QE in the US has again done what it’s always done- frighten investors and portfolio managers ‘out of the dollar’ and into the likes of gold and other commodities.
And because sufficient market participants believe it works to increase aggregate demand, it’s also boosted stocks and caused bonds to sell off, as markets discount a higher probability of higher growth, lower unemployment, and therefore fed rate hikes down the road.
But, of course, QE in fact does nothing for the economy apart from removing more interest income from the economy, particularly as the Fed adds relatively high yielding agency mortgages to its portfolio.
As ever, QE is a ‘crop failure’ for the dollar. It works to strengthen the dollar and weaken demand, reversing the initial knee jerk reactions described above.
But the QE myth runs deep, and in the past had taken a while for the initial responses to reverse, taking many months the first time, as fears ran as deep as headline news in China causing individuals to take action, and China itself reportedly letting its entire US T bill run off.
But with each successive QE initiative, the initial ‘sugar high’ is likely to wear off sooner. How soon this time, I can’t say.
Global austerity continues to restrict global aggregate demand, particularly in Europe where funding continues to be conditional on tight fiscal. Yes, their deficits are probably high enough for stability- if they’d leave them alone- but that’s about all.
And as the US continues towards the fiscal cliff the automatic spending cuts are already cutting corporate order books.
And oil prices are rising, and are now at the point cutting into aggregate demand in a meaningful way.
Yes, the US housing market is looking a tad better, and, if left alone, probably on a cyclical upturn. And modest top line growth, high unemployment keeping wages in check, and low discounts rates remains good for stocks, and bad for people working for a living.
Too many cross currents today for me to make any bets- maybe next week…
High yielding mortgages?
3% is relatively high compared to other agency and govt secs
Warren – We’re seeing the familiar sell of in Treasuries with the FOMC announcement of QE3, despite the worn out often repeated fairy tale that QE is supposed to bring long term interest rates down. Where does the fed get the hubris to say in public that they want to raise the rate of inflation to their desired 2% level and not expect to scare the living daylights out of bond investors? However, QE3 will focus on buying MBS so I reckon fixed income traders have been selling Tsys and buying MBS as a spread tightening strategy. Can you confirm?
The fed opporates as a (for profit) true?
false. all profits are turned over to the tsy
@WARREN MOSLER,
It acts like a tax then? When they turn profits over to the Treasury they are removing money from the private sector just like a tax?
@rumble, Warren, when people sell treasuries to the Fed at current value, how many of them just use the money to buy more treasuries? is this just a way of ratcheting up?
they can’t do that in total as there are a fixed quantity of tsy secs at any one time.
so what happens is yields go to where the economy is indifferent between holding that amount of reserve balances and that amount of securities
yes.
The Fed also pays a dividend to member banks on their stock.
it’s like a non voting preferred stock that pays a flat 6% on a very small investment.
@WARREN MOSLER, If the fed turns over ALL it!s profits to the Ty’s
Then how can it pay it!s member banks a dividend?
It doesn’t count the dividend paid to member banks (on their stock in their regional reserve bank) as profit, I guess.
all profits after expenses. it pays a flat 6% dividend on those very small investments
Right on Warren……..is this still muddling?
Its like giving a blood transfusion to somebody covered in leaches
Its like watching a fish flopping around in the bottom of a boat and thinking its swimming
The trickle down theory of the wealth effect is alive and well …for 1% of the population and 100% of Ben’s audience .
given that changes in fiscal policy aren’t happening anytime soon due to congressional disfunction, isn’t QE the best possible tool available to provide any kind of stimulus? what’s a better option at this point?
@jah,
It’s pretty apparent that’s why the Fed is doing what it’s doing. It knows full well fiscal stimulus is not coming anytime soon. They just have monetary policy to work with. The fun for them it to see how many different QE permutations they can come up with.
🙁
doing nothing.
better still, telling Congress they can’t run out of money, aren’t dependent on China for funding, and that we set our own interest rates
@WARREN MOSLER
what about raising rates a bit. wouldn’t that put some money in the average worker’s pocket?
yes, but I’d prefer a FICA cut
@Warren Mosler,
What if instead of a FICA cut, the Government was to issue a tax credit for up to all the FICA collected in the employee’s name, to the employee? Wouldn’t that be a better strategy? This can be based on last year’s income to have an immediate impact!
