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Quantitative Easing Explained

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There is a new cohort making itself heard on the net under the flag of MMT (Modern Monetary Theory). Most of these are smart but confused people but the trend is fueled by a handful of smooth talking snake oil merchants with a political agenda or vested interests that require that our economies be inflated to oblivion. The lot is encouraged by the occasional (and predictable) half truths from the Fed who never hesitate to create confusion so they can keep doing what they want without proper oversight or interference.

One example in the smart but confused category is Pragmatic Capitalist (http://pragcap.com/), a very good read, but who on this subject clearly got his knickers in a twist, going as far as stating that money is not money to try and keep the whole MMT edifice from crumbling on its own inconsistencies.

There is a wave of confusion taking shape (I am beginning to see 'smart but confused' posters on hpc) so I present the latest post from Acting Man (http://www.acting-man.com/), a blogger recommended by Mike Shedlock but without the political undertones and with a sound understanding of banking (and a good writer which helps).

I recommend that anyone with questions WRT QE read this:

http://www.acting-man.com/?p=5546

The key points to take away in the context of QE:

- QE does add to the monetary mass; it adds to deposits (which also does add to bank reserves), thus increasing direct spending power in the economy

- QE is NOT a swap of financial instruments: it swaps financial instruments for money that people can use to spend in the economy. As Acting Man states, you can't go to a shop with a treasury bill and expect to have it accepted as payment. However if the Fed buys your bill then you can spend the money you get in return.

- A billion of QE adds 1 billion to bank deposits / the monetary mass. This could then be turned into 10-20-30 billions of loans should banks lend more but even if they don't, the monetary mass has increased. 1 billion in today's worthless currencies is not much obviously but if you start QEing trillions then you are beginning to talk real money, even if it hasn't been 'multiplied' by bank lending.

- The 1 billion addition to deposits usually begins with Primary Dealers (a.k.a. people who depend on gambling to maintain their bloated lifestyles). You can be confident that some of it will be spent (on commodities for example) which may have inflationary consequences. Those recipient of the money will then spend it and so on.

Sorry I can't include the piece in this post, I get the 'You must enter a post' whenever I try to post.

Edited by _w_

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This is my understanding in brief:

QE is the monetising of gilts, whereas normally, they would be monetised by investors, in this case, although the gilt IS monetised by the usual Spigots with real cash, the spigots sell ( for a cut) direct and very quickily to the fed, who, having no cash, simply prints IOUs to cover it.

the FEDS books remain in balance, but their balance sheet has just increased,....the only place in the banking world where it can out of thin air.

Meanwhile, the Government gets a diluted cash sum for which it will pay dearly over the term of the Gilt, the banking Spigot gets a few hundred thousand dollars for which it can lend.

The QE is then spent in the economy via the Government.

The Government has full buying power of the new dollars....as they enter the system, late receivers will find inflation and a lowering of value of their dollars, and this will apply to ALL dollar holders.

As for the Extra lending...well I dont see capital reserves being increased much as the QE will go back to banks as deposits, and therefore, liabilities on them.

It does, however, increase liquidity in insolvent banks....they lie about their reserves in any case, so the net effect is A: liquidity in banks, B: with nowhere to lend they buy things ( stocks etc) and C: resulting inflation for everyone.

Merv said at the start of HIS QE that the aim was to support Asset prices....he is not wrong.

They MUST BE STOPPED.

Edited by Bloo Loo

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A nasty side effect is that as money is devalued those in high positions realise and so want more of it to get ahead of price inflation. Which in itself is going to create more price inflation because to pay for their excesses they will charge more for their goods (or cuts costs i.e. jobs). Then bosses at other firms and now the public sector compare their wages and also want more! They have to have the market rate or someone might leave!

SIR TERRY LEAHY - Chief executive of Tesco

2008-09 SALARY: £9.1m

2009-10 SALARY: £15.6m

BART BECHT - Chief executive of Reckitt Benckiser, best known for cleaning products

2008-09 SALARY: £36.8m

2009-10 SALARY: £90m

MICK DAVIS - Chief executive of mining company Xstrata

2008-09 SALARY: £4.9m

2009-10 SALARY: £25.5m

http://www.thisismoney.co.uk/news/article.html?in_article_id=517324&in_page_id=2

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Bit in bold...don't think that is true. Any entity, bank or no, can create an asset and a liability 'from nothing'.

CDS, a loan or other credit, other credit derivatives, invoices blah, blah, blah all have the effect of increasing balance sheets from nothing. The bigger, the more 'risk' in the system of course as liabilities increase and not necessarily matched by where the assets can be found...only promises

No other organisation can issue means of exchange in this way.

