The Fed can’t buy from individual investors, only from the primary dealers (commercial banks) who act as an intermediary for either the Treasury or the investor but pays the primary dealers in the form of bank reserves. I think you’re saying in effect the Fed buys more from the individuals via the banks than either the banks’ own holdings or from the Treasury? I don’t think the gated reserve theory is a theory but rather simply the mechanics of how the bank works?
In any case if the Fed does buy bonds from an investor via the bank then that cash deposit for the investor is a liability for the bank, not an asset. How would it improve leverage ratios?
Primary dealers are market makers. Technically, yes the Fed purchases through the market makers, but the flow is coming from external parties, not the balance sheet of commercial banks. This much is clear if you simply look at the stock of UST + MBS on commercial bank balance sheets. The gated reserve theory is not how QE is described by the Fed or BOE - they agree with my explanation here. GRT I think is primarily based on the incorrect assumption that QE is taking securities off of commercial bank balance sheets (its not).
For avoidance of doubt I agree with the portfolio rebalancing and the effect it has which obviously was what QE intended for, and it’s for this exact reason why commercial banks hold more bonds than ever. They swap the reserves for bonds from treasury or other financial institutions. They don’t pay for these bonds using real economy money so to speak, because “real economy” money is a liability for the bank, not an asset. All it is I believe is an asset swap between reserves and bonds for both the central bank and the commercial banks with other instructions and the Treasury.
i just want to ask about commercial banks as a role of "PRIMARY DEALER". Because role of PRIMARY DEALER is to fill clients' ORDERS by itself trading, PRIMARY DEALER is known as INTERMEDIARY that connects BUYER and SELLER of SECURITIES. The reason resulting in increase in"FEDERAL RESERVE" (effect of QE) comes from increase in "DEPOSITS" (because PRIMARY DEALER connects FED and BUYERS from private domain ) - result in increase in PRIMARY DEALER's BALANCE SHEET, not comes from "LIQUIDITY ASSET SWAP" (Primary dealer swaps its OWN holding treasury security to FEDERAL RESERVE) - NO CHANGE in the scale of primary dealer's BS. Talking about aspect of "TREASURY SECURITIES", THESE INSTRUMENTS are issued by TREASURY. To understand whether QE is "PRINTING MONEY" (increase in money supply or broad money) , we need to understand the purpose of ISSUING TREASURY SECURITIES. If
i. They are issued to ROLLING OVER previous Government debt (maturity treasury security ). From my perspective, QE does not result in INCREASE BROAD MONEY because FED directly inject money to TREASURY "within the air" and TREASURY use this to repay FED --> MONEY created with the air just comes back from FED "vault"
ii. They are issued to "PRE-FUND" US GOVERNMENT DEFICIT or FUND US GOVERNMENT SPENDING, QE does result in INCREASE BROAD MONEY because EXPENDITURE from government comes into REAL ECONOMY
I am looking forward to hearing your response and comments whether i misinterpret QE. Have a good day!
Hey Bear, new reader and going through some of your historic posts (which i'm loving btw). The only question re the reverse flowback point is that we didn't see a commensurate rise in bank deposits with bank reserves during the first phase of QE, pre-COVID. So the money did effectively flow straight from the fed to the commercial banks without touching the real world?
More so , yes. Perhaps the best way to think about it, is without fiscal spending as a direct channel to transform QE into deposits, it takes more time for the commercial banking system to "digest" the QE. But critically, this digestion process takes time and continues even after the Fed shrinks its balance sheet with QT. For more on this, read my more recent piece, The Furnace.
Thank you very much for the article. I think it is super interesting how you describe the different theories. I would have maybe two questions regarding QE, which I am a bit unsure about.
Japan for example is doing QE since the 90s if I remember correctly yet they don’t have for example the massive inflation the US or Europe is facing (maybe because they didn’t increase the amount of money that drastically). Do you know maybe the differences in QE policies Japan and the US did?
And maybe another question: what do you think about the Modern Monetary Theory?
Great writeup. I recall a succinct description of QE/QT being something along the lines of: QE results in asset inflation and price deflation, QT results in asset deflation and price inflation. The main reason there has been fairly muted inflation for the past decade of QE (compared to today) is because nearly every financial contract globally is denominated in USD as a function of being the world reserve currency. As global growth expands so does the demand for USD and much of these dollars are used for increasing the supply of things. In essence, the US exports it's inflation. On the flip side as global growth contracts and the USD becomes stronger relative to other currencies, so does the value of those dollar debts become greater. It is counter intuitive but the Fed trying to tighten further is only making it harder for inflation to come down, unless they pull a Volcker and absolutely destroy the demand side of the equation. Which wouldn't really help with the issue being mostly supply side, as a decade of underinvestment in the energy sector is what mostly brought us here to today, on top of a historic fiscal spending response to covid.