@WARREN MOSLER,
Warren, This QE reeks of insider manipulation. Too many on Wall St. have Bernanke;s ear. They needed some pot stirring to get some action on equities. And they got it.
There is nothing here for the middle class.
could be…
Warren, please clarify this: “QE is a ‘crop failure’ for the dollar. It works to strengthen the dollar”
I thought QE weakened the dollar, at least initially ? Did you mean it strengthens the dollar long term, after the initial “sugar high” wears off and the QE “tax” kicks in ?
@Dan Lynch,
Not certain but I think this is the answer:
Lowers interest payments from the US government, therefore lowers the amount of money that would have been, which is the opposite of what everyone thinks will happen and therefore certain assets are bid up on inccorectly and later fall back and then some.
it immediately works to remove interest income
@WARREN MOSLER,
Not the whole story. It immediately works to give realized capital gains to investors holding Treasuries and MBS, which outweighs the lower accrual of interest income for months at least.
And there is also the wealth effect from unrealized capital gains in the bond and stock markets.
@ESM,
Has the wealth effect been measured in an economy with a non-accelerating debt to GDP ratio?
@ESM,
@Neil”
I’ve never looked into it myself. I do remember Greenspan mentioning some studies of the stock market wealth effect during Congressional testimony. No doubt the effect is real, but it is probably highly dependent on general credit conditions and confidence (which of course are involved in a complicated feedback loop with the markets themselves).
Speaking for myself only, when I reap an unexpected windfall in the markets, I am more inclined to spend that money (after mentally deducting the amount I need to pay taxes), especially if they are realized gains that end up as cash earning zero interest in my brokerage account.
I suspect I am not an outlier in that regard.
@ESM, But the issue surely is how many are benefitting from the higher stock prices ?
is this method more effective that deficit spend or lower payroll taxes at replenishing the majority’s bank balances ..
@ESM,
@Walid:
I am not advocating the Fed implement QE3. In fact, I’m against it. But the Fed doesn’t have the authority to spend more or lower payroll taxes, so it’s the only tool left in their toolbox to stimulate demand. I disagree with Warren that it actually hurts rather than helps in the short-term (it probably is counterproductive in the long run).
One good thing about QE, though, is that it helps prove that “monetizing the debt” doesn’t actually cause inflation.
the capital gains are offset by the lower income earned by the remaining investments
@ESM, It’s a net present value wash on existing securities and an interest payment reduction on new securities.
Hi Warren, you summarize the issue very very clearly, I was always why they forget to ask you on CNBC..and Bloomberg (speaking of wich an italian journalist that has been working for Bloomberg for years and now does his own news and videos asked me comment the FED thursday, but explained me …” I do not want conspiracy theories like signoraggio and MMT..”)
I was amazed to hear Bernanke in Q&A to state that now he is mainly concerned with employment and therefore the main positive effect is to pump up house prices making people feel rich and “buying more home…if they see the prices going up because it promises them a better return…”. For Bernanke, even when people buy their owm home, it is a speculation on rising asset prices that he has to promote. People are supposed to buy homes when they are more expensive and it is easier to borrow, not when they are cheaper and have the money to buy it.
Anyway this time it might take a week before the market reverses itself.
The first QE was altoghether 1.550 billions (http://www.bankrate.com/finance/federal-reserve/qe1-financial-crisis-timeline.aspx), it was announced in Dec 2008 for 700 bil and another 850 in March. It was directed at morgages and brought down morgage rates from 6.2% to about 5.3%
the second QE http://www.investopedia.com/terms/q/quantitative-easing-2-qe2.asp#axzz26SZO6OIM was of 600 billions in Treasurys plus reinvestments of another 250 billions in mortgage stuff and was announced in September 2010 e and started in December. The market turned up from about August 18, topped in March but it was only until May 2011 when Europe started to fall apart that came down.
So, this time the market has turned in July, almost 2 months before the announcements, and the fact that is “open ended” does not mean that is for more money, just that they are more uncertain. And it is hard to push mortgage rates when they are already at 3.7%
On top of it the European markets are up in the case of Spain for instance 35% (in dollars EWP the Spanish ETF went from 19$ to 30$) and Italy 25% from July without the BCE buying a single tesobono or BTP. And there is no sign, given the fall of all the Spread and rally of the markets, tha the gov of Spain is going to ask to do it since it would require to sign for more austerity.
