that our ultimate central bank has done something that was only discussed in the 1930s. The Fed has built up a balance sheet that is unlike anything the world’s economy has seen before. I’m speculating that at maturity these bonds are written off. Do you think “Treasury must …” is controlled by a law or something? I’m just asking, I have no clue.

  170. I think MR should clarify ist position as follows (just an example):

    QE is outside money printing of reserves (not banknotes, though reserves can be converted in bank notes).

    QE can be done with a) banks, b) private non-bank sector

    In case a) the reserves may never enter the money supply, as the latter depends in this case on banks lending. The only way reserves can enter the Money supply is through bank notes withdrawn by depositors on queues in front of banks / ATMs.

    In case b) the banks will swap the reserves with inside money, so QE directly enters the money supply. But QE has traditionally been a minor source of money supply, as the latter has consisted mostly of inside money. This historic relationship could change though (is changing right now). Although inflation danger is currently low, as QE offsets private sector deleveraging mostly, if the speed of QE accelerates, it could become inflationary. QE has also psychological and redistributory indirect (negative) effects. Etc.

  171. I’m sure somebody is going to speculate that such a “write off” will cause massive inflation. But most on this board know better. Inflation is caused by a different factor: Borrowed money chasing overbought assets. Way too much credit sold and “printed” by under regulated banks and non-bank institution.

    I speculate that the world’s central banks working in sic can write off the bonds they have amassed from their various sovereigns and NOTHING will happen. Making these “write offs” too fast or too slow will be seen in currency markets and nowhere else.

    Please understand that I am speculating in a vacuum.

  172. I rule now is that The Treasury cannot overdraft its TGA (Fed deposit) … since the early 1980s or late 70s I think, and that it must turn to the private sector for funding (purchasing its Treasury’s at auction). Of course these rules could be changed. And I think you are right, if they were, then that wouldn’t necessarily cause inflation.

    But if the rules were not changed, I don’t think it’s necessarily impossible to pay down the debt either. We did after WWII at the debt/GDP ratio was even higher then. There was some coordination, in that I think the Fed capped interest payments on bonds… something like that. Of course after WWII the US was in a unique position in the world, with lots of undamaged cities and industrial capacity, whereas Germany, Japan, Europe in general were not doing as well and weren’t in as strong a position.

  173. InvestorX, I’ve tried to illustrate your case b) here:

    Maybe we’re on the same page, but I can’t quite tell. As you can see, in case b) the reserves grow the bank balance sheet, but not the non-bank balance sheet: the reason is because the reserves cannot go directly from the Fed to the non-bank. Thus the Fed gives the bank reserves and the bank in turn increases the non-bank’s deposit.

    In your case a), only the Fed’s balance sheet grows, as it’s a direct exchange of assets for the bank (thus the banks’ BS doesn’t change size).

    Regarding whether its inflationary or not, I’ve seen it argued both ways and I’m agnostic to that at this point. Certainly I think if the Fed were purchasing the basket of goods in the CPI it couldn’t avoid being inflationary, but it’s not doing that. Does it inflate financial asset prices though? Seems very plausible.

  174. You are correct. However, I think that MR finds it less useful to consolidate the Treas and Fed balance sheets though… but that is a common assumption with M M T. The Fed is treated as an independent entity in MR, and there’s some good justification for that. However, it’s also clear that it’s not completely independent.

  175. So if a government bond isn’t going to be issued in money, what’s it going to be issued in – promises?
    (Remember that gauranteed repayment?)
    And while you’re explaining this, remember that you’re speaking to a 6-year old.

  176. We separate the Fed and Tsy because that’s how the current legal structure deems it be. MMTers like to say that money is a creature of law and the laws in the USA very clearly created the Fed as an independent entity. A key aspect of the Fed’s independence is its role as a firewall between banking and govt as the creators of money. The Executive Branch in the USA (and Tsy by extension) DOES NOT have a monopoly over money. Consolidating the Fed into the Tsy mangles that relationship and is often used by MMTers to imply that banks are simply agents of the govt and essentially part of the govt. They act as though we have a nationalized money system when it’s anything but.

    For accuracy in descriptive understanding it is absolutely imperative that one not distort the powers of the executive branch as they are currently designed by law. MMT’s description is largely void of value due to this important misrepresentation of the institutional structures in place. All MR does is accurately describe the actual institutional structures.