Any other would either have to have it in the register/vault or borrow it.

So in the case of the FED, the purchase is made outright and settled, without funds being in the kitty before the deal was made.

Edited by Bloo Loo

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Forgive me if I sound pedantic however much I try not to. Please don't take it personally.

This is my understanding in brief:

QE is the monetising of gilts, whereas normally, they would be monetised by investors, in this case, although the gilt IS monetised by the usual Spigots with real cash, the spigots sell ( for a cut) direct and very quickily to the fed, who, having no cash, simply prints IOUs to cover it.

Investors don't monetise anything. They may sell something, and they will get money in return.

The last sentence is one key source of confusion. With QE, the fed doesn't print IOUs, it prints money. The bit on US banknote that says 'pay the bearer' etc. is confusing in that it relates to the gold standard; I suspect it is there to respect some US constitutional requirement that USD notes/coins be backed by metals. But in the days of pure non metallic fiat money, the bank note IS the money and is not meant to be redeemed by anything. Right or wrong, that is the standard we are under. Fiat money, just like gold in the days of the gold standard, is not an IOU.

the FEDS books remain in balance, but their balance sheet has just increased,....the only place in the banking world where it can out of thin air.

The Fed's books, as with any other bank, always remain in balance: it creates a deposit for whoever sold it the bonds, and creates an entry for the asset it just bought. The deposit bit is, as with any other bank, just an accounting entry.

Meanwhile, the Government gets a diluted cash sum for which it will pay dearly over the term of the Gilt, the banking Spigot gets a few hundred thousand dollars for which it can lend.

The QE is then spent in the economy via the Government.

The Government has full buying power of the new dollars....as they enter the system, late receivers will find inflation and a lowering of value of their dollars, and this will apply to ALL dollar holders.

The government does not participate in the QE process, it's all Fed and the entities it buys the stuff from (and who may then spend that money on other things). What you are getting into here is the deficit financing process which is something else.

As for the Extra lending...well I dont see capital reserves being increased much as the QE will go back to banks as deposits, and therefore, liabilities on them.

It does, however, increase liquidity in insolvent banks....they lie about their reserves in any case, so the net effect is A: liquidity in banks, B: with nowhere to lend they buy things ( stocks etc) and C: resulting inflation for everyone.

Merv said at the start of HIS QE that the aim was to support Asset prices....he is not wrong.

Merv increases the amount of money in the economy. What the impact of this is is pretty debatable.

They MUST BE STOPPED.

I wish! This has been going on for a few centuries and I cannot imagine the system changing other than it being renamed while functioning under the same principles.

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I was just questioning the assertion that they are the only bank that can 'spontaneously' increase their balance sheet. I agree they are the only one's able to create base money.

absolutely, thats me in trying to keep it simple mode.

but for me to increase my balance sheet, I would need to add an asset and a liability, an invoice minus a profit minus a cost.

the invoice is created out of thin air, but some other cost would be associated with it.

and to settle the invoice, I would normally receive means of exchange. In the FEDS case, it doesnt have to receive means of exchange, it can print them..It is the only bank in that system that can do this....contrary to what other posters here might say.

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The chairman may actually be relying on a technicality here. As mentioned above, the Fed buys already existing bonds, so technically it is merely buying assets that represent deficits of the past, not current ones.

Got to love that.

As long as it doesn't buy direct issues it's always buying past ones.

Brilliant.

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Got to love that.

As long as it doesn't buy direct issues it's always buying past ones.

Brilliant.

The amount of disinformation in the form of half truths that comes out of central banks is beyond belief. They need to maintain this 'fog of war' to exist. If everyone knew what these guys are up to they would not be able/allowed to function.

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Forgive me if I sound pedantic however much I try not to. Please don't take it personally.

Investors don't monetise anything. They may sell something, and they will get money in return.

The last sentence is one key source of confusion. With QE, the fed doesn't print IOUs, it prints money. The bit on US banknote that says 'pay the bearer' etc. is confusing in that it relates to the gold standard; I suspect it is there to respect some US constitutional requirement that USD notes/coins be backed by metals. But in the days of pure non metallic fiat money, the bank note IS the money and is not meant to be redeemed by anything. Right or wrong, that is the standard we are under. Fiat money, just like gold in the days of the gold standard, is not an IOU.

The Fed's books, as with any other bank, always remain in balance: it creates a deposit for whoever sold it the bonds, and creates an entry for the asset it just bought. The deposit bit is, as with any other bank, just an accounting entry.