In the meanwhile Brent is close to 120$ and the Euro is back at 1.31$ and combined they cut at least 0.5% from Eurozone GDP if they stay here (spain and italy for instance had good export numbers in the last months thanks to the weak euro)
Obama talks budget cuts and Romney/Ryan do not talk about much else on the economy, maybe is just talk, but the fed deficit is now below 8% of GDP against 10% a year ago and the overall gov deficit is going to shrink even with no fiscal cliff. Japan is raising sales taxes, France that was the big spender in Europe, deficit at 6% of GDP is raising taxes (Holland though had an election that puts her a bit more at odds with austerity because the previous gov was cutting almost 2% of GDP)
Maybe this time the turns come much sooner
good analysis thanks!!!
And, of course, one of the reasons rates came down after each QE, and maybe the main reason, was that the economy did not improve pushing out the prospects for Fed rate hikes.
This could happen again.
@WARREN MOSLER,
Dead on! It wasn’t QE that brought interest rates down. It was economic weakness.
@Ed Rombach,
Try telling that to the true believers.
@Ed Rombach,
a previous post by Warren covers it well :
QE is nothing more than a tool for changing interest rates by adjusting the available supply of securities of various maturities. And it’s not a particularly strong tool at that. It’s the resulting interest rates that may or may not alter the economy, inflation, and the value of the dollar, etc. and not the quantities of reserves and Treasury securities per se.
It is clear to me that the FOMC does not fully understand this. If they did, they’d be in discussion with the Treasury about cutting issuance of bonds in the first place. And, additionally, If they wanted the term structure of interest rates to be lower, they would simply target their desired term structure of rates by offering to buy unlimited amounts of Treasury securities at their desired rate targets, and not worry about the mix between reserves and Treasury securities that resulted.
Which is what they did in the WWII era. And how they target the Fed Funds rate. With today’s central banking and monetary policy with its own currency, it’s always about price (interest rates) and not quantities.
yes
@Ed Rombach,
“QE is nothing more than a tool for changing interest rates by adjusting the available supply of securities of various maturities….. It is clear to me that the FOMC does not fully understand this. If they did, they’d be in discussion with the Treasury about cutting issuance of bonds in the first place. And, additionally, If they wanted the term structure of interest rates to be lower, they would simply target their desired term structure of rates by offering to buy unlimited amounts of Treasury securities at their desired rate targets, and not worry about the mix between reserves and Treasury securities that resulted.”
Walid M – That was like listening to a Bach Cantata. I wish I had said it that well in this Reuters video…… http://reut.rs/ujyyqp
yes! anticipating the fed lower for longer
@WARREN MOSLER, At some point, doesn’t the Fed have to signal that it wants rates to go up? If potential investors, home-buyers, etc. are waiting until they are sure we are at the price bottom in the borrowed funds market, don’t efforts to lower rates even further just make them say, “Let’s wait, we’re not at the bottom yet?”
Why should deflation in the cost of funds work any differently than other deflations?
beats me!
Isn’t true that MBS purchases can have at least some stimulative effect?
After all some of those bonds will default causing an increase NFA’s unlike government bonds which don’t default.
Also the fed is putting a floor on the value of those MBS which might cause some private investors to get involved that would not have otherwise.
No telling whether these effects are enough to offset the loss of interest income though.
They are agency guaranteed mbs so no default risk for gov. that’s not already there.
@WARREN MOSLER,
Could you run through the nfa picture? So a loan was made to buy a house, the banks created a deposit and created an asset for themselves too. No new nfa (for the non-currency issuing sector). Several mortgages are bundled together into an MBS, and payments on mortgages now flow to the holder of the security. Now the fed buys these with newly created reserves, clearly new nfa’s. So isn’t this adding nfa’s? Which will be taken back out of the system as mortgage payments are made to the Fed… Whereas QEII, with only treasuries, was easy to see as a 1-for-1 nfa swap.
And with reserves instead of mbs, what exactly can the banks do with the reserves? Can they just pay themselves big bonuses or buy something?