  177. OK, but first, just to clarify, say we start with Tsy, Fed, bank, Person x, Person y, and everybody’s balance sheet is clear:

    Fed, Tsy, bank, x, y balance sheets:
    Assets: $0
    Liabilities: $0
    Equity: $0

    Now say the non-bank takes a loan from the bank:
    Bank BS:
    Assets: loan to x for $100
    Liabilities: $100 deposit for x

    Person x:
    Assets: $100 deposit
    Liabilities: $100 borrowing from bank

    So at this point the bank has created $100 of deposits in inside money ex-nihilo for person x. Now lets say person x loans that $100 to person y by writing her a check, which she deposits:

    Assets: $100 loan to x
    Liabilities: $100 deposit for y

    Person x:
    Assets: $100 IOU from y
    Liabilities: $100 borrowing from bank

    Person y:
    Assets: $100 deposit
    Liabilities: $100 IOU to x

    So do you see the difference between the bank loan and Person x’s loan? No deposit was created with person x’s loan: it just changed hands from x to y. Other than the banks, only the Fed creates dollar denominated deposits like that. Sure an IOU can be in dollars, but it’s not equivalent to dollars. The banks’ and the Fed’s IOUs are essentially the same as dollars, and they are created in much the same way you’d write an IOU to a friend: from thin air. If you view all these balance sheet manipulations as exchanges of IOUs between the various parties… the deposits (Fed or bank) are special… they are actually completely equivalent to dollars.

    Now a Tsy bond issued by Tsy is NOT a dollar denominated deposit, but it is a safe asset (in that it won’t be defaulted on)… however its value can go up and down with changing interest rates. The holder must wait to collect the principal back, or risk selling in the near term for a loss. The interest compensates for this risk.

    Practically speaking, you can say a Tsy bond is close to money because it is so safe and can always be sold, but it’s not as much like money as deposits (which are money). So in our example, lets say person y buys a Tsy bond through Tsy direct:

    Assets: $100 Fed deposit
    Liabilities: $100 bond issued

    Assets: $100 reserve loan to bank
    Liabilities: $100 reserve deposit for bank

    Assets: $100 loan to x
    Liabilities: $100 reserve loan from Fed

    Person x:
    Assets: $100 IOU from y
    Liabilities: $100 loan from bank

    Person y:
    Assets: $100 Tsy bond
    Liabilities: $100 IOU to x

    The bank (bank for both x and y) had to be an intermediary because inside money does not go directly into the outside money deposit of the Tsy. The bank can create inside money (bank deposits) but it cannot create outside money (Fed deposits). What happens when y’s inside money goes to by the Tsy bond is that the bank borrows outside money from the Fed, which in turn creates it ex-nihilo, and then sends that to Tsy on y’s behalf to pay for the Tsy bond. In return, the bank is allowed to then erase y’s inside money deposit. So essentially, the inside money got transformed into outside money in this process. The opposite happens when Tsy spends the money.

    So those are all the relationships… all those items on the balance sheets represent “promises” of varying risk levels: either promises given or promises accepted, with the IOU from Person y probably being the most risky to accept. Does that help?

    The following example is similar and follows the process through a few more steps, including spending of the deposit by the Treasury and some of the loan re-payments:

    So again, the only entities in the above example creating dollars are the bank (inside money) and the Fed (outside money). Everyone else is stuck with creating something else: Tsy bond, IOU, etc.

  178. Cash, however, is just a convenience for us private non-bank entities: First of all, in almost ALL circumstances it originated from a bank deposit (inside money… think ATM withdrawal). Sure you may have been paid by your friend in cash, by he got it from an ATM, or the person he did got it from one.. or from the cashier at the bank, etc. Trace it back far enough, it came from a bank deposit. And when that cash goes back to the bank… the same thing happens in reverse: it goes right back to being a bank deposit. So cash is just a temporarily suspended bank deposit… transformed into paper until it goes back to a commercial bank. That’s it! Nothing mystical about cash.

    The Fed will sell cash to banks when they need more of it for the convenience of their customers. What do banks pay for it with? With electronic reserves. While the cash sits in the banks’ vaults it’s just another form of reserves. Exactly equivalent. When the bank has too much cash on hand and wants to exchange it for electronic reserves, it can sell it back to the Fed anytime.

    We could eliminate physical paper cash and metal coins ANYTIME and not significantly affect QE. What you’re saying gives paper money some special significance. It doesn’t have any actually. It’s purely for convenience, and we could get rid of it tomorrow and not change anything, except our convenience level.