The government does not participate in the QE process, it's all Fed and the entities it buys the stuff from (and who may then spend that money on other things). What you are getting into here is the deficit financing process which is something else.

Merv increases the amount of money in the economy. What the impact of this is is pretty debatable.

I wish! This has been going on for a few centuries and I cannot imagine the system changing other than it being renamed while functioning under the same principles.

yep, fine lines between the words and their exact meanings, but I feel we have an accord.

Apart from the Government not being involved....Although the Fed claims it is buying other bonds, Im pretty sure that the amount is pretty insignificant compared to the Government stock it buys.

It is odd that the proposed QE is for just about the same amount as predicted Government borrowing requirement for the period.

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They MUST BE STOPPED.

Firstly, no one can stop them. Secondly, even if the political will exists to stop them, the alternative (a massive deflationary depression) will prove to be so bad, that it won't be long before everyone wants them to get back on the job. Thirdly, I'm cool with them carrying on, I think they're doing a great job B) .

Edited by General Congreve

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yep, fine lines between the words and their exact meanings, but I feel we have an accord.

Apart from the Government not being involved....Although the Fed claims it is buying other bonds, Im pretty sure that the amount is pretty insignificant compared to the Government stock it buys.

It is odd that the proposed QE is for just about the same amount as predicted Government borrowing requirement for the period.

Indeed, pure money printing to fund deficit spending, but by another name. All good though.

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Firstly, no one can stop them. Secondly, even if the political will exists to stop them, the alternative (a massive deflationary depression) will prove to be so bad, that it won't be long before everyone wants them to get back on the job. Thirdly, I'm cool with them carrying on, I think they're doing a great job B) .

yes. and no, there is no will to stop them...not now they have drunk from the well.

the result, will be far worse than a deflation, which has an end. Inflation can go on till we are all dead.

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It is odd that the proposed QE is for just about the same amount as predicted Government borrowing requirement for the period.

There may well be a link, all I know for sure is that they won't tell us if there is. But at the end of the day what the Fed buys (government bonds or other) doesn't matter much since the market will at least rebalance itself after a short while: sellers of government bond will buy other government bonds from other people who will buy municipal or mortgage bonds with the proceeds because government bonds have become too expensive, etc. The fact that new money is injected in the economy is the important bit IMO.

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There may well be a link, all I know for sure is that they won't tell us if there is. But at the end of the day what the Fed buys (government bonds or other) doesn't matter much since the market will at least rebalance itself after a short while: sellers of government bond will buy other government bonds from other people who will buy municipal or mortgage bonds with the proceeds because government bonds have become too expensive, etc. The fact that new money is injected in the economy is the important bit IMO.

nothing wrong with new money...as long as its worth something.

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nothing wrong with new money...as long as its worth something.

The problem being, generally central bank/government policy is to make sure enough of it is created to make sure it is worth less and less.

Edited by _w_

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The problem being, generally central bank/government policy is to make sure enough of it is created to make sure it is worth less and less.

someone else agrees....tickerforum today: the Feds Mandate is to promote price stability....ahem

If you manage to keep your mandate of "2% inflation" over 50 years, how much of your original money's purchasing power do you have left?

Answer: About 40%.

This is "price stability"?

The hell it is. It is a brazen attempt to force people to "invest" in risky things like the stock of companies, rather than keeping their earned surplus safe and privately held under their own control.

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yes. and no, there is no will to stop them...not now they have drunk from the well.

the result, will be far worse than a deflation, which has an end. Inflation can go on till we are all dead.

Or until a move into a sounder currency is made. Zimbabwe switching to the US dollar as official currency, from the hyperinflationary Zim dollar, put a stop to their inflation immediately. For the mean time at least :lol::lol::lol:

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someone else agrees....tickerforum today: the Feds Mandate is to promote price stability....ahem

If you manage to keep your mandate of "2% inflation" over 50 years, how much of your original money's purchasing power do you have left?

Answer: About 40%.

This is "price stability"?

Yes :-) I like the rule of seventy to get a quick feel for these numbers: Divide 70 by the inflation rate to find out you how long it takes to lose half your money.

The hell it is. It is a brazen attempt to force people to "invest" in risky things like the stock of companies, rather than keeping their earned surplus safe and privately held under their own control.

Actually the primary objective is and always has been to devalue government debts, the rest is misleading central bank drivel aimed at hiding the truth and bankers finding they could become immensely rich by profiting from this policy.