@joe, See below under 16 for the nfa picture (as I see it).
the fed purchase adds reserves which are financial assets. but the purchase also removes mbs, also financial assets.
so net stays the same
reserves are bank assets/investments.
it changes the risk balance though. Risky MBS assets are exchanged for risk-free reserves and credits to bank accounts. The price paid by the Fed for those assets is usually in excess of the price that would have been paid by non-fed purchasers. So for the previous holders of those assets, it’s a net gain.
@WARREN MOSLER, I know this is asking too much, but I drew out the T Accounts of QE to the best of my knowledge with some tentative inferences. Maybe others would find it helpful, but I’m not sure of its correctness http://sites.google.com/site/jahufford/qe3/. I understand the swap aspect, it’s just that the original liability of the borrower is now owed to the fed instead of a bank. So as the loan gets repaid, reserves go back to the fed through the payment system (I believe). So isn’t this just a sort of temporary injection of reserves?
yes, as the bonds amortize/mature the fed’s portfolio shrinks as do corresponding reserve balances debited
@brian, “Also the fed is putting a floor on the value of those MBS”
Not really. If the prices drop, that just means the Fed can buy even more as their monthly $ amount for purchases remains fixed (scale down buying).
In fact, the FRBNY prefers lower prices on the bonds as they seek to “get a good deal for the taxpayers”.
This is all printed in this NYT story from QE2:
http://www.nytimes.com/2011/01/11/business/economy/11fed.html?pagewanted=all&_moc.semityn.www
““We are looking to get the best price we can for the taxpayer,” said Mr. Frost, a buttoned-down 34-year-old in a striped suit and rimless glasses.”
Unless this kid’s boss tells this kid to raise his bid, he will seek ever lower prices “for the taxpayer” and lower his bid.
He is a monopolist but he doesn’t realize this. He will keep lowering bond prices as best he can… (same thing going on in reverse in OPEC imo) there is a strong human tendincy to get the best price whether buying or selling.
Unless this kid gets a memo specifically stating in effect he should “lose money” on his trades, he’s not going to be satisfied paying higher prices imo… who knows, Ron Paul might “audit” him and accuse him of a crime against the taxpayers…
This has the unintended effect of raising interest rates which would be against the Board’s stated policy, but again, morons are in control of all of this so an exactly opposite result should not be surprising… rsp,
A few questions please:
1) Are all the mortgage backed securities, that are going to be bought, federal agency instruments or are some securities issued by private entities?
2) If a combination, does that mean interest and principals payment paid by the private entities is money directly taken from the private sector by the government sector?
agency
Warren,
Currency users collectively hold cash in circulation, reserves or tsy secs. In all cases the State, federal govt (consolidated view, cb+tsy together) is the counter party.
When the cb buys tsy secs from us it does not add net financial assets (nfa), it just swaps the tsy secs we hold for reserves.
Are those agencies that issued these mortgage backed securities part of the federal govt?
In other words, do these purchases add net financial assets to the economy?
@walter,
No its a financial asset swap. NFA are only added to the economy when the government busy something other real (swaps a financial asset for a real good or service) or over pays for a financial asset (i.e. buys a worthless MBS at an inflated price).
@Adam1, If you issue mbs and I buy them from you, then reserves just go from my account to yours, no aggregate change.
If then subsequently the cb buys those mbs from me, then nfa (the sum of cash in circulation, reserves and tsy secs), in the economy increase.
Do I misunderstand?
@walter, the private sector liability which is the mortgage backed security still exists. If the fed were to pay off the MBS for the owner or the owner were to default then I think NFA is +
@walter,
NFA is the sum of ALL financial assets not just cash, reserves and treasuries – that’s just the monetary base (not the same).
Therefore when the FED buys my MBS I trade my MBS asset for reserves which are also an asset – no net change in financial ASSETS.
right.
@walter, @Adam1 @Jcmccutcheon
Looks to me jcmcc has a point.
In the private credit markets, all transactions net to zero. So, ultimately the nfa that we as currency users collectively, on a consolidated basis, hold are the financial assets with as counter party the currency issuer (consolidated view, cb+tsy together) minus the fin liabilities to the currency issuer. This is the sum of currency in circulation, reserves and tsy secs minus the fin liabilities. In case the currency issuer, here via the cb, buys a loan from us as currency users, in this case an mbs, then we get reserves, but we also get a fin liability to the currency issuer. So, no addition of nfa.