Thanks! I tried as much as possible to avoid the term "inflation" here because while monetary policy is a key variable, it is not the only one. My personal explanation of current consumer price inflation is best described below and include discussion of both supply and demand issues:
Love the reading
All models are wrong, some models are useful and some models are dangerous
The Fed can’t buy from individual investors, only from the primary dealers (commercial banks) who act as an intermediary for either the Treasury or the investor but pays the primary dealers in the form of bank reserves. I think you’re saying in effect the Fed buys more from the individuals via the banks than either the banks’ own holdings or from the Treasury? I don’t think the gated reserve theory is a theory but rather simply the mechanics of how the bank works?
In any case if the Fed does buy bonds from an investor via the bank then that cash deposit for the investor is a liability for the bank, not an asset. How would it improve leverage ratios?
Primary dealers are market makers. Technically, yes the Fed purchases through the market makers, but the flow is coming from external parties, not the balance sheet of commercial banks. This much is clear if you simply look at the stock of UST + MBS on commercial bank balance sheets. The gated reserve theory is not how QE is described by the Fed or BOE - they agree with my explanation here. GRT I think is primarily based on the incorrect assumption that QE is taking securities off of commercial bank balance sheets (its not).
For avoidance of doubt I agree with the portfolio rebalancing and the effect it has which obviously was what QE intended for, and it’s for this exact reason why commercial banks hold more bonds than ever. They swap the reserves for bonds from treasury or other financial institutions. They don’t pay for these bonds using real economy money so to speak, because “real economy” money is a liability for the bank, not an asset. All it is I believe is an asset swap between reserves and bonds for both the central bank and the commercial banks with other instructions and the Treasury.
i just want to ask about commercial banks as a role of "PRIMARY DEALER". Because role of PRIMARY DEALER is to fill clients' ORDERS by itself trading, PRIMARY DEALER is known as INTERMEDIARY that connects BUYER and SELLER of SECURITIES. The reason resulting in increase in"FEDERAL RESERVE" (effect of QE) comes from increase in "DEPOSITS" (because PRIMARY DEALER connects FED and BUYERS from private domain ) - result in increase in PRIMARY DEALER's BALANCE SHEET, not comes from "LIQUIDITY ASSET SWAP" (Primary dealer swaps its OWN holding treasury security to FEDERAL RESERVE) - NO CHANGE in the scale of primary dealer's BS. Talking about aspect of "TREASURY SECURITIES", THESE INSTRUMENTS are issued by TREASURY. To understand whether QE is "PRINTING MONEY" (increase in money supply or broad money) , we need to understand the purpose of ISSUING TREASURY SECURITIES. If
i. They are issued to ROLLING OVER previous Government debt (maturity treasury security ). From my perspective, QE does not result in INCREASE BROAD MONEY because FED directly inject money to TREASURY "within the air" and TREASURY use this to repay FED --> MONEY created with the air just comes back from FED "vault"
ii. They are issued to "PRE-FUND" US GOVERNMENT DEFICIT or FUND US GOVERNMENT SPENDING, QE does result in INCREASE BROAD MONEY because EXPENDITURE from government comes into REAL ECONOMY
I am looking forward to hearing your response and comments whether i misinterpret QE. Have a good day!
Hey Bear, new reader and going through some of your historic posts (which i'm loving btw). The only question re the reverse flowback point is that we didn't see a commensurate rise in bank deposits with bank reserves during the first phase of QE, pre-COVID. So the money did effectively flow straight from the fed to the commercial banks without touching the real world?
More so , yes. Perhaps the best way to think about it, is without fiscal spending as a direct channel to transform QE into deposits, it takes more time for the commercial banking system to "digest" the QE. But critically, this digestion process takes time and continues even after the Fed shrinks its balance sheet with QT. For more on this, read my more recent piece, The Furnace.
Thanks you for reading!
Thank you very much for the article. I think it is super interesting how you describe the different theories. I would have maybe two questions regarding QE, which I am a bit unsure about.
Japan for example is doing QE since the 90s if I remember correctly yet they don’t have for example the massive inflation the US or Europe is facing (maybe because they didn’t increase the amount of money that drastically). Do you know maybe the differences in QE policies Japan and the US did?
And maybe another question: what do you think about the Modern Monetary Theory?
Thank you very much!
Great writeup. I recall a succinct description of QE/QT being something along the lines of: QE results in asset inflation and price deflation, QT results in asset deflation and price inflation. The main reason there has been fairly muted inflation for the past decade of QE (compared to today) is because nearly every financial contract globally is denominated in USD as a function of being the world reserve currency. As global growth expands so does the demand for USD and much of these dollars are used for increasing the supply of things. In essence, the US exports it's inflation. On the flip side as global growth contracts and the USD becomes stronger relative to other currencies, so does the value of those dollar debts become greater. It is counter intuitive but the Fed trying to tighten further is only making it harder for inflation to come down, unless they pull a Volcker and absolutely destroy the demand side of the equation. Which wouldn't really help with the issue being mostly supply side, as a decade of underinvestment in the energy sector is what mostly brought us here to today, on top of a historic fiscal spending response to covid.
Thanks! I tried as much as possible to avoid the term "inflation" here because while monetary policy is a key variable, it is not the only one. My personal explanation of current consumer price inflation is best described below and include discussion of both supply and demand issues:
https://thelastbearstanding.substack.com/p/to-reap-and-sow?s=w