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I personally think QE is *just* a disguised way of letting the banks make additional revenue to rebuild capital bases ... it's aim is to push bond rates down so banks can fund themselves cheaply & lend at a wider spread. The old 3/6/3 (borrow from a saver @ 3%, lend to a mortgagee @ 6%, and be on the golf course @ 3pm) has been replaced by 0/5 (borrow @ 0% and lend @ 5%)

Thinking out loud here, so feel free to give my argument a good kicking ...

Printing money and using it to buy government bonds is not necessarily inflationary, as you are moving a liability from a bond to a cash claim on US Treasury (ie you are moving the liability from a bond account to a checking account at the Federal Reserve).

For example, if you issue a bond to say a foreigner for $100, you issue a bond and they give you cash, so you have:

Assets (cash) $100

Liabilities (bondholder) $100

If you then print another $100 and use that to buy that bond you have:

Assets: (original cash) $100 + (bond you now own) $100 = $200

Liabilities (bondholder - actually this is now you) $100 + (cash you have given to the bondholder which is a claim on US Treasury) $100 = $200

So the bond you own (part of the A) and the bondholder you owe it to (which is now you) (part of the L) cancel out in cashflow terms, and what you actually have is an asset of $100 being cash and a liability of $100 which is the position you were in before.

Now the bondholder who sold you the bond can use the cash to buy stuff, but he has no more cash (or motivation to buy stuff) than before (because before, if he needed to buy something, he could have flogged the bond for cash).

If the US Govt printed cash and gave it to people (ie Helicopter Ben's ultimate fall back plan) who say then used the cash to buy commodities that's inflationary in the sense that those prices go up and also inflationary in the purest sense of assets = unchanged but monetary base has increased.

As I say, I may be thinking about it far too simplistically.

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I personally think QE is *just* a disguised way of letting the banks make additional revenue to rebuild capital bases ... it's aim is to push bond rates down so banks can fund themselves cheaply & lend at a wider spread. The old 3/6/3 (borrow from a saver @ 3%, lend to a mortgagee @ 6%, and be on the golf course @ 3pm) has been replaced by 0/5 (borrow @ 0% and lend @ 5%)

There are desirable side effects to QE but side effects is all they are.

Thinking out loud here, so feel free to give my argument a good kicking ...

Printing money and using it to buy government bonds is not necessarily inflationary, as you are moving a liability from a bond to a cash claim on US Treasury (ie you are moving the liability from a bond account to a checking account at the Federal Reserve).

For example, if you issue a bond to say a foreigner for $100, you issue a bond and they give you cash, so you have:

Assets (cash) $100

Liabilities (bondholder) $100

If you then print another $100 and use that to buy that bond you have:

Assets: (original cash) $100 + (bond you now own) $100 = $200

Liabilities (bondholder - actually this is now you) $100 + (cash you have given to the bondholder which is a claim on US Treasury) $100 = $200

So the bond you own (part of the A) and the bondholder you owe it to (which is now you) (part of the L) cancel out in cashflow terms, and what you actually have is an asset of $100 being cash and a liability of $100 which is the position you were in before.

Now the bondholder who sold you the bond can use the cash to buy stuff, but he has no more cash (or motivation to buy stuff) than before (because before, if he needed to buy something, he could have flogged the bond for cash).

If the US Govt printed cash and gave it to people (ie Helicopter Ben's ultimate fall back plan) who say then used the cash to buy commodities that's inflationary in the sense that those prices go up and also inflationary in the purest sense of assets = unchanged but monetary base has increased.

As I say, I may be thinking about it far too simplistically.

Here's the kicking :-)

You are confusing and mixing government accounts with Fed accounts which makes the hole thing mindboggingly complex.

Just forget about the government issuing bonds (the Fed doesn't issue bonds, it's the government that does) as it has no direct bearing on QE. QE just buys anything that can be bought, some of which may be government bonds, or not. The Fed may decide to buy government bonds to give these a short term boost in price, but eventually the new money will spread through all markets thus diminishing the impact on government bonds prices.

QE involves the Fed on it's own. From an accounting perspective:

- It creates an asset entry: the asset it has bought.

- It creates a liability entry: the money it has created and holds in its accounts on behalf of the seller of the asset.

The fact that the money is stored as a liability entry on the Fed's books does not mean it must be viewed as a debt that has to be paid back like a bond. This is bank accounting terminology, just like the credit (liability) column in your bank statement. That money that is a bank liability is in reality an asset to the economy: it is not meant to be paid back, it is meant to be spent.

Edited by _w_

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Yes :-) I like the rule of seventy to get a quick feel for these numbers: Divide 70 by the inflation rate to find out you how long it takes to lose half your money.