By the way, as far as I know: The monetary base is the sum of currency in circulation and reserves. Tsy secs are not included in the monetary base.
yes, and the further purpose of carving out that aggregate called ‘monetary base’ fell by the wayside when we floated the currency
@walter, Hi walter, I have the exact same question, I posted it above too. If Jcmcc’s is correct, then that also means the reserves used to buy the mbs were new to the system, and then they are taken back out of the system when mortgage payments now go to the fed instead. (I don’t see how a new liability to the currency issuer is created. It’s the same liability, the mortgage, just the cash flow recipient changes, ?????)
So is QE with mbs really just about removing mortgage default risk off of the banks books and onto the govt? (Just who exactly is the Fed buying, MBS’s from? Warren should do a complete primer on QE.)
with agency mbs there is no default risk
qe is about the term structure of rates
if you are a bank instead of mbs, you have reserve balances balances
both are financial assets
“with agency mbs there is no default risk”
What’s the reason to sell, then? Isn’t the price on these assets being bid up by the Fed? i.e. the Fed is willing to pay an above-market price for the asset?
as monopoly supplier the fed is necessarily ‘price setter’ of the term structure of risk free rates, directly or indirectly, so in that sense there is no ‘market price’.
@walter,
good point. in other words, why would the CB buying MBS be any different than buying gold, which is considered to add NFAs?
@MamMoTh, see below under 16.
Cb buying mbs adds reserves as financial asset, but also leaves the currency users with a financial liability that does not fall away anymore when consolidating the currency users.
So cb buying mbs does not add nfa.
Gold is for the Currency users not a financial asset, while reserves are. So exchanging Gold for reserves adds nfa to currency users.
it’s different only in that people have desires to hold financial assets.
if gold is a perfect substitute for some buyers then it wouldn’t be any different.
but for the most part it’s not.
@WARREN MOSLER,
a perfect substitute for what?
then the question is why would MBSs be a perfect substitute for whatever and not gold?
i’m confused
just saying that if an agent decided to buy gold because he considered it a financial asset his demand for actual dollar denominated financial assets would be that much lower.
@WARREN MOSLER,
i’m still confused.
i believe it’s been often said here that the Fed buying gold or fx is adding NFAs to the private sector, which makes sense if NFAs are USD denominated liabilities of the government.
have i missed something? because otherwise i can’t see why buying MBSs is any different.
buying gold adds dollar balances and removes gold, and gold is not a financial asset for purposes of this analysis
buying mbs adds dollar balances and removes mbs, both financial assets
@WARREN MOSLER,
why isn’t gold not a financial asset for purposes of this analysis?
what else can it be? the Fed doesn’t buy gold for industrial purposes nor in order for Bernanke to wear it as jewelry.
@walter,
“By the way, as far as I know: The monetary base is the sum of currency in circulation and reserves. Tsy secs are not included in the monetary base.”
That is correct, I got ahead of myself without thinking through my thoughts.
“In case the currency issuer, here via the cb, buys a loan from us as currency users, in this case an mbs, then we get reserves, but we also get a fin liability to the currency issuer. So, no addition of nfa.”
When the government net spends and creates NFA for the Non-Government sector it also creates liabilities on its balance sheet. QE does not create NFA because it removes an equal amount of financial assets from the Non-Government’s balance sheet as it adds. NFA are created when the sum total of financial assets on the Non-Government’s balance sheet increases.
A great tool to play with to visualize the nations balance sheet…
http://econviz.org/macroeconomic-balance-sheet-visualizer/
@Adam1,See below under 16.
Unfortunately, the visualizer you refer to only deals with QE by way of the cb buying tsy secs. Their variation 1 and 2 correspond to my variant 1.
What is relevant here is the N in NFA. It is about Net Financial Assets, i.e. Financial Assets minus Financial Liabilities. (comparable to the concept of Net Asset Value)
I would amend your statement to:
NFA are created when the sum of (total financial assets minus total financial liabilities) on the non-govts balance sheet increases.
The financial assets and financial liabilities with counter party within the currency users will automatically then net to zero. We are then left with my definition as I gave previously above.
yes they are functionally agents of congress
the purchases do not add nfa.