  179. Here’s a simple example demonstrating that physical cash no special significance, say we start with a Treasury (Tsy), Fed, bank, Person x, all with absolutely clear balance sheets:

    Tsy, Fed, bank, x:
    Assets (A): $0
    Liabilities: $0

    Now say person x takes a loan from the bank for $100 and uses it to buy a T-bond, and then the Fed buys the T-bond from person x during QE.

    A: $100 Fed deposit
    L: $100 T-bond issued

    A: $100 T-bond & $100 loan of reserves to bank
    L: $100 reserves at bank

    A: $100 reserves (Fed deposit) & $100 loan to x
    L: $100 reserve loan from Fed & $100 deposit for x

    Person x:
    A: $100 deposit at Bank
    L: $100 loan from bank

    Person x could now withdraw his deposit in cash. But in order to do that the bank must first obtain cash from the Fed. The Fed already has a stack of cash in inventory which does not appear on its balance sheet because cash is essentially worthless when held by the Fed: it’s literally just paper when held at the Fed. It only takes on its facee value when sold to a bank, at which point it becomes a liability of the Fed and is entered onto the Fed’s balance sheet. This is probably the concept which confuses people: that paper money held at the Fed is worthless.

    A: $100 Fed deposit
    L: $100 T-bond issued

    A: $100 T-bond & $100 loan of reserves to bank
    L: $100 paper money distributed

    A: $100 vault cash & $100 loan to x
    L: $100 reserve loan from Fed & $100 deposit for x

    Person x:
    A: $100 deposit at Bank
    L: $100 loan from bank

    Notice what happened to what I called “reserves” before? Those were electronic reserves. They disappeared. Electronic reserves are Fed deposits (called “reserves” when in commercial bank Fed deposits). The bank paid for the paper money with its reserves, so the Fed erased the bank’s electronic Fed deposit, and sent it some cash (at which point the cash took on value). The Fed just replaced one liability for another. The bank just replaced one asset for another, both of which are classified as “reserves” (electronic Fed deposits and vault cash held at commercial banks are both “reserves”). Now when Person x withdraws his deposit as cash we have:

    A: $100 loan to x
    L: $100 reserve loan from Fed

    Person x:
    A: $100 cash
    L: $100 loan from bank

    Nobody else’s balance sheet changed. When this $100 is redeposited by x (a stand in here for all of the non-bank private sector) because it’s now more convenient to go back to an electronic bank deposit (again, assume is actually all the non-bank sector, so it could have changed hands several times), this process is exactly reversed, and then bank sells the $100 cash back to the Fed, and the Fed then retires this cash, and re-enters a $100 electron deposit for the bank as a liability in it’s place.

  180. I forgot to add the $100 Fed deposit at Tsy to the liabilities of the Fed in the above sets of balance sheets! So the Fed has a total of $200 in assets and $200 in liabilities in both sets!

  181. Here’s the starting balance sheets:

    Step #1: Initial balance sheets:

    Tsy, Fed, XYZ bank, non-banks:
    Assets (A): $0
    Liabilities (L): $0
    Equity (E): $0

    Step #2: Tsy auctions $10B in T-bills, XYZ buys them:

    A: $10B Fed deposit
    L: $10B T-bills auctioned

    A: $10B reserve loan to XYZ
    L: $10B deposit for Tsy

    XYZ Bank:
    A: $10B T-bills
    L: $10B reserve loan from Fed

    Step #3: Gov spends its Fed deposit on non-banks (assume they all bank at XYZ):

    A: $0
    L: $10B T-bills auctioned
    Negative Equity: $10B

    A: $10B reserve loan to XYZ
    L: $10B deposit for XYZ

    XYZ Bank:
    A: $10B T-bills + $10B reserves
    L: $10B reserve loan from Fed + $10B deposits

    non-banks (assume they all bank at XYZ):
    A: $10B deposit
    L: $0
    E: $10B

    Step #4: Now assume that XYZ bank uses the $10B in reserves on its balance sheet to repay the reserve loan it took to buy the T-bills (only the Fed and XYZ balance sheets change):

    A: $0
    L: $0

    XYZ Bank:
    A: $10B T-bills
    L: $10B deposits for non-banks

    Step #5: Now the Fed buys the T-bills (again, only the Fed and XYZ balance sheets change, but I’ll write them all down):

    A: $0
    L: $10B T-bills auctioned
    Negative Equity: $10B

    A: $10B T-bills
    L: $10B reserves at XYZ

    XYZ bank:
    A: $10B reserves
    L: $10B deposits for non-banks

    A: $10B deposits at XYZ
    L: $0
    Equity: $10B

    Notice that at Step #3, the non-banks get $10B in equity from gov spending. This is not changed by steps #4 or #5 (#4 was a step I inserted … the original Fed loan repayment,… just to keep the balance sheets tidy, but #5 was yours).

    In other words, all that happened was that deficit spending (defined as the Tsy auctioning bonds and then spending the proceeds… i.e. everything through step #3) put $10B in equity into the private sector. Everything after this step did NOT change anybody’s equity, including the private sector. That’s why deficit spending adds equity to the private sector, but QE does not! Here’s a case demonstrating QE wherein Tsy buys Tsy debt from non-banks instead of banks:

    Again notice that QE did not change anybody’s equity. Here’s an example of deficit spending with the non-banks buying the Tsy debt instead of the banks doing it:

    Notice that the non-bank’s equity increased by the exact same amount that Tsy’s equity decreased.

  182. Also important to note that QE does not fund the govt. How do we know this? Well, that implies low demand for t-bonds or insufficient demand from the pvt sector. But we know that’s false because QE2 ended and interest rates FELL. So the public’s demand for risk free interest bearing debt remains high. And that makes total sense since we’re in a low inflation environment.

  183. I think you’ve got it! By “net financial asset” I always read that as “net of liabilities” i.e. “equity” and of course it means in the private sector that they increase. Due to the nature of double entry accounting, if ALL balance sheets (public and private) are consolidated you get a great big $0 all the time of course!!

    Your (3): yes, that is the sense in which there’s no “money printing.” Technically money is created by the Fed during QE, but in equal measure with debt and in such a way that nobody’s equity changes! QE does not change anybody’s equity!

    I don’t think it’s the case that MR doesn’t try to predict anything …for example, MR says that it’s EXTREMELY unlikely that the US won’t be able to pay its bills… at least given that we don’t have any major calamities (hackers erase all the Fed’s computers at the same time Washington DC is obliterated with a terrorist NUKE) … or congress decides to default to teach America a lesson…. or for some other brain dead idea. But basically I think you’ve got it.

  184. In that 2nd set of balance sheets, the Fed balance sheet should have been:

    Assets: $100 reserve loan to bank
    Liabilities: $100 reserve deposit for Tsy

    The error was on the “Liabilities:” line. The correction was to replace “bank” with “Tsy.”

  185. “Regarding whether its inflationary or not, I’ve seen it argued both ways and I’m agnostic to that at this point. Certainly I think if the Fed were purchasing the basket of goods in the CPI it couldn’t avoid being inflationary, but it’s not doing that. Does it inflate financial asset prices though? Seems very plausible.”

    As I meant inflationary, I meant a rise in money supply, not in CPI. A rise in money supply can manifest itself in CPI and/or (financial) asset inflation. Obviously QE with the public leads to higher money supply, unless the latter is offset by inside money deleveraging.

    That QE can inflate financial asset prices is not that obvious to me. For example QE did not stop the bear market of 2009, it was the end of mark-to-market. Then it is also not clear which effect of QE allegedly raises asset prices – i) money supply increase; ii) psychological effects/misunderstandings, e.g. TINA / Fed model, (hyper)inflationary hedging/frontrunning; iii) stimulates speculative activity, e.g. banks prefer to give margin debt / speculate in risk assets, then create loans at these low rates / low growth / no creditworthy borrowers situation (kinda the Greenlight founder’s critique; iv) anything else?

  186. Actually JKH explains my case b) in his new post. I meant the same.

    -> QE is “money printing”, although it is (historically) a minor source of money printing.

  187. I still think the present Fed balance sheet is unpresidented. There is no doubt that the debt/GDP ratio of during WWII was very high and that deficit spending had a lot to do with finally bringing us out of the depression. But GDP was quite low, and thus in real terms so was the debt per capita. Finally, the Fed did not buy sovereign debt in the 1940s. It marketed the debt pretty much like now.

    I think what you’re suggesting is: “don’t worry, our kids are on the hook for this but they’ll have plenty of moola by then.”

  188. Fed balance sheet: yes, probably true there! Yes, private debt was very low at the end of WWII (probably in part because everyone was still in the save-every-penny mode from 15 years of depression and war, while the government was spending like crazy).

    I don’t know if I’m suggesting our kids will pay it off fine!… but there are things that can be done to mitigate the effects of paying off the debt, even in a rising interest rate environment. There’s the post-WWII capping idea, but then there’s also the idea that Tsy could just stop issuing long term debt. If 30 year interest rates are high, don’t issue 30 year bonds. Also, the Fed can control any part of the yield curve it wants to: they can effectively set not just the overnight rate, but say the rate on 10-year bonds through OMOs. They’re not doing that now.

  189. I think I got my answer––
    According to JKH:
    “In fact, the Fed will decide if and when it wishes to sell back its QE bonds to the private sector as a function of a QE “exit” strategy. Moreover, many of the bonds may end up being matured on the Fed’s balance sheet instead of being sold back. So it will be the Fed’s option to sell in the case of both the occurrence and the timing of any such exit transactions. There is no legal or economic obligation, as is the case with actual repo transactions.”

    “If the Fed decides to hold these bonds on its balance sheet until they mature then that’s the grand “exit” strategy. The bonds will simply roll off slowly and the Fed’s balance sheet will naturally shrink.

    “The majority of people out there seem to think the Fed has to “unwind” QE at some point and the fear mongering people on certain websites and representing certain political views like to portray this as some sort of world ending moment.”

    Thanks Cullen, This is what I have been wondering about because it’s not just websites, so many “main stream” pundits (Fox and cNBC famous Santelli: Collateral Damage of QE Exit), are panicked about this. I’m just trying to reconcile these two roads. It’s not possible because they seem to be travelling in different realities.

  190. You’ve got to be shitting me. Did you run this explanation past your 6-year old son or daughter (or niece or nephew) before giving it to me?
    Cullen is wrong (yes CR worshippers – WRONG). This cannot be explained to a 6-year old.
    Bottom line: the U.S. can and does create money out of nothing. How you wish to obscure that fact – and to obscure the fact that all we have is a faith that the dollar will purchase something – is your business (and your self-deception), not mine.
    Sorry, I have a short fuse.

  191. We’re not printing money. We’re printing net financial assets that have 99 percent moneyness and are being redeemed every month by electronically created 00s by the Fed.
    But we’re not printing money.

  192. Electronically created 00s that have next to no long term inflationary impact on the economy. Details matter Johnny and troll…

  193. Bonds aren’t 99% money. How could you assume that? Cullen is pretty clear that bonds and most financial securities are money-like, but not money in the sense that neoclassicals define something like the monetary base.

  194. Sorry troll, I’ll try once more. You’re absolutely correct, it’s all promises: they are either written and exchanged for real goods and services or they are exchanged for other promises. It all starts off like this, where nobody owes anybody anything:

    John is owed nothing. John owes nothing.

    Sue is owed nothing. Sue owes nothing.

    This can be re-written as:

    John has no assets. John has no liabilities.

    Sue has no assets. Sue has no liabilities.

    Now let’s say John does some work for Sue, then she could pay him with an IOU:

    John has Sue’s IOU. John owes nothing.

    Sue has nothing. Sue gave John an IOU.

    That’s how someone get’s paid for their work with IOUs. They could also get paid for their real property (house, car, etc.) this way. Either way notice that if John and Sue were consolidated into one person (JohnSue), then Sue’s IOU would cease to exist because JohnSue would owe that to JohnSue.

    Alternatively, John and Sue could just exchange IOUs:

    John has Sue’s IOU. John gave Sue an IOU.

    Sue has John’s IOU. Sue gave John an IOU.

    That’s what it all boils down to! Double entry accounting: assets (what’s owed to you) on the left, and liabilities (what you owe) on the right. When an IOU goes back to its originator (e.g. when John returns Sue’s IOU to Sue) it’s destroyed (e.g. Sue rips it up). It all follows that same basic pattern. It ALL comes from nothing (all the financial assets, including money). Consolidating everyone’s records together, the IOUs always add to zero. Note that real assets (houses and cars) don’t go away, just the financial assets. That’s how our system works. Other than that basic idea, here are the other rules of the system:

    1. The Fed’s IOU is special. It’s a Fed dollar. ONLY the Fed can write this kind of IOU. Fed dollars ALWAYS represent what the Fed owes. Like all IOUs, when Fed dollars are returned to the Fed, they are destroyed.

    2. The banks’ IOUs are special. They are bank dollars. ONLY banks can write this kind of IOU. Bank dollars ALWAYS represent what a bank owes. When bank dollars are returned to the banking system, they are destroyed. All bank dollars are equivalent no matter what bank they came from, and they are completely transferable between banks (i.e. one bank will be willing to take over an IOU from another bank if the originating bank pays it in Fed dollars to do so).

    3. Fed dollars and bank dollars are both dollars and they are equal but they are not the same thing. Only the Fed can create and destroy Fed dollars, and only the banks can create and destroy bank dollars.

    4. Treasury can ONLY have Fed dollars (not bank dollars). It CANNOT get them by exchanging its IOUs (Treasury bonds) to the Fed for Fed dollars. That’s prohibited! It can NEVER spend more Fed dollars than it has: that’s also prohibited. Nor can it ever borrow Fed dollars from the Fed directly, but the Fed can obtain Tsy IOUs by writing IOUs to banks in exchange for Fed dollars they have. Likewise, the Fed can trade Tsy IOUs to banks in exchange for returned Fed IOUs (which the Fed then destroys).

    5. Everyone else: you, me, all individual people, and all non-bank businesses can have bank dollars, but we CANNOT have Fed dollars. We can get them from each other or from banks. That’s OUR money!

    6. Banks can get Fed dollars from each other, from Treasury, or from the Fed. Fed dollars are money for the banks and Treasury.

    7. Banks act as intermediaries between non-banks (people and businesses) and the Treasury. E.g., if the Treasury wants to pay you for work you’ve done for the government, it pays your bank in Fed dollars, and the bank in turn writes you an IOU of bank dollars. Likewise, when you pay your taxes, you end up returning your bank dollars to the banking system, and the banks pay Treasury your taxes in an equivalent amount of Fed dollars.

    8. Banks also act as intermediaries between non-banks (people and businesses) and the Fed. This happens in much the same way as is done in item 7. above with Tsy.

    I’m oversimplifying a bit, and I haven’t mentioned cash (which is a minor issue… just another IOU!), but that’s pretty much it! It’s all a system of IOUs, but not all IOUs are equal. Some IOUs are exactly money, and there’s two perfectly equivalent but separate forms of money: Fed money, representing what the Fed owes and which is traded between banks and between banks and Treasury, or traded back to the Fed (where it’s destroyed). And bank money, representing what a bank owes, and traded between people and businesses or traded back to the banking system (where it’s destroyed).

    The point is that “money” in our system is not like a house or a car or a pile of gold or any other permanent asset. It’s a promise, and it’s destroyed when returned to the entity which wrote it as an IOU.

  195. A bond is not “money” in the neoclassical sense as others have pointed out. A bond is a type of security that cannot be used for final means of payment. Something with the highest level of moneyness MUST be able to meet that one purpose. Things like stocks and bonds do not meet this criteria and must therefore be exchanged into something with a higher level of moneyness. Do not misconstrue bonds as money or you will incorrectly portray the primary role of what most people believe “money” is. Bonds are money-like, but are not perfect substitutes for something like a bank deposit. The US govt issues bonds because it must obtain money from the private sector. They do this for the same reason that a corporation issues a bond. The issuing entity wants the thing with higher moneyness so it issues a money-like instrument to entice others to give it something with higher moneyness. This is a basic fact of security issuance and so confusing bonds with bank deposits is a rather egregious error that misportrays the reason why something like bonds exist in the first place. If the US govt really just issued all its own money there would be no need for bonds in the first place. It doesn’t do that though. It issues bonds so it can obtain money from people who are willing to let the govt use their bank money.

    You could argue that QE “monetizes” the bonds when a non-bank sells it to the Fed, but again, you must be very careful to explain this process correctly to avoid the inevitable “money printing” and hyperinflation shrieking. You must also avoid the idea that the govt is the issuer of the deposit as it is most definitely not.

  196. I am only wrong if you think bonds are money. In that case, we might as well start calling all financial securities money. In which case there’s no need for any company or entity at all to issue financial assets because they can create their own money….Obviously, that’s wrong so let’s all get on the same page here and stop referring to bonds as money in the same sense that a bank deposit is money. It’s not and stating that bonds have the same level of moneyness as bank deposits is a very confused portrayal of the monetary system.