The Fed: Still Not Monetizing the Debt

Following QE2 I wrote a controversial piece that argued the Fed was not monetizing the debt.  The purpose of the article was to show how the Fed was not increasing the net financial assets via QE or enabling the government’s fiscal policies.  My argument was rather simple:

1)  QE involves swapping reserves for bonds which results in no change in the private sector’s net financial assets.  It merely changes the COMPOSITION of assets.

2)  Monetizing the debt implies that there is not enough demand for government bonds and that the Fed needs to backstop the market for government bonds.  This can’t be true though because the Primary Dealers are required to bid at auctions and would only reject this mandated duty in case of a hyperinflation where it became unaffordable for them to serve as the government’s funding agent.   (This doesn’t mean inflation couldn’t result in currency and bond rejection!).

So I was extremely pleased to see Bernanke say the following this morning:

“By buying securities, are you “monetizing the debt”–printing money for the government to use–and will that inevitably lead to higher inflation? No, that’s not what is happening, and that will not happen. Monetizing the debt means using money creation as a permanent source of financing for government spending. In contrast, we are acquiring Treasury securities on the open market and only on a temporary basis, with the goal of supporting the economic recovery through lower interest rates. At the appropriate time, the Federal Reserve will gradually sell these securities or let them mature, as needed, to return its balance sheet to a more normal size. Moreover, the way the Fed finances its securities purchases is by creating reserves in the banking system. Increased bank reserves held at the Fed don’t necessarily translate into more money or cash in circulation, and, indeed, broad measures of the supply of money have not grown especially quickly, on balance, over the past few years.” (emphasis added)

Dr. Bernanke’s always understood this.  The general public has gotten this colossally wrong though….For more on QE please see the understanding QE section on the site.


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

Cullen Roche

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

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  • Kyle F.

    So, Orcam has been unveiled! Very nice… Best of luck on the new venture.

  • But What Do I Know?

    “Monetizing the debt means using money creation as a permanent source of financing for government spending. In contrast, we are acquiring Treasury securities on the open market and only on a temporary basis, with the goal of supporting the economic recovery through lower interest rates. At the appropriate time, the Federal Reserve will gradually sell these securities or let them mature, as needed, to return its balance sheet to a more normal size.”

    I’m sure when Ben Bernanke wakes up in with a bad conscience in the middle of the night, he soothes it by telling himself that everything he has done is “temporary” and “reversible.” But that’s really the crux of the matter, isn’t it? From where I’m sitting, it’s not reversible, at least without a drastic increase in long-term rates and a corresponding hit to financial asset prices. Right now, the Fed owns one-third of Treasuries with maturities of over ten years. How in the world are they going to unwind that position, especially when they would do so when economic conditions improved (thereby presumably weakening the demand for long-term Treasuries at anywhere near these prices)?

    I hate to use this analogy because of the book, but the Fed is like Atlas, unable to set down their burden without damaging the world. And there is no Hercules set to come along and switch with them. Maybe the helpless giant kept telling himself that the weight on his shoulders was temporary as well.

    If I’m wrong, please tell me how the Fed is going to unwind its Treasury purchases–or in fact, keep from buying more to maintain rates at these levels. I’d really like to know.

  • Bond Vigilante

    For me the case is extremely simple. If the balance sheet of the FED increased during QE2 (or any other QE) then the FED is monetizing debt(s). It bought debt/T-bonds from the banks.

    Yes, with those (increased) reserves banks are bidding on government bonds. So, the net effect is that the FED is backstopping the government. Sounds simple to me.

  • Windchaser

    Cullen, could you explain what *would* constitute monetizing the debt? (if such a thing is still possible?).

    Also, I have a bit of a hard time with your first bullet point, that QE doesn’t change the private sector’s net financial assets. The Fed bids up bonds *whenever* it enacts QE, no? I.e., it makes bonds more valuable than they otherwise would have been, as evidenced by the fact that the banks are selling bonds to the Fed (they wouldn’t sell them to the Fed if they thought they’d get a better deal elsewhere). Maybe QE doesn’t move the needle much, but supply and demand says that asset prices will rise on the margin.

    If you disagree, then I’m missing something.

  • whatisgoingon

    And the Japanese experience with QE last decade showed that
    1. Inflation and equities can fall during QE (especially when the government is pursuing austerity)
    2. The exit from QE may not be as unknown and dire for yields or equities as some suggest

  • Windchaser

    Honestly, *any* time the Fed lowers interest rates, I see it as a sort of “soft monetization”, where monetization exists on a continuum from “soft” to “hard”:

    1) “Soft”. Lowering interest rates makes debt more attractive. There’s an implicit Fed threat, “buy these assets, or we will.”
    2) QE, in which the Fed fiddles around with lowering interest rates on the long end.
    3) “Hard”. The Fed pins long-end interest rates. Again, the market buys up bonds, but only because if they don’t, the Fed will.

    Because the Fed can move markets simply by threatening, the Fed’s balance sheet is unimportant. The real price of money is the important thing.

  • Johnny Evers

    The Federal Reserve will ‘let them mature’ …
    How does that work? Does it just tear up the bond? Or does it ‘pay’ itself somehow (taxes? procuring funds for another bond?)

  • Obsvr-1

    He may not be monetizing the debt, based on semantics or timeframe illusions; but answer these questions:

    When a bond is sitting on the FED balance sheet, the US Gov’t is effectively creating a debt with zero interest, so :

    1. isn’t that effectively monetizing the debt ? or said differently creating Debt without interest ?

    2. What actually happens, or what operationally happens when a bond sitting on the FED balance sheet matures ? Does it just evaporate into thin air, from where it came ? or does the UST have to reissue another Bond (rollover) since the US Govt is in a deficit spend environment (no funds to redeem / pay for the bond) ?

    these are the unintended consequences for wrapping around the axel.

  • krb


    In my view, this is a simple exercise in semantics by both you and Bernanke to support arguments you’ve both made earlier. What is the practical reason for “monetizing debt”? Wouldn’t it be to enable govt borrowing where they wouldn’t otherwise be able to or be able to afford to do? That is clearly what is going on.

    To cite primary dealers buying treasuries to support the argument the fed isn’t monetizing is disingenuous, when the law REQUIRES them to buy, and with the PDs quickly flipping them back to the fed….sometimes within days. Add to this the net result of interest cost suppression so the govt can afford to continue borrowing without blowing out the deficit, and it seems quite obvious to any objective observer that the fed is enabling low cost govt deficit spending.

    In the alternative, if the law didn’t require treasury purchase by PDs, and the fed wasn’t making the explicit/implicit promise to buy them all back at a profit to the PDs, and therefore interest rate returns on said bonds were set by an un-manipulated market, would the Treasury find sufficient buyers for their issuance? Not a chance! krb

  • krb

    I should have said “…..find sufficient buyers for their issuance, AT THE INTEREST RATES THEY CURRENTLY ISSUE THEM……”. If the answer is….no way…..which is my view, then the fed is clearly enabling govt low cost govt debt…..with no practical difference from “monetizing” govt debt. krb

  • GreenAB

    Bernanke 2002, nuff said:

    “…In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman’s famous “helicopter drop” of money…”

    i encourage everyone to read the whole speech.

    “…By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

    Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior).8 Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys…”

  • krb

    And by the way….it IS inflationary because the govt cash IS entering the economy. To put blinders on and only look at the relationship between PDs and the fed is a diversion…..the whole purpose behind this circle jerk of an arrangement. Having the fed cash enter the economy would make it MORE inflationary, but to claim the current behavior isn’t inflationary is, again, disingenuous. Bernanke’s whole intent is to reflate in order to save the bankers’ behinds, to then claim the policy is not inflationary plays us all for fools. krb

  • jt26

    The issue is more subtle. If the gov’s actions are deemed to be “reckless spending” vs. “financial stability/currency management” then it would be monetization. As I commented recently, if people understood that government spending had this implicit dual purpose, then it might help depoliticize Congress. No one asks about monetization during a war (specifically, WWII), because the government’s intent is clear.

  • Cullen Roche

    Monetizing the debt implies that the Fed is funding the govt by creating new money for financing. This is not true. The Fed is buying on the secondary market from the banks. The idea that the Fed has to buy the bonds to support the market can easily be debunked by looking at the post-QE2 and pre-QE1 bond auctions. In both periods, there was no change in demand. In fact, bid to covers have DECLINED since the QE’s started.

  • Cullen Roche

    What happens when your mortgage matures? The bank essentially tears up the paper or erases it from its spreadsheet. The same way they created it. From nothing and back to nothing….

  • dis737

    “Fed finances its securities purchases is by creating reserves in the banking system. Increased bank reserves held at the Fed don’t necessarily translate into more money or cash in circulation”

    This is what gets me about the The Fed/Bernanke. He wants to have it both ways, QE will have positive monetary effects on the economy increasing inflation expectations, but at the same time, “not translate into more money or cash in circulation.” So at the end of the day, what’s the point of doing it in the first place!

  • Cullen Roche

    See the post QE2 auctions or Tsy prices. There’s ZERO evidence that there wasn’t enough demand for bonds during these periods even though many famous people predicted the demand for bonds would collapse or overwhelm the market.

  • LRM

    To get an Austrian point of view on the recent QE there is a worthwhile video of David Stockman.