Warren
About bets… A complex and complicated system has many variables to follow. The trick is to identify the causal rate of change structure of variables and those that are higher in the structure. Say that this restricted set of variables is of order n, meaning that the variables in the set are nth time derivatives of quantities we agree are simple stocks (not including stocks of stocks).
If one has identified correctly this set of variables, the causal structure of observable variables, and one knows actual order n variables values, one can deduce future values of order n-1 variables at instant k+1, k being number of present instant. The process can be repeated till one gets to the order n-J1, n-J2, etc variables that are of interest.
sorry, i forgot the context?
Maybe this time Draghi and Bernanke will succeed reducing, psychologically if not logically, private cash hoarding and other demand leaks?
MMT takes the “logical” path: deficit spend (money creation) during economic down turn and taxing higher (money destruction) during economic boom.
It is like I (the Govt’) grant you (the private) money when you are depressed (economic down turn); but when you are happy, I will have ways to get my money back (e.g., via taxing).
On the other hand, Draghi: You already have debt but I lend you more, so that you can do useful things and pay me back later.
Perhaps for all practical purposes a long term debt is like a grant? Much like what the Chinese have done or been doing?
Psychologically, via the bond purchases, Draghi and Bernanke are giving the impression that market will be flooding with money, much like a sizable deficit spending?
Yes, an initial trigger (deficit spending and/or money from the CB) is required to start an economy in recession; but after a that, the private must increase the leverage to sustain the momentum.
So if confidence is key, then the question is which one is more effective to bring the confidence back in the short to medium term: deficit spending or more money from the CB? Maybe the former because it creates higher multiplicity?
Deficit spending and taxing require Congress approval and could take months, whereas loans from the CB does not. I think Draghi’s recent action has significantly helped lift confidence (or reduced the “European uncertainty”).
Any constructive criticism is highly appreciated.
i doubt they will succeed in doing that.
japan has been trying for decades with the same tactics.
for now for the size govt we have we remain grossly overtaxed as evidenced by the output gap
Berny buy Mortgage instead of Treasury plus CDS Volume on Mortgage +70% vs Oct 2008 Lemahn !
Spring 2013 Hot Europe => They have to finish compulsory administration of Spanish&Italy..
then the ball fire will return in US ?
They will not make QE ,QE is like Kriptonite for OBAMA election, SO until OBAMA will win the 2nd mandate(20 january ?).
But in reality they are making QE, Fed Announces $400 Billion in Operation Twist …
it’s only a game of words …
Some people are getting wealthier out of all this QE business, right?
The people who are losing out are average and poor people who depend on pensions and are immediately affected by higher oil and commodity prices.
But some people are making a killing on these higher asset prices and lower borrowing costs, i.e. QE is helping to make the already-wealthy even wealthier.
Isn’t this just pure trickle-down economics, the hope being that by handing out free money to the wealthiest people, they might feel inclined to spend a bit more and maybe even hire some people?
The NFA picture as I see it is like this:
(I added a few notes that I think are relevant in the greater scheme of things)
On a consolidated basis there are 2 parties in the fiat money system, the currency issuer and the currency users.
Note 1: In MMT, The State, represented by the consolidated govt, is the currency issuer. So cb and tsy are both part of this. This is in contrast to mainstream where cb is considered the currency issuer and tsy is considered a currency user.
The balance sheet of the currency users looks as follows:
Asset side:
A. Currency in circulation
B. Reserves
C. Tsy Secs
Liability side:
D. Loans from currency issuer
E. NFA
The balance sheet of the currency issuer is the currency users’ balance sheet mirrored:
Liability side:
A. Currency in circulation
B. Reserves
C. Tsy Secs
Asset side:
D. Loans to currency users
E. Accumulated Public Deficits
Note 2:
NFA = A+B+C-D = Net Worth or Equity or Capital of the currency users = Accumulated Public Deficits = Accumulated non-govt Surpluses.
Note 3:
To prevent that the private sector gets overleveraged, special attention needs to be paid to the following dynamics.
NFA function as a buffer for all the lending, leveraging activity within the private sector. It’s the equity that supports the credit structure, private credit markets.
During an economic upturn normally the private sector debt expands. At the same time the automatic stabilizers decrease the public deficit (i.e. the addition to private sector equity, NFA, goes down) or even turn it into a public surplus (i.e. a reduction of private sector equity, NFA) when tax receipts