So what you are saying, not heard of this one? £100k, 5% inflation every year for 14 years, after 14 years the £100k has the purchasing power of £50k relative to the power of £50k in year 14. So to keep up with the compounded 5% yearly inflation if you earnt £1000.00 per week in year 1, you would need to earn £2000.00 per week at the beginning of year 15. A compound interest rate of 4.73% per annum for 14 years to keep up with inflation.

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So what you are saying, not heard of this one? £100k, 5% inflation every year for 14 years, after 14 years the £100k has the purchasing power of £50k relative to the power of £50k in year 14.

Yes, this rule is an approximation but works really well.

So to keep up with the compounded 5% yearly inflation if you earnt £1000.00 per week in year 1, you would need to earn £2000.00 per week at the beginning of year 15. A compound interest rate of 4.73% per annum for 14 years to keep up with inflation.

It works both ways so a compound return of 5% of 14 years doubles your money (70/5% = 14 e.g. number of years to double your investment).

One caveat to that: if you think you need 5% to keep up with inflation think again :-) In reality you need 5% return after tax, fees and whatnots if you intend to spend the money. So to compensate for 5% inflation, you need something more like 7-10% gross return. Or take your money out of sterling.

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There are desirable side effects to QE but side effects is all they are.

Here's the kicking :-)

You are confusing and mixing government accounts with Fed accounts which makes the hole thing mindboggingly complex.

Just forget about the government issuing bonds (the Fed doesn't issue bonds, it's the government that does) as it has no direct bearing on QE. QE just buys anything that can be bought, some of which may be government bonds, or not. The Fed may decide to buy government bonds to give these a short term boost in price, but eventually the new money will spread through all markets thus diminishing the impact on government bonds prices.

QE involves the Fed on it's own. From an accounting perspective:

- It creates an asset entry: the asset it has bought.

- It creates a liability entry: the money it has created and holds in its accounts on behalf of the seller of the asset.

The fact that the money is stored as a liability entry on the Fed's books does not mean it must be viewed as a debt that has to be paid back like a bond. This is bank accounting terminology, just like the credit (liability) column in your bank statement. That money that is a bank liability is in reality an asset to the economy: it is not meant to be paid back, it is meant to be spent.

Let me drink some more and think through your counter-argument/gentle kicking.

Fair point on me getting Fed/US Treasury mixed up, although if you are looking for a safe haven for your money, the safest thing currently is to park your 3m US T bills in your a/c at the Fed, so it's arguable whether they are really that separate. The US Treasury has it's clearing a/cs at the Fed as well. So I think the complexity (in my argument) is the key thing to understand.

I do agree with you 100pc that if the Fed prints money and buys something that *isn't* govt debt, then that is QE & therefore inflationary, or if it prints money and gives it to someone for nothing in return then that is inflationary (obviously, even I can understand that).

So the question to ask is: why isn't it printing money and buying and buying commodities or sending Bernanke up in a helicopter, as those are presumably the best ways of generating inflation if that's what you want?

Instead that isn't what the Fed is doing, it's actually going out and buying govt debt. Who benefits them from buying govt debt? Not the man on the Los Angeles omnibus.

And it doesn't (or hasn't yet) generated inflation. So if QE and QE2 is massively inflationary, where is the inflation? HFs and banks buying up commodities in the hope of furture prices rises isn't actually inflation in the technical sense.

(Obviously my argument collapses if there is massive inflation).

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So the question to ask is: why isn't it printing money and buying and buying commodities or sending Bernanke up in a helicopter, as those are presumably the best ways of generating inflation if that's what you want?

That's exactly what Ben is trying to do IMO ... but indirectly. The commodity market is too small a conduit to channel new money in the kind of quantity that Ben thinks is needed. To achieve the kind of quantity needed via the commodity market would send the price of oil to $10,000 per barrel with two impacts: it would be political and economic suicide while most of the money would still end up flowing to other asset markets anyway. So instead Ben buys into the most liquid and sizeable asset market in the world: the treasury market knowing that the new money will end up flowing, in part, to other asset markets.

Instead that isn't what the Fed is doing, it's actually going out and buying govt debt. Who benefits them from buying govt debt? Not the man on the Los Angeles omnibus.

And it doesn't (or hasn't yet) generated inflation. So if QE and QE2 is massively inflationary, where is the inflation? HFs and banks buying up commodities in the hope of furture prices rises isn't actually inflation in the technical sense.

(Obviously my argument collapses if there is massive inflation).

There are several factors that contribute to inflation such as supply-demand balances or speculative trends. Quantity of money is one of them, the more there is the more prices are likely to go up.

Edited by _w_

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  • 259 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
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