    In the video he implies that there is a profit potential that may be actualized by the PD’s due to the purchase of the MBS and UST. He seemed to think there was 50 billions of profits made in 50 minutes to these banks thus helping to shore up their balance sheets.I don’t know if this is possible?
    His real beef is that a hand full of people are trying to control too much of the capital markets thus will lead to unknown unintentional consequences.
    He implies that the low interest leads to a lack of discipline by legislators who can see the low cost of additional deficits thus the monetary policy is indirectly supporting the fiscal policy in this manner. He does not say direct monetizing in this talk.
    He talks about the importance of saving to investment and how the the low interest discouraging savings is hurting the importance of investment and improved production which comes with this.
    Not sure how this differs from the MR savings thesis.
    Check out the video if you like this sort of thing. He is not a CB fan for sure

  • Cullen Roche

    You don’t have this right. The PD’s obtain reserves. Reserves are only held by banks. They aren’t cash out in the real economy. And if a non-bank sells a bond to a bank they are not necessarily more inclined to spend the money. Spending is a function of income relative to current saving. Since QE does not alter the NFA of the private sector there is no transmission mechanism by which it can improve income relative to current saving. When you sell a stock on the stock market can get cash you don’t necessarily go shopping because you have cash. In fact, if you have no capital gain on the sale your income relative to saving has not changed at all and any spending you do is not due to the sale of your stock, but due to you dissaving.

  • Frederick

    I’m shocked that people still argue with Cullen over QE. Has any analyst or pundit been more right about its affects over the years than he has? I am pretty sure no one understands how QE actually impacts the economy, but Cullen has gotten it a lot more right than most other people.

  • krb


    The law REQUIRES to PDs to provide demand……to then cite the demand as evidence of “real” demand (in the absence of the legal requirement) is rationalizing…in my view. I’m aware we are BOTH claiming the unprovable….I’m choosing, rightly or wrongly, to inject some common sense. Bernanke is relying on the Webster’s dictionary definition of monetizing to divert everyone’s attention from what is going on and claim he’s doing nothing of the kind. A common sense view of the incestuous, circle jerk exercise between treasury, PDs and the fed says otherwise. krb

  • Johnny Evers

    My mortgage matures when I have finished paying it off. I’m paying principal and interest.
    What am I missing here?

  • dctodd27

    “Monetizing the debt means using money creation as a permanent source of financing for government spending…At the appropriate time, the Federal Reserve will gradually sell these securities or let them mature, as needed, to return its balance sheet to a more normal size.”

    This is where Bernanke is being disingenuous. While what he is saying is technically correct, he knows that he can’t just reduce the size of the Fed’s balance sheet without disrupting the market. He makes it seem as though he can just snap his fingers and sell off the Fed’s holdings whenever he wants. Unless growth picks up right now, or interest rates stay where where they are for the next decade, the Fed has a major problem.

  • Pierce Inverarity

    You’re glossing over “or let them mature, as needed.” The FED can hold the securities indefinitely.

  • Mountaineer

    “What am I missing here?”

    Probably, that the Treasury is continually paying interest to the Fed on the Fed’s accumulated stock of government bonds. If the Fed never sells them, they will eventually ‘mature’ like any other bond with principal repayment and then…well…nothing, they are gone. Just like your mortgage.

  • dctodd27

    @Pierce Inverarity

    Except that the Fed is holding longer maturity paper at extremely low yields at over 50x leverage. If interest rates rise even a little bit the Fed might be insolvent before its holdings even reach maturity. Then what?

  • krb

    What did the govt do with the cash rec’d for the treasury issued?…….it entered the economy. To the extent the PD and Fed facilitation of low cost debt spending beyond what they otherwise could, it is inflationary. I’m aware that without the PD/Fed circle jerk to suppress interest costs the govt could still spend by just printing currency…..but then there would be no mystery and everyone would clearly see what they were doing…..and there would be no disagreement that it was inflationary. The PD/Fed participation diverts attention, and allows the PDs to skim some unearned profits along the way.

    As I said, Fed cash entering the economy would make it MORE inflationary. This does NOT even consider the speculative inflation the PDs are creating through their activity in equity and commodity markets……activity they may not be able to conduct in the absence of the Fed padding their balance sheets and reserves.

    As I’ve been saying for 3 years, you can’t claim on the one hand to pursue a policy of “reflating asset prices to something higher than they otherwise would be”……for whatever reason claimed be it padding bank balance sheets, wealth effect on private sector psyche, etc……and then on the other hand to be claiming to have no inflationary impact from your policy! Let’s use some common sense, or at least make sure our left hand pays attention to what our right hand is doing! krb

  • Johnny Evers

    I *thought* it works like this.
    Bank has $1 million on reserve at the Fed.
    Fed takes that $1 million and buys a bond. Bond now acts as bank reserve.
    That’s an exchange swap, right.
    But now you’re saying that when the bond matures the Fed tears it up. So what happens to the reserve?
    Why would the bank do this. Before it had two financial assets — a bond and a reserve. Now it has one, the $.
    My head hurts. :(

  • Cullen Roche

    Yes, when banks create loans they create money from nothing. And when loans are paid off the loan is erased from the books.

  • Cullen Roche

    You can’t just claim it’s “fake” demand because you don’t like that they’re required to bid. It’s very real. By design. If the banks really didn’t want to buy the bonds they’d tell the govt to take a hike. They don’t do that because they like being in business with the govt and collecting fees for just taking orders.

  • Cullen Roche

    Why would rates rise? You can’t just skip a step in the analysis there. Tell us why rates will rise. Connect the dots….

  • Johnny Evers

    Where does the principal repayment come from?

  • Cullen Roche

    most of the time – someone else’s loan. It’s all just inside money being shuffled around. When you pay the interest on your loan where did you get the money from? Most likely someone sent you some bank deposits and you shifted them around to meet your expenses. It’s all just a flow of inside money for the most part.

  • jt26

    Maybe BB doesn’t know what he is talking about. According to bloomberg,

    ” Central bank policies to boost growth should not damage the value of the dollar on foreign currency markets, Bernanke said. The dollar “is about where it was before the crisis,” and pursuing maximum employment and low and stable inflation will make the U.S. currency attractive, he said.
    Also, Fed easing, including the zero-interest-rate policy, will help savers by fueling the expansion, Bernanke said. “Only a strong economy can create higher asset values and sustainably good returns for savers.” ”

    What? Every hot-money asset bubble has been followed by a disaster. I would be scared in the aftermath of a rising USD and rising “asset prices”.

  • Johnny Evers

    Yes, but in your example only the interest is being paid.

  • krb

    Ok, I guess we won’t agree. Step back a little and re-read your argument, which I agree is accurate. If two private sector companies entered into the same arrangement it would be called collusion and they would both be prosecuted….or at least would have been under prior justice departments (under either party). “If you promise to buy my product at the price I set, I will promise you it will always be profitable for you, through either/both fees collected or by profitably selling it back to me”.

    You can call it real demand if you want, I call it fake. We’ll agree to disagree…..I like your blog too much to do otherwise. thx krb

  • dctodd27

    Does it matter? Pick a reason. Another downgrade. A failed Treasury auction. A popular uprising. The point is, the Fed has put itself in a very precarious position whereby the only happy outcome is if goldilocks shows up.

  • JJTV

    Banks do demand treasury securities and would take them even if they were not required to. Most financial entities prefer to hold liquid, risk free, interest bearing securities. Sovereign treasuries happen to fill that need.

    When Australia was running high primary surpluses there was not enough treasury debt being created to meet the demand for risk free assets. The government was forced to create debt so that the banks had an interest bearing medium (banks complained until they did).

    As Cullen noted, I haven’t seen any demand side problem with treasuries. In fact, money flows indicate a strong demand for all types of fixed income instruments. Treasuries may be less popular due to their lower yield but adequate demand is certainly there.

    It is also important to note that US banks are not the only ones that demand treasuries. Foreign central banks and commercial banks demand them as well.

  • Johnny Evers

    ‘Most likely someone sent you some bank deposits and you shifted them around to meet your expenses.’

    C’mon. You can do better than that.

  • krb

    Good point, I have no quarrel with it. But withdraw the controlled or required demand provision by PDs and what interest rates would prevail in the market by these other buyers, who have choices on where to allocate their cash?

    I haven’t read the origins or rationale of the PD buying requirement law, but I suspect it was for just these reasons…….”never leave a bond auction demand to a “real” market, and never leave bond auction interest rate to a “real” market”…..both of which will manipulate the market that the buyers you cite will participate in……”and in return we’ll assure you profitable transactions in your bond buying”. krb

  • Johnny Evers

    Rates are not going to rise. The federal government cannot issue $2 trillion a year in bonds at 6 pct interest. It must keep rates low.
    As to the Fed holding the bonds until it matures — let’s be real: When the Fed buys a bond it is retiring the bond. The question is: Where does it get the money to retire that bond?

  • krb


  • Cullen Roche

    Long rates are a function of short rates and the Fed’s view of the economy so you can’t just “pick a reason”. Downgrades don’t cause rates to rise. Tsy auctions don’t fail by design in the USA because the PD’s are REQUIRED to bid at auction. So you’re just glossing over important details…

  • Cullen Roche

    Better than that? Do you want me to lie to you? Where do you think most of your money comes from? It comes from banks creating deposits so we can shuffle them around amongst one another. Perhaps the truth hurts, but that’s what it is.

  • Obsvr-1

    we (the all inclusive we) have not yet seen the other side of the mountain with respect to Bernanke’s QE operations. Until the massive load of crap on the FED BS is unwound there can be no gloating on who is right.

  • Anonymous

    “Where does the principal payment come from?” The same place any principal payment comes from: the bond ssuer. In the case of Treasuries, the issuer is the US govt. Of course, in many cases a bond is repaid with the proceeds of a new bond issue, and Treasuries are no exception.

  • Don Levit

    However this power is defined, and whatever impact is has on the economy, one thing is certain: every act, no matter how large or small, has an upside and a downside.
    So, too, does this power of not being constrained by taxes, debt, etc. This ability to do QE, whatever the heck that means, must have either a huge upside or huge downside, for it seems to be an important part of the Fed’s strategy to revive the economy.
    Either that, or this QE power, whatever the heck it is, has been merely a diversion for several years now, assuming it has little impact on the economy either way.
    Don Levit

  • Geoff

    Sorry, the above comment was me.

  • Obsvr-1

    not where does it (presuming the FED) get the money, the question is where does the US Treasury get the money, the UST needs to redeem/pay the bond. So, back to my question way up the thread

    When a bond on the FED BS matures, what happens ? Does it just evaporate into the ether from which it came, or does the UST need to issue another bond to redeem/pay the maturing bond (rollover) ?

    In either case, we will be witnessing a new event when the T’s of bonds start to mature, the unintended consequences of wrapping around the axel of the US Gov’t irresponsible fiscal policy around the FED Monetary machine.

  • steve

    When the bond matures, the treasury sends the check but the FED just erases it. Right?
    So the treasuries only benefit is the interest it pays recyles back to itself via the Federal Reserve paying profits back to the Treasury. Right?

  • LVG

    The government rolls over most of its debt. MBS mature and roll off the balance sheet. The Fed just keeps buying more. I think they’re buying most of the MBS issuance on the market today.

  • JJTV

    I don’t think you can make that point. Primary Dealers, of which there are 20 or 21, act as a market maker and purchase the securities with the intent to resell them. They account for around 70-75% of the demand at any given auction. The 10 largest primary dealers also account for a significant amount of the FOREX traded on any given day as well. You could take away the requirement, but the market makers would still buy. Treasuries are the best ticket in town.

    Do you have sources indicating that banks would not buy treasuries if it wasn’t required by law? If so, I would be interested in reading them.

  • LVG

    Good piece Cullen. It looks like your views on this are slowly but surely being vindicated.

  • Bond Vigilante

    The FED doesn’t lower interest rates, “Mr. Market”does.

  • Cullen Roche

    No, the Fed controls short rates completely. They could control the long end of the Tsy curve if they wanted to. But the important point to understand is that banks hinge their lending rates largely from the overnight rate. This sets the spread. So rates have a very high correlation with the Fed’s perception of the economy. Assuming that rates will on day surge on their own due to bond vigilantes (as you’ve been arguing here for years now) is misleading.

  • krb

    I don’t have a source….if a PD let it slip they were only buying because they were required to, I suspect buyers would dry up at the next auction. But I’ll make the same comment back to you……I don’t think you can make that point.

    If all PDs were bidding because they truly wanted those lo/no interest bonds for holding on their own balance sheets, or because they were confident of having sufficient demand for reselling them, then there would be NO need or benefit of the Fed creating money for buying them back a few days later and expanding its own balance sheet……if there was sufficient “real” demand for all the issuance the fed could stay on the sidelines. By definition, ANY fed activity indicates an intent to manipulate…… whether it be to suppress rates lower than they otherwise would be, create demand where there is none (or perhaps insufficient), inflate prices higher than they otherwise would be. I’m just following the fed’s own actions and connecting the dots…..and pointing out where their own explanations are inconsistent.

    I’m sure you’re right when you say, for the reasons you cited…. “You could take away the requirement, but the market makers would still buy.” The question is whether they would buy in sufficient quantities, to soak up treasury issuance, to suppress rates low enough, to inflate MBS or other prices high enough, and if not, we’re back full circle to why the fed is intervening and manipulating. krb

  • Lance

    As The Bernanke said, the Fed can simply sit on these bonds forever (“let them mature”). The idea that they must at some future date be sold into the market is simply not true.

  • KB

    “…funding the govt by creating new money for financing.”


    Could you kindly elaborate on that? Does it mean, let’s say, the Fed printing $100m and giving it to the government? But they cannot do it by definition, as I understand, they always should get something in exchange to balance the ledger.

  • Lance

    You assume, as so many incorrectly do, that there is some pressure that is going to *force* the Fed to “unwind”. Please explain that. They can sit on this stuff until the sun becomes a red giant.

  • The Undergrad

    I still don’t understand how this is such a contentious topic.

  • Cullen Roche

    Half the population wants you to believe QE is fixing the problem. The other half wants you to think it is the problem. Then there’a handful of people in the middle who think it’s just totally blown out of proportion by both sides.

  • Bond Vigilante

    Agree. And I still have to see the first evidence that contradicts that notion.

  • http://pragcap Michael Schofield

    I’m glad you’re here to explain it, Cullen, otherwise I’d have no clue. Keep up the good work. And thanks to all the others who contribute.

  • dctodd27

    Long rates are a function of short rates until the market decides they’re not…do you remember the “conundrum” the fed publicly acknowledged in the middle of the last decade? Short rates came up and long rates didn’t budge…rates will rise when the market decides inflation is a bigger problem than the “official” numbers show…

  • http://None Pete

    That’s just simply not correct. The mortgage is created by lending to someone cash to the seller. That’s not nothing. To the borrower, the bank creates a mortgage debt, a commitment from the borrower to pay cash. To the seller, there is a stack of real green bills. Not nothing. This is real transaction, and settled by cash money.

    Fed cannot buy treasury bill directly from treasury. This is law. Treasury has primar dealers. When Fed buys MBS from bank, it is a kind of monetization from strictly the sense of the transaction, give cash for exchange for MBS.

  • http://None Pete

    Reserve is just cash account, nothing magic about it. Your example of stock sale is good one. You don’t go shopping after the stock sale is because you have other money to shop. You certainly CAN go shopping with the cash after the stock sale. That’s actually what many people did for their 401k after their jobs lost.
    Let me ask you this, what happened to the cash from Fed after QE1? Are they all sitting on bank reserve?

  • http://None Pete

    Krb, I believe you got it right. Bernanke narrowed the word monetization of debt as a way to fund government to prove it is not true. He is monetizing temporarily, not permanently with a goal to stimulate economy. Either way, no matter how you see it, he is using cash in exchange for other assets, illiquid assets, any kinds of assets. Call it whatever you want.

  • Geoff

    Don’t hold your breath.

  • Geoff


  • Andrew P

    The Fed is loading up on long term US Treasuries. Bernanke knows that the actual “monetization” will take place later. That happens when the US Congress cancels bonds owned by another US Government agency (The Fed) so the interest expense can be reduced. This won’t happen right away, but it eventually will take place a decade or two from now when the Fed owns hundreds of trillions worth of 30 year bonds.

  • Andrew P

    Monetizing is when a future Congress erases the 30 year Treasuries owned by the Fed in their entirety. The asset and liability sides of the 2 branches of Gov’t (Treasury and Fed) are erased, but the cash the Fed printed to buy the bonds still exists. Hence, the debt has been monetized. Ultimately, the power to monetize rests with the Congress and not the Fed.

  • Andrew P

    A couple of decades from now, the Fed might be run by someone who wants to crush inflation. He will be raising interest rates. The Congress will get sick and tired of the $30 trillion (and rapidly rising) annual interest cost on its $1000 Trillion debt, of which most is 30 year bonds owned by the Fed (a government agency under the ultimate control of Congress). So Congress simply cancels those bonds and deletes them from the Fed’s balance sheet. The money the Fed printed to buy those bonds still exists, but the interest costs go away. This is the true meaning on “monetization”.

  • Pierce Inverarity

    I don’t understand how you all can continue thinking that raising interest rates mean increased debt servicing on EXISTING debt. The Fed will want to crush inflation if, and when, it comes. If it’s cost push, the Fed will hopefully realize it cannot contain it, like in the case of increasing oil scarcity. If it is demand driven, the economy will be expanding and tax receipts should rise in response. The natural thing to do would be to raise rates and retire debt with the increased tax revenue.

  • http://None Pete

    Cullen, I went back to re-read your monetary system, and I realized that you equal money to cash. I believe this is not entirely Correct. Cash can only be created by Fed. Bank can only create credit, which is a form of money. Bank can not print cash. But credit is not equal to cash, especially in stress situation. Cash needs to be printed, like gold needs to be mined. Credit can be created from thin air. Bank becomes insolvent, not because bank has a lot cash, but because bank has a lot assets, in this case, debt of the borrowers who cannot repay with cash or credit, because no bank will give a borrower a credit when he cannot repay.
    Under normal circumstances, credit is equal to cash, but not always. I agree we live in a credit world, but that’s exactly why we have credit crisis.

  • Stephen

    Cullen – what about excess reserves? I understand that if the Fed decides to hold assets to maturity, the asset side of its balance sheet will shrink accordingly. By definition, the liability side of its balance sheet will shrink by the same amount, and I assume it is the excess reserves that will decrease as treasuries/MBS mature. But what exactly happens to the excess reserve balances of these banks? Does the $ in these accounts simply vanish as assets mature, or do banks have the ability to transfer these $ from the excess reserve accounts at the Fed to their own balance sheet?


  • Zio

    If the reserve requirement is 10% (law of the land), and the Fed credits away on the reserve account, what stops banks from taking that cash out from the credit, long as they maintain the 10%? How is that not printing money?

    Where does the Fed get money to credit the bank’s reserve account?

    I think the printing money idea comes from the fact that the Fed uses a keyboard and digital keystrokes to create this money in the bank’s reserve account out of thin air! Where else do they get it? The treasury who borrows 40 cents to every dollar just to keep government running and constantly hitting the debt ceiling?

    Since we have a fractional banking system, with reserve reqmt of 10%, every time the Fed uses the keyboard to credit banks accounts it’s counterfeiting is it not?

    Isn’t there a misconception banks don’t lend out reserve money? Isn’t the fact of the matter is they can do whatever they so choose, long as they maintain the law of 10%? So by crediting their reserve account at $40 billion to infinity, eventually banks will be sitting on 20,30,40,50% and so forth reserve amounts. Can the banks not take that cash and do whatever they want long as they maintain 10%

    If the answers above are true, e.g. Yes banks only have a 10% reserve reqmt, and Yes, anything above that they can take as cash and loan out etc, then it sure does sound like QE is a back door money printing scheme only Mr. Madoff could be proud of.

  • Cullen Roche

    Loans create deposits. The deposit is money.

  • Cullen Roche

    Here’s how I explain this. Banks create most of the money in our monetary system. This is called “inside money” because it is created inside the private sector. The govt creates notes, coins and reserves which are “outside money” because they’re created outside the private sector. Outside money facilitates the existence of inside money. That is, most of our transactions and exchanges occur in inside money. And outside money helps to settle or facilitate transactions in inside money. Cash, for instance, is used primarily to draw on a bank deposit. Reserves are used primarily for interbank settlement. The idea that deposits are not “money” is totally wrong. In fact, it is the most important kind of money in our economy.

  • Stephen

    You’re not grasping the different between excess reserves and required reserves. Totally different concepts. Banks cannot and do not lend from excess reserves – in fact, excess reserves are completely unrelated to bank lending activity.

  • beowulf

    “as I understand, they always should get something in exchange to balance the ledger.”

    And so they shall receive. :o)

    In the private sector, if someone owns an asset but passes the income to a second party, its the second party who the courts (and the IRS) will assume be the beneficial owner holding equitable title.

    The structure of the Fed is set up by Congress to make it impossible for politicians to use it as inexhaustible funding source for federal spending without the whole world knowing it.
    The beauty of this is is it imposes some discipline on federal spending in ordinary times but when the federales genuinely need funding without limitation (war, financial panics, depressions), the Fed stands ready to roll out the zero point energy piggy bank.

    I honestly don’t know what’s more pathetic, that the Europeans are stuck with a central banking system without this power or that we’re stuck with congressmen who are completely clueless about the power they have but won’t use.

  • krb

    I agree with Cullen’s comments as far as his first two views go……it is NOT solving the problem so the 50% who think it is are wrong, but ending QE will NOT solve our problems either so the other 50% are also wrong. I may differ however in how big a problem I think QE is. QE, I believe, is a HUGE problem still in that it helps a very small segment…..propping up the still-insolvent tbtf banks and lines the pockets of the tbtf bank executives, while the inflationary consequences of QE on equities and energy/food commodities plus the suppressed interest income on safe investments continues to oppress the middle and lower classes and elderly. The middle and lower classes have a far lower percent of their assets in the inflated stock market and they pay a far higher percent of their income on inflated food and energy costs…..the income gap is getting worse through QE. And to the extent our govt leadership think QE works, they are NOT doing the fiscal things that actually could be leading to economic revival. Make no mistake….QE is NOT a jobs or economic revival program, it is a tbtf bank support program, and Bernanke/Geithner have known it all along. krb

  • JKH

    The Fed debits Treasury’s deposit account with the Fed.

    Assets down (bonds); liabilities down (Treasury deposit)

    Treasury’s bond liability disappears – i.e. is “torn up”

    Treasury has to tax or borrow to get money into its account to cover the debit – that’s a shift on Fed books from bank reserves to the Treasury account (both liabilities)

    And at its option, the Fed can buy new bonds in the market to replace those reserves

    Also, the rules allow the Fed at its option to replace any maturing bonds by purchase at auction (the only exception to prohibition of direct purchases); the Fed debits the Treasury account for the maturity and credits it for the new issue

  • Ricky

    Wait a minute, isn’t he asking a rather simple questions and isn’t the answer rather simple? The principle is paid back with money (okay, numbers) out of the Treasury account, and the Treasury account numbers were increased either through tax receipts or the sale of treasury debt. I am wrong on this?

  • JKH

    That’s what Cullen said.

    The tax and borrowed money that flows into the Treasury account is inside money (commercial bank deposit liabilities) at origin, with payment settled in the reserves held by the commercial bank that has issued the inside money. And inside money is originally created by loans. Loans create deposits.

  • Not an Economist

    “Pick a reason. Another downgrade.”

    I sure hope we get downgraded again…looking to buy a house and would like to see interest go down some more, just like they did after the first devasting downgrade…

  • GreenAB

    no comment on Bernanke´s words Cullen?

    to me it looks like that he is exactly doing what he described 2002 in the quotes above.
    “open market purchases” to finance tax cuts, “asset purchases” to inject money into the economy.

    was he dumb then when he outlined those theories 10 years ago or is just not telling the truth right now?

    would love to hear your thoughts.

  • The Undergrad

    But still, I’d like to think the people on this site took the time to read your writings. Then, generally speaking, conversations here would be more constructive, rather than circular. BTW, congratulations on getting ORCAM up and running. I’ll be sure to pass the site along.

  • http://ts millhouse

    when the us went off the gold standard in 1971 it was announced as a temporary move. more than forty years later, is it still temporary. is the federal reserve monetization the same type of temporary move.

  • Observer

    China and other emerging markets stops buying US bonds?

  • But What Do I Know?

    Sit on them for 10-30 years? Sort of belies the meaning of temporary. And when they mature, the Treasury will need to issue something to replace them. If the Fed doesn’t buy the new issue, that’s the equivalent of unwinding. If it does, that sure looks like monetization.

  • Very Serious Sam

    Fortunately I am not a trained economist, that’s why I don’t look all to stupid just because I never get why they central banks don’t buy on the primary markets, which should save the taxpayers fantastillions of dollars, euros, pound, yen…

    For instance, the ECB gave the commerical banks more than a trillion Euro in LTROs for about 1% interest, which the commercial banks then used to buy bonds, interest rates some 2….10 or so percent? This generates huge profits for the banks, may it cost the taxpayers what it wants, no? And the same principle applies in the US and everywhere, maybe with the exception of North Korea and Cuba, no?

  • But What Do I Know?

    Oh, and it wasn’t me saying the Fed “had” to sell their bonds–it’s Bernanke himself. Read the quote–he believes that an “appropriate time” will come along (presumably when the economy has recovered) and we can return to the status quo ante crisis. I simply contend that this is a pipe dream–the Fed cannot unwind its holdings, and will be forced to sit on them (and buy more). That is tantamount to monetization, whether they go through the intermediate step of buying them from the primary dealers or directly from the Treasury.

    Monetization is not necessarily the worst option–but let’s not kid ourselves with those soothing words “temporary” and “reversible.”

  • Andrew P

    Even 30 year debt has to be rolled over and TIPS pay more interest as inflation rises.

  • Pete

    So loan is inside money, created from thin air, and that loan generates equal amount of deposit. In the case of buying a house, the seller of the house gets the deposit. The seller can get the cash from the deposit, which is the outside money. Following the logic, loan from thin air by the bank (inside money), to deposit/cash, real money (outside money) by the Fed. Smooth transition. If nobody borrows, loan stops, deposit is absent. Bank stops creating money, then goes broke?

  • TheUnbeliever

    I am really baffled by what I am reading here.

    A cash-strapped government turns to its central bank, issues and borrows $100m of debt from it and pays the bills: undisputable monetization, right?

    A cash-strapped government turns to Donald Duck, issues and borrows $100m of debt from him and pays the bills. Donald Duck turns to the central bank and sells the debt for $100m: the end situation is strictly identical to that in the paragraph above and therefore there is undisputable monetization as well. Intermediation is not relevant. A crucial point.

    Additionally, remember that the central bank credits back the interest payment received from the government to the government: the net borrowing cost is nil, whatever the interest rate, confirmatory evidence that it is straight monetization.

    Where am I wrong??

  • Steve W


    I don’t have time to read all the comments on this topic, so please excuse me if this has already been addressed.

    One of my partners expressed a concern that the price of MBS has been pushed up by the Fed’s purchasing activities and that ultimately, the differences between the “high” prices being paid today and the values of the MBS at maturity will end up being more significant than people realize — and that gap is a form of monetization (or will result in monetization later). A crude example: the Fed pays 110 for bonds this week, holds them to maturity and gets 70. My partner’s contention is that the mortgages that are backing the MBS will experience significant defaults. I realize that MBS are more complex (and structered differently) than plain old bonds, notes, etc.. Do you think my partner’s points about “inflated” prices and potentially poor credit quality on the MBS are valid?

  • Obsvr-1

    unprecedented size of assets (aka crap) on the FEDs balance sheet;

    nobody, repeat, nobody knows what the effect this will have on the economy, money supply, inflation …

    If the new normal is for the FED to grow the BS to ever increasing monstrous levels, then hey, why not just monetize everything; in fact why not have the FED buy all Under Water mortgages across the land …. fairy tales run amok.

  • Obsvr-1

    If everyone just believed the information posted by CR (and definitely no disrespect to Cullen here, I totally appreciate this site and his intellect), then the blog would be empty.

    Good debate is the catalyst to learning and expanding the scope of knowledge.

    Remember the words of the legendary coach John Wooden
    “It’s what you learn after you know it all that counts.”

  • Obsvr-1

    very good….

    remember, If they take $1 billion from 330 million people and pass it to a small number of money/power elite … it is only $3 each

    so, the peanut buttering of the huge economic problem whether monetary or fiscal across 300+ million people (in fact over a couple billion people world wide, the other 5 billion being destitute) has been a well established practice of the boom/bust cycle caused (controlled) by the plutocracy (and the FED) .

    However, this time it is different as more and more of the “commoners” have instant access to information via the WWW – internet -. This time the emperor has no clothes and the world is on the edge of a revolution against the “New World Order”.

  • Obsvr-1

    you are right

  • krb

    Absolutely valid. And boy, are the tbtf banks breathing a sigh of relief that Bernanke took this marked-to-fantasy crap off their hands! Like I’ve said before, this has never been about jobs or economic recovery, that’s been the mealy-mouthed cover story… is a tbtf bank support program. Only fiscal policy can bring about real recovery action….and I define fiscal policy broadly…. including regulatory restructure, REAL health care reform, prosecution of wrong-doing so the rules become clear again, tax simplification so incentives become clear again, etc. etc.

    Going further, do you believe there is ANY chance these tbtf banks are going to allow electoral victories by any reform candidates that risk Bernanke’s audit or replacement and an end to this gravy train! I realize I may be dreaming that there are actually reform candidates out there, but if there are they have an ice cube’s chance in h… of surviving. krb

  • The Undergrad

    Your absolutely right, no one should just believe anything that is spoon fed to them. However Cullen’s explanation of how our economic machine ‘works’ shouldn’t be so contentious, at least to my mind, because it is descriptive only. Quite unlike any other economic framework, which insists on mixing the descriptive with the prescriptive.

  • Johnny Evers

    Thanks for the answer. The debt is being rolled over.

  • Cullen Roche

    The economy is built on inside money. Not outside money.

  • krb

    Good comment UG. Speaking for myself, I completely agree with Cullen’s description of the machine…..I’ve seen very little here to indicate that topic is contentious at all. What appears contentious to me is what policy prescriptions are actually happening, the efficacy of them, and what govt leaders are claiming about them.

    Another appealing thing about Cullen’s site is the apolitical nature of it……rarely is there the lib vs con viciousness you see on other sites. It happens, I’m sure I’m guilty of it myself sometimes, but its rare here compared with other sites. krb

  • Cullen Roche

    The Fed does not buy on the primary market. Saying the Fed is financing the govt is like saying that you’re financing Apple’s IPO 20 years ago because you bought 100 shares this morning. That’s completely wrong. Financing occurs on primary markets. The Fed does not buy on the primary market. And there’s zero evidence of a lack of demand on the secondary market. Yields falling after QE2 proved this DEFINITIVELY.

  • Johnny Evers

    One of the weaknesses of Cullen’s argument is that he will not address the question of ‘What if?’
    In this case, ‘what if rates rise.’ Anotther would be ‘What if we have inflation.’
    His tack is to argue that those things will not happen, so he won’t address the risk.
    Let me make a couple of analogies.
    Let’s say you are a military planner and the generals comes to you and say, ‘What if Iran launches a nuclear attack? Gives ua plan.’
    It wouldn’t be right for the planner to come back and say, ‘That will never happen, so I won’t do that.’
    Or let’s say you’re the mayor of San Francisco and you say to your engineers, ‘What if we get hit with an 8.2 earthquake.’
    It wouldn’t be right for the planner to come back and say, ‘Not possible. Not going to do it.’
    The point is that risk exists, whether we like it or not, and simply by planning for it we can better determine if your argument makes sense.
    MMR says that the only risk to excessive debt is inflation, but then turns around and says excessive debt does not cause inflation. So we don’t have to plan for it. If it happens, it’s out of our control.

  • Cullen Roche

    You mean, like, when I wrote this piece titled “What happens if and when rates rise”?


  • krb

    Simple question then…..

    With so much demand, why does the fed do ANY buying back of bonds from the PDs?

  • Cullen Roche

    Because they think it’s stimulating the economy by lowering rates and mystical confidence fairy effects….

  • krb

    Exactly! Without their (Fed) “demand”, rates would be higher. There is NOT sufficient demand, at the rates the treasury wants to pay.

  • Cullen Roche

    Doubtful. As I’ve said many times in this thread, rates FELL when QE2 ended. Everyone like you who predicted there was a lack of demand that would lead to surging rates was 100% wrong. Rates are low primarily because the Fed has kept the overnight rate at 0% and the economy remains weak. QE’s effects have been marginal.

  • Johnny Evers

    That proves my point.
    To the question, ‘What if rates rise?’, you say, ‘It can’t happen because the Fed won’t let it happen.’

  • krb

    There is little/no practical difference between a “promise” to buy from PDs in the secondary market or buying directly in the primary market. This is the fallacy of Bernanke’s attempt at deception or misdirection and his use of Webster’s narrow definition of monetization.

  • Johnny Evers

    Plus 1 to the Unbeliever.
    Cullen, to your Apple stock analogy, a better comp would be to Facebook.
    Let’s say that when Facebook issued its stock that I knew the Fed would buy it from me on the secondary market for $40. Well, of course I would buy the stock when it was issued. And if the Fed wound up buying a third of the company on the secondary market it would be the same as buying at the IPO.
    Of course that would completely distort the market for Facebook.

  • krb

    Then we should just stop here, because our arguments have become circular……if demand is so high low rates can be achieved without the fed buy backs, then there is no need for the buy backs. If the fed buy backs are lowering rates, then the absence of fed buy backs means rates would otherwise be higher.

  • Cullen Roche

    If the Fed doesn’t want rates to rise they won’t let them rise. What is confusing about that? They are the monopoly supplier of reserves to the banking system. They can control the entire yield curve if they want. This is an irrefutable fact.

  • Stephen

    Can we shift gears and focus on how this ends?

    What about excess reserves? I understand that if the Fed decides to hold assets to maturity, the asset side of its balance sheet will shrink accordingly. By definition, the liability side of its balance sheet will shrink by the same amount, and I assume it is the excess reserves that will decrease as treasuries/MBS mature. But what exactly happens to the excess reserve balances of these banks? Does the $ in these accounts simply vanish as assets mature, or do banks have the ability to transfer these $ from the excess reserve accounts at the Fed to their own balance sheet?

  • Cullen Roche

    Not correct. It highlights the inflation constraint. The only environment the banks would become unwilling buyers is in a hyperinflation when it becomes unaffordable for them to do so. They have choice, but they understand the boundary of their choice to buy the bonds. And as long as inflation is low they’ll be willing buyers. Fixed income traders all know this. Inflation is the constraint. Not solvency. Not funding. I don’t think you guys are quite connecting all the dots here. Maybe I am not explaining it very well….

  • Cullen Roche

    You keep saying demand is artificially high. I keep saying it’s not. We have crystal clear evidence following QE2 that you are not correct. What’s circular here? You would have made this exact same point before QE2 ended (just as many people did). It was wrong. I don’t know why you don’t admit that demand is not an issue. It’s abundantly clear that demand is not an issue.

  • dctodd27

    Yes, the Fed has complete control over the yield curve but it emphatically does not have control over the unintended consequences that go along with distorting free-market pricing. All the Fed would be doing is creating an increasingly unstable environment that would eventually blow up in its face. It is the price of the hubris of thinking you are bigger than the market.

  • Johnny Evers

    Why would inflation be a constraint on the primary dealers if they know the Fed will buy the bonds from them on the secondary market?

  • Cullen Roche

    The Fed is in the business of distorting interest rates. Of course there are consequences to this, but it’s pointless to argue whether or not this happens. It’s always happening. The Fed is in the interest rate distortion business.

  • Cullen Roche

    The Fed can’t control quantity value (purchasing power). If the purchasing power of the currency were cratering the banks would have no incentive to buy bonds and on-sell them. In fact, the economy and currency would likely be so unstable that no one would want to hold govt bonds at all. The Fed could hoover them all up to no avail. Who wants to do business with an entity that guarantees something that’s becoming worthless?

  • Very Serious Sam

    “The Fed does not buy on the primary market”

    Indeed. Same with the ECB. Question: why don’t they do it? Formal objections (like Article 123 of the EU Treaty) aside, for the sake of the argument: this would drive down the costs for the nations by a huge margin.

    And, of course, take away huge profits from the commercial banks. But, last time I checked, no constitution obliges the taxpayers to finance the profits of private banks.

  • krb

    We may not be agreeing on the fed’s intent or effect, but I think we’re close on everything else. I agree with everything you just said about the inflation constraint, etc. It comes down to the fed promise to buy them back in the secondary market…..with the fed promise in place their (PDs) willingness to keep facilitating treasury issuance will remain high…..they’re skimming nice risk-free profits after all, legal requirement or not…..withdraw the fed promise and the PDs attention to the inflation constraint relative to the profits they’re skimming goes way up.

    I hadn’t thought about this before your reply, but was/is the fed’s quick buy back, sometimes within a few days of issuance, any insight into the PD’s or Fed’s skittishness about the inflation constraint….otherwise, what’s the point? With SO MUCH secondary demand out there there wouldn’t, apparently, be any trouble reselling those bonds. (sarc)

    Contrary to what you may think or feel, I don’t like arguing with you……I’ve learned more from you and PC than anywhere. I simply believe where fed policy actions, impact, and explanations are concerned you are ignoring the practical or common sense view in order to abide by the narrow definition……which, in my view, is what Bernanke/Geithner hope everyone will do. I’m not coming up with conspiracy theories or ideas counter to MR…..I’ve exclusively taken common sense positions…..if fed buying lowers rates or raises prices from where they otherwise would be, removing the fed demand will do the opposite.

  • dctodd27

    Then the Fed shouldn’t be surprised when (not if) something extraordinary happens to derail their efforts.

  • Cullen Roche

    It’s not an argument. It’s a debate. I don’t know everything. These are just my views based on my understanding. I could be wrong. One day I might be proven totally wrong. But I’d say that my track record is pretty good thus far on this stuff….

  • Cullen Roche

    Agreed. :-)

  • Geoff

    I’m also concerned about price distortion in general, but not really in the case of Treasury securities. The US govt is the monopoly supplier and should therefore be able to price them where they want.

  • Colin, S.Toe

    I don’t know enough to say for sure how huge a problem QE may become, but I fear you may be right.

    Where I would disagree is that Bernanke and Geithner know “it is a tbtf bank support program”.

    MY take on those those whose experience is limited to narrow circles (Ivy League Academe; GS, JPM et al; private equity; etc) is that they confound narrow interests with systemic good. Thus the CEO said “what’s good for GM is good for America” without any self-awareness – whether of arrogance or irony. I find this more terrifying than cynicism or hypocrisy.

  • JJTV

    The Fed is buying the securities from the primary dealers because they believe it has some effect on the economy (forcing rates lower by increasing demand). The Fed has the same theory on MBS (force rates lower by increasing demand). This will result in new home buying (good for economy) or refinancing (more money in people’s pocket, good for economy).

    As was the case with Primary Dealers in Australia, I would expect the same from the primary dealers in the US. Also bear in mind that primary dealers are reselling to pools of managed money for which there is a significant demand. If you look at the flow of new money into fixed income securities you will see adequate and increasing demand across all spectrums of securities.

    The demand is real, however, the Fed is offering to buy large amounts of securities as part of their open market operations. The purpose of the primary dealers is to aide FOMO and create a market for the securities. I agree with Cullen on this one. The demand is not “fake” or supported by the Fed. Take the Fed out and you still have a lot of demand.

  • Ted

    Forgive me Cullen, but why then is the fed doing this if the debt isn’t being monetized so people can spend the money and create jobs etc… Why is everyone so excited if all they are doing is selling short term debt and buying long term? Thanks.

  • krb

    It’s this simple, in my view……is the fed buying lowering rates/raising prices?…….or is it not?

    If it IS lowering rates, then its demand is material in the whole. I’ve never said they isn’t “a lot” (your term, not mine) of demand other than the fed demand. What I AM saying is that other-than-fed demand is insufficient to lower rates or raise prices to where the fed or treasury want them… HAS to be, otherwise the extra fed demand would NOT move the needle on rates and prices, and the fed could stand aside.

  • kim

    I think that whether the losses are monetisation depends on the approach.

    If the CB simply creates money to cover its losses, that’s monetisation.

    If the CB decides to wear the losses, and trade out of them, or receives a promise from the government to cover the losses (to be paid out of government revenues) that’s not monetisation, just unfortunate and a bit embarrassing.

    Even then, it might have been the best policy choice when the alternatives were worse and hindsight not available. Not saying that it is, but sometimes you choose between the least bad, and are groping in the dark.

  • Windchaser

    Just to clarify, you believe that the bond vigilantes can/will act on the *short* end of the curve?

  • Colin, S.Toe

    PS: This is the pavement on the proverbial road to hell (where we may all join krb’s ice cube).

  • JasonH

    OMG, as Cullen notes, the FED has virtual control of short-term rates & huge influence on long-term rates (even more than the market).. see the previous charts posted on how interest rates follow short-term rates set by the Fed exactly & almost exactly for long-term rates

    Bond Vigilantes HAVE NO POWER against the Federal Reserve WHO HAS UNLIMITED POWER TO CREATE RESERVES for perpuity

    Warren Mosler is running for Congress (he got 37% of the vote last of the US Virgin Islands)

    -get the word out so that he’ll enter Congress & change it for the better instead of the clueless deficit-hawks there now & improve the US economy so that our finaacil portfolios grow!

    It’s win-win because when his recommendations are enacted, our stocks & funds will go up along with the economy!

  • Ricky

    Your example is not wrong but you didn’t analyze something very important. You said, “A cash-strapped government turns to Donald Duck, issues and borrows $100m of debt from him and PAYS THE BILLS.” When Treasury “pays the bills” it increases bank reserves by your $100m. It’s kinda like there’s a yin to your yang example which evens things out.

  • off_leash

    I think it would be helpful to many of your readers if you came up with a checklist of sorts, that could be used to identify a point at which the Fed could be justifiably accused of monetizing the debt. It is unlikely that there will ever be a clearly defined leap from QE to monetization. Any such change would be a slow, creeping one that would occur so gradually as to be effectively imperceptible. Think sunrise on a foggy day. I feel it would be useful to lay down some list of objective criteria before the fact, so that our definitions don’t shift over time, and the issue can be constructively debated.

  • Zio

    I’m confused how some comments on here say there is no printing or inflationary effects from the Fed QE actions in any way shape or form, it’s just an asset swap.

    You pointed out a very example I’m confused with… If the Fed is taking a toxic bond which the issuer has defaulted (e.g. pays 0% and/or high risk of ever getting anything), and credits that bank’s reserve (swap), and now pays .25% risk free guaranteed interest to the bank on reserve, isn’t that printing money by that .25%?

    Am I missing something here?

    The other question I can’t figure out is where does the Fed get money to pay the .25% interest on reserves? Is this money out of thin air?

    On a side note (well, relevant to printing), I took a monetary policy class last year, taught by a FED EMPLOYEE, who stood in front of our class and said, quote, “We print money out of thin air!” he then held up a dollar bill to the class and said quote, “You see this? We don’t print this anymore, heck this cost 5 cents.”

  • wh10
  • JKH

    “today money”, “tomorrow money”?

    rather messy

    Bernanke’s criterion is based on one thing and one thing only – QE is intended to be long duration, but not permanent – they’ve been describing their approach to exit strategy for several years now, and this just emphasizes it

  • JasonH

    FYI, the Federal Reserve can also CREATE fiat reserves out of thin air to buy bonds from private banks

    it has this power by law & it’s charter to create as much fiat reserves PERPETUALLY as it needs forever unless modified/changed by law –unlike regular banks, it does NOT need reserves or other money to do so.

    So it can always payoff/buy bonds from the private market or US gov(as a last resort buying directly) —“you can’t fight or outbid the Federal Reserve when it has infinite ammo”

    ie, if the Fed says it will buy X bonds for X time at X interest rate/price, it can do so infinitely

    Can the banker in a game of Monopoly go bankrupt? That’s how the rules were made & how the rules are made now –it can’t!

    Back in the old days of the golds standard, ya, but it’s all fiat now –and for the better too if you look at history where 17+ year long Depressions & wild inflation/deflation was rampant every 3 to 4 years.

    It can still be improved much more too, btw if it incorporated MMT or MR policies

  • JasonH

    Primary Dealers buy & the general population & Japan, China, Europe,etc buy US gov bonds because they GIVE GUARANTEED INTEREST INCOME that is safe that will be repaid in US dollars (that can purchase $15 trillion in US goods & services from US foods, cars, software, machinery,etc)

    Primary Dealers want US bonds because they can resell them AT PROFIT to the general public/private market because there is huge demand for them because there are millions of people who want interest income from grannies to retired people who don’t want the risk of the stock market or commodities

    ie, it’s the reason why banks want to be the underwriters/banks that do the IPOs for Google, Apple, or Facebook where you are guaranteed interest income on the bond –they can make millions/billions in profit acting as the resellers for US gov bonds

    Also, other banks buy US gov bonds because they are counted as ASSETs of the bank in their capital requirements as well as serve as reserve substitutes also (banks can buy US fed gov bonds with their reserves)

  • Cullen Roche

    Yeah, I also think the tomorrow money vs today money is overly complex. I don’t know why people have such a hard time understanding the basic accounting behind QE and standard monetary operations. The Fed buys and sells assets in QE just like they do when they target the overnight rate. Except in QE they’re targeting a longer duration set of rates or rates outside of Tsys. But for some reason everyone makes a big deal out of QE without ever noting that it’s just open market ops on a different part of the curve. And implemented in a totally different way (not by targeting an exact rate) which makes it even less effective than targeting the overnight rate….

  • Cullen Roche

    There’s no such thing as “MR policies” and I’d appreciate it if you took the time to learn MR so that you stop mixing MMT with MR as you so often do. This is not an MMT website and your constant promotion of MMT and confusion of MMT with MR is confusing a lot of people. Here’s a very detailed link on the MR critique of MMT. They’re totally different views of money and the economy so mixing the two is like mixing oil and water.


  • JasonH

    STockman is a fool stuck in the outdated paradigm of gold/commodity backed currency where savings funding investments where banks are limited in their loan creation powers by how much reserves they have… but in fiat non-convertible curency systems like US, Japan,etc –bank loan creation powers to giving loans out for investments DO NOT DEPEND on their savings deposits nor reserves… banks loan/create money first, & borrow any needed reserves from the interbank market or Federal Reserve later after the fact

    This is why Canada operates it’s banking system without reserve requirements & why Federal Reserve that it too remove the reserve requirements for banks too & Federal Reserve’s own papers on it’s websites show that banks are no longer limited by reserve requirements –and admits it on it’s website also

  • wh10

    Yeah, Izzy’s analogy didn’t really click with me either (although the Rubik’s Cube visuals were kind of cool).

    The other difference with QE vs OMOs, and the one that makes it contentious IMO, is that it affects non-bank balance sheets, whereas OMOs typically just interact with banks. We all agree # reserves for banks doesn’t affect lending potential. But how does #deposits vs other types of financial assets on non-bank balance sheets affect spending/saving behavior? This is the issue. I’m not sure if I think the today vs. tomorrow money thing explains the dynamics properly.

  • Cullen Roche

    That’s what the Fed does though. They shift the quantity of outside money in a manner that is supposed to have an impact on inside money. I know there are a lot more moving parts here than that, but QE is not nearly as magical as people imply it is.

  • JasonH

    sure, won’t use them together..

    when I see MR & MMT policies, I mean that the recommendations that they both share, which is increased deficit spending as boons to the economy (significantly cut taxes to most people such as suspension of payroll taxes, more gov funding technology, power & increased production)

    .. I exclude the job guarantee since that is major policy difference & exclude state theory of money (both of which I think is irrelevant when it comes to the bottom-line & results)

    It seems to me that MR’s mains operational difference is the inclusion of Primary Dealers whereas MMT just glosses over that as saying the federal gov via control of the Federal Reserve has final power

    For me, the main point is how the final effects on the economy/money/inflation/etc because that is what really affects our stock/finacial portfolios, jobs, employment rate, etc & in that, MR & MMT both describe the same thing, right?

    so “the origin of money, whether it’s ‘state theory of money’ that originated from gov vs. private banks/primary dealers & private inside money””
    “the how” of whether it’s Primary Dealers or gov acting through Federal Reserve/Primary dealers is secondary & not that important in the final after effects

    Because it all comes down to the bottom-line of what effects it has on our stock/finacial portfolios, interest rates finacial effects, unemployment rates, bond rates, etc

    MR & MMT both say that interest rates of countries that issue their own currency(thru primardy dealers or federal reserve or whatever) where
    the gov ultimately controls the central bank depend on the target rate set by the Federal Reserve, regardless of mythical bond vigilantes, credit ratings, or size of gov debt/deficit..

    which is true & why US, Japan, & Singapore have almost 0% interest rates, 0%-3% inflation, etc for the past 4 to 20+ yrs despite upwards of 200%+ debt levels

    Anyways, the economic theories that are really oil & water are Mises/Austrian/libertarian, Chicago School, etc —those economic schools of outdated myths are disproven by facts (they predict hyperinflation & higher interest rates despite all evidence to the contrary) & are the opposite of MR & MMT which are the only 2 schools that are correct

  • JasonH

    I understand you want MR to be policy neutral & politically neutral.. that if the gov/fed reserve does X, Y will happen.. if it does A, B will happen

    Do you realize that if MR says if Fed Reserve or gov can do X policy to try to improve the economy/unemployment rate (as it it’s mandate) & it won’t cause hyperinflation (or significantly higher inflation), nor higher interset rates, etc

    –then it directly contradicts the ‘conservative’ deficit hawks of the Austrians/Tea Party/Republicans? It becomes the enemy of Austrians, conservative economists, Tea Party/Republicans?

    If MR says that signficantly cutting gov spending/austerity will lead to worse economic results (sch as laying off 400,000+ gov workers as UK did resulting in worse economy), it also contradicts & becomes the enemey of ‘conservative’ economists/politicians

    It reminds me of the fitness trainers, doctors, gyms, dieticians who tried to be neutral when hi-protein/low-starch diets first appeared in the 1970s & then popularized in the 1990s showing that they had TWICE the fatloss of low-fat diets & still had better heart/triglyceride health levels..

    the medical establishment & mainstream media establishment attacked Dr. Atkins & Dr. Atgaston(South Beach diet) as false & incorrect because they contradicted the ‘low-fat is best’ paradigm that was taught for the past 50 years
    gyms like 24 Hour Fitness tried to be neutral saying they were neither for nor against any hi-protein diets

    It also reminds me of when Dr. Sammelweiss(a gov doctor at at public university hospital in Austria) that introduced antiseptic/disineffecting procedures in 1847 (before the discovery of bacteria) that reduced death rates by 90%
    requiring doctors to disinfect their hands before delivering babies/surgeries
    the medical establishment & authorities back then also attacked him
    fought against them because it meant that the authorities & the doctors of the day were killing their patients because almost all of them never used antiseptic procedures –it was unheard of!

    It took more than 30-50 years later before their policy recommendations (antiseptic procedures & hi-protein/low-starch diets) became accepted after dozens of studies by Pasteur in the 1880s & weightloss/cardio studies by Stanford/Princeton in 2000s.

    It wasn’t just the studies/experiments because most old people/authorities are stuck in their ways of thinking & dogmatic & refuse to admit that they were wrong..

    it also takes 30-50 yrs for those dinosaurs in positions of power stuck in their ways who refuse to accept new empirical evidence that contradicts their previously held beliefs they first learned (as kids or first read in school) to retire and/or die off so that new correct policies can be implemented & old myths allowed to die off.

  • Cullen Roche

    No, you clearly don’t know what MR is. There is no such thing as MR making a “recommendation” of “increased deficit spending”. That is MY current opinion based on my understanding of the monetary system.

    Saying the difference between the state theory and MR’s view is “irrelevant” is like saying that a capitalist should call himself a communist because they both end in IST. MR DESCRIBES how we have a market based monetary system based primarily around the private sector and its independent private purpose serving banking system. MMT describes a government based money system in which all money comes from the govt in a state form and the monetary system exists for the purpose of public purpose. MR says this is wrong and that the money system exists primarily for private purpose. Saying this difference is “irrelevant” is missing the boat by an entire ocean. MMT is state centric. MR describes the reality – which is private sector centric with govt as a facilitating feature. Everything MMT does flips this role around and makes the state the center of the economic universe. It’s a flawed view of the world.

    You might read that link I offered previously. The differences here go much deeper than you imply.

  • Tom

    Didnt realize you were only 32. Congrats you have seemingly had a lot of career in a decade.

  • JasonH

    Hey, I agree that MR is more accurate description of how the US monetary/currency system was created (by bankers & for bankers)

    But the end result is the same?

    And ya, I assumed because you are for creating a gov fund to fund technology & increases in production (like a giant investment bank similar to what China, Singapore, & Japan does) & that you’re for increased fiscal policy/deficit spending that was also MR

  • Cullen Roche

    Thanks Tom. I feel like I’ve been around forever. It’s been a long decade. Due to the unusual historical circumstances, I’ve been forced to cram a lot in. :-)

  • Cullen Roche

    I don’t think the end result is the same at all. If you learn the monetary system from MMT you come away with a state centric view of the world. If you learn MR you come away with a private sector centric view of the world. Personally, I think MMT abuses the state centric description in order to promote their prescriptive portion. It distorts reality and results in errors in understanding.

    MR is just descriptive. When you hear me talking about my personal political or policy preferences I am not saying MR endorses policies. I am saying I do personally. There’s no policy ideas embedded in MR. It’s a descriptive view of our monetary system that is intended to help people understand how the system works and is designed.

  • JasonH

    OK, thanks for clearing that up..the CIA World Factbook lists that about $7 trillion of the US $15 trillion economy is based on credit/loans (aka money creation) so the economy absolutely depends on ‘inside’ money creation by private banks..

    … and when the private banks reduce their money creation, recessions happen unless the gov steps in to counteract the contraction in money creation by fiscal policy/gov money creation.

    MR is more accurate than MMT.. on the bright side, the descriptive element allows for fiscal policy/gov money creation/deficit spending to do as described above to increase production without fear of higher interest rates nor hyperinflation, bankruptcy or insolvency (those are the biggest insights) up until the point of maximum real production (ie, full employment, not idle factories, etc)

    –none of the doom/gloom by Austrians/conservatives decrying gov spending as long as the economy is stagnant(high unemployment & lax production capacity)

    Even my conservative friends agree that increased spending by consumers increases business income & spending & stimulates increased production (which increases hiring & also offsets any increased money supply/offsets inflation)

    So the goal is to increase production to increase material standard of living for the population, from FDR’s electricity to most of the population of the US, GI Bill’s benefits that funded military mortgages, university educations, business loans, healthcare

    –ie, as your article on China showed, the point that China & Japan built tons of hospitals, production-increasing factories, cities, bullet trains, etc is to increase supply of those for the population to utilize in the future for their benefit

    They hit snags when some of the cities were ‘empty’ (unlike Singapore that had a 1 home er person policy that gets gov help, China allowed no limits..thus, the homes were all bought up by distant far-off speculators/house flippers who priced them out of reach of the local population who would use them –China is solving it by reducing their prices by 33%-60% & giving out loans to cover the difference)

  • Dave

    Dear CR, you write “Monetizing the debt implies that there is not enough demand for government bonds and that the Fed needs to backstop the market for government bonds.”

    First, to me monetizing means that the FED prints money to lend to the government to pay the securities at maturity (so at maturity securities are not anymore payed with tax dollars which would take out money from the system).

    If the FED implies that it will purchase / swap for billions of $ bonds, who can you argue that the FED does not backstop the market? This is wishful thinking.

    And yes, the primary dealers have to bet, but the rates they will ask for in the future might by disastrous. Especially if Bernanke throws his bonds (together with the treasury) on the market to take out liquidity.

    Then with the primary dealers there is much confusion. They only have to bet for the securities at the bond auction by the treasury. If Bernanke wants to sell “his” bonds there is no auction and no law to force the primary dealers to buy. It all depends on the premium they’ll get from the FED.

    Bernanke is actually with his back against the wall. If he wants to start sell his securities to take out liquidity the bond price will eventually be damaged. The banks will expect ever higher bond rates in the future and not buy securities (even with a premium) from the FED. And if Bernanke holds the bonds to maturity the total supply of dollars will decrease rapidly. And the government can’t finance it’s debt anymore. So then either the government is broke or Bernanke starts to monetize in the real sense.
    The other problem is that bonds are liquid as money. So if the banks buy “Bernanke’s” bonds they will sell them right away and be liquid again, which won’t be intended by the FED. The excess reserves are already now filling the stock bubble. The excess liquidity might fuel a credit bubble and huge malinvestments.

    The FED is trapped in a spiral. I really wonder how the markets will react if Bernanke tries to take out the excess liquidity if economy improves.

    But having said that, the “deadliest” inflations in the past never occurred because of excess in the banking system but rather from government deficit spending.

  • Cullen Roche

    Right Jason! To me, the power of MR is that you can understand and still have whatever policy preference you want. You can favor job guarantees or austerity or deficit spending or whatever. Understanding the monetary system isn’t some magical fix to making the world a perfect place. But it helps steer us in the right direction.

    And on understanding the private/public dynamics I prefer to think of the stock of financial assets in the economy. The govt is directly responsible for roughly $16T of our net financial assets. Whereas the rest is mostly built from private investment and private expansion. Getting this public/private balance right is crucial to a sound understanding of how the monetary system works.

  • Dan M.

    If the market controls rates, then the market is SCREAMING at the US government to borrow right now. So let’s just assume you’re right and enact another payroll tax cut and stimulus.

  • john

    The “the Federal Reserve,” despite the fact that they are not federal, and they keep no reserves, agrees to “buy” all the bonds the government does not sell. During this exchange, trading new paper currency (paper) for a real live Treasury bond (money), the Fed is not really buying anything, they are selling freshly printed cash, at interest. The government is actually buying spending cash, using real money, or our bond, which is a binding promise that our children will toil on the central bank’s behalf.

  • Colin, S.Toe

    The last thing I am is a ‘gold bug’, but this is the part I have a problem with.

    Sure, unlimited credit/debt money creation by private banks can fuel rapid (and reckless: eg ‘housing bubble’) expansion, but by the same token, equally rapid contraction. (Canada has a ‘commodity driven’ economy that has been able to cash in on the long boom – if this is starting to see a major contraction, look out below for them.)

    If the Fed steps in to limit the latter (Greenspan & Bernanke ‘puts’) it risks rewarding bad behavior by banks, while not protecting or even harming ordinary household interests.

    Moreover, the banks get to collect interest on virtually every dollar in use, funneling profits and power to the financial sector at the expense of the producing economy.

    The only solution I can see, short of ‘100% reserve’ banking, and probably an expanded government presence within the banking system, would be to severely limit the ratio of credit/debt ‘money’ the banking system can create.

  • Pierce Inverarity

    The Federal Reserve does not buy bonds that the government cannot sell. It can only buy bonds on the secondary market after Primary Dealers have purchased them. Which means the Primary Dealers have, at some point, used reserves to purchase bonds at the original issuance auction. The Fed, during QE, then offers to buy those bonds back in a reverse operation (giving the banks back their old reserves). There is no creation of new financial assets in this process.

    Please learn the facts before posting.

  • Colin, S.Toe

    PS: Such limitation ought to increase the effectiveness of fiscal policy in stimulating or stabilizing the economy, since the dollars (NFA) added to or subtracted from the system would represent a greater proportion of those in effective circulation.

  • krb

    You have it correct. Anyone claiming there is NO inflationary impact is focusing only on the macro view and aren’t getting into the details, and are doing the fed’s bidding by the way. It may not be as inflationary as it would be if fed cash went directly into the economy, or if the govt/treasury doubled deficits…..but there are several ways the Fed/PD activity lets cash leak into the economy…….the fed itself has admitted as much when they state that among their goals “is to raise prices higher than they otherwise would be”.

    Another issue I haven’t seen much attention on since the fed expansion of their tbtf bank support to MBS….what price are they paying for them? Up to now they’ve been buying back treasury debt, and while the PDs are skimming some nice profits along the way, no one could argue they were off-loading impaired assets. With MBS the question of impairment, and to what degree, SHOULD be now front and center in our discussion. Many of these assets are worth much less than when issued/bought. We also know the banks have resisted marking these assets to market and kept them on their balance sheet at full value. I’d be curious to know what price Bernanke is now paying to take that crap off the banks hands…….impaired price or full price?! I think we all know by now what the answer is…….just another reason we’ll never see a full and transparent fed audit and why reform candidates, if there are any, have no chance of getting elected. krb

  • krb

    this was a reply to Zio above…

  • Edward Bailey

    Maybe he is relying of hopes that developing countries will want to purchase US assets as their currency appreciates. Maybe he hopes that as the US modernizes the infrastructure, Americans get their acts together and become productive members of the modern world, and the various entities who are sitting on mountains of cash, as a result of the Govt taking on loads of private debt, finally begin putting that cash back into economic rotation, then he will be able to unwind what the fed has taken on and reap a healthy profit for the Federal Reserves private banking member clients.

  • Dave

    Dear CR, the markets – as we saw with QE3 – where expecting the FED to step up and to do “something” (which means buying bonds since other instruments where already useless). So the market/banks anticipated the FED actions. If we look at the stock market we see that weeks before QE3 was announced media wrote plenty of articles claiming that the FED has to step up again and stocks went up because everyone was anticipating the move.

  • Arnold

    I’m confused. This sounds like a case of a bunch of learned economists all with their own motives and vastly different expectations for the same complex actions? Seems like I can bet on no one knowing what will happen, except I can follow the long term fiat trend of devaluation, asset/commodity price rising (but maybe not real prices) and perhaps another real estate bubble. Are we arguing over how much inflation Fed actions will result in? Or the definition of inflation vs. disinflation; CPI vs. other measures; money supply vs. price trends?

    Is the point here that Krugman things Ben should do more to create actual significant inflation?

    From Krugman:
    “I’m a bit puzzled by the tone of this FT report on how QE3 is doing so far, US inflation fears rise after QE3, which seems to imply that a rise in breakeven rates — the difference between the interest rate on ordinary bonds and inflation-protected bonds — is a danger sign. (Breakeven rates are a simple gauge of expected inflation).

    On the contrary, it’s the whole point of the exercise. For almost fifteen years, some of us have argued that central banks can gain traction even in a liquidity trap if they can create expectations that money will remain loose after the economy recovers, generating modestly higher inflation. And that’s what the Fed’s new tack is supposed to achieve.”

  • Arnold

    As far as I recall, this all comes down to what the commercial banks choose to do, do they spent the excess reserves they acquire via the fed’s actions? Are you just saying the Fed won’t let this money be dumped into general circulation, thereby causing much higher inflation?

  • Arnold

    Sorry for 3 comments in a row. I understand the US can’t technically go bankrup, not sure anyone is really arguing that it can technically. I’ve always thought the real fear is if belief in the monetary system itself. Sure the Fed can create whatever money it wants and the Fed government can create whatever laws it wants. The amount of QE is like the lack of the emperor’s clothes… at some point people will start to recognize that he is naked, and then his fairy tale rule will dissolve. At that point people will look to get out of the dollar. What am I missing?

  • Cullen Roche


    Banks don’t spend reserves. Reserves are deposits in the interbank system used ONLY for settling payments and meeting reserve requirements. They don’t get spent into the economy. And they don’t get loaned out either….

  • Arnold

    OK, that may be true but then it is simply correlated with what can be lent out, since it is a reserve serving as collateral for loans, no? An increase in reserves could allow banks to increase lending?

  • Cullen Roche

    Banks are constrained by their capital. Not by their reserves. Reserves are merely an asset. When a bank makes a loan it finds reserves AFTER the fact if necessary. QE does not change the net financial asset position of a bank (bonds, an asset of the bank get swapped for reserves). Therefore, it does not make it more or less capable of making loans.

  • Cowpoke

    Cullen, How could one best relate in layman’s terms the social value comparison of Reserves being an asset?

    For example, A home, a motorcycle a boat a gold krugerrand could be considered assets. However, they all have varying value daily with regards to their meaning/term asset with regards to the amount of inside money they can be exchanged for. Do Reserves have the same amount of fluctuations/ constraints?

  • baburunotoki

    Hello Cullen,

    QE does not monetize but QE can create specific assets bubbles.
    Could this end up having some inflationary impact on aggregate demand, say if holders of stocks were to cash in their profits ? Or would that be compensated by holders of annuities that are loosing when interest rates fall ?

    Thank you !

  • Cullen Roche

    Think of reserves as cash held on deposit at Fed banks for use in the interbank market. They don’t leave this market and they serve only to settle payments and meet reserve requirements.

  • Cullen Roche

    Yes, it can distort markets. See this paper I wrote.

  • Conscience of a Conservative

    QE may not be directly change a bank’s balance sheet since a bank gives up one asset( Treasury bonds) for another ( cash reserves sitting at the Fed) but that action is at the bank side not the Fed Side and the discussion that the Fed is not monetizing or printing isn’t discussing how the Fed accounts for it’s side of the equation. The Fed is now holds an unprecedented amount of debt. And banks don’t have to keep commit that Free up Treasury bond or MBS as cash, but can purchase commodities, Swaps CLOs etc. The Fed’s QE move may not be able to increase bank lending, but it can increase the amount of cash floating around, since it’s Treasury bonds and Taxes that sop up liquidity.

  • Arnold

    When is it necessary? When they are highly leveraged to begin with and approaching imposed (self or regulatory) fractional reserve limits? I don’t see how it matters whether it needs to find reserves to cover a loan after or before. What happens if they can’t find reserves? Presumably it must curtail loaning? If it is pumped up with reserves, it could, if it chooses, loan more? What am I missing?

  • Arnold

    In other words if it has been lending previously seeking now gotten reserves from the Fed, why wouldn’t it play the game again to entice further reserves from the Fed? Is the commercial banking cartel that afraid of market discipline after round after round of bailouts?

  • Colin, S.Toe


    It helps to think of the banking system as a single large bank. When this ‘bank’ makes a loan, it creates and credits new credit/debt ‘money’ to a new account (a liability, with a new ‘loan receivable’ as the corresponding asset). It doesn’t have to ‘cover the loan’ since the new ‘money’ exists and stays at this ‘bank’ (nobody takes out a loan in order to covert it to cash to keep under their mattress).

    In reality, the borrower (or the seller of a house or car to him) might deposit the funds at a different bank from the one that made the loan, forcing the latter to make a ‘payment’ to the former, but through the interbank lending system, it could borrow reserves from the former to cover this payment. Reserves are there to cover payments, not loans. If necessary the Fed can be relied on to provide additional reserves to keep the payment system working – on a massive scale if necessary, in the event of crisis, mass defaults, etc, causing interbank lending to freeze up, as it did in the fall of ’08.

    This fact – that the ability of the banking system to create new ‘money’ by lending – is not ‘reserve constrained’ – is what has led me to ask if there is any practical measure that could limit such lending by the system as a whole, eg to some ratio of base money/NFA (Net Financial Assets). Others favor something like the ‘Chicago Plan’ based on ‘100% reserve’ banking.

  • Indignado

    An additional question on this point: what about the purchases of 40 billion of MBS a month being implemented indefinitely by the Federal Reserve. Is this a first step towards a solution to the consumer balance sheet recession? Would you recommend an extension of this program and have the fed purchase a higher volume MBS securities to bring relief to the large portion of underwater home owners in the U.S. How about expanding this program to auto loans, student loans, and other unpayable debts in the financial system? Is it possible to QE all outstanding private sector debt in the hope of stoking the flames of consumer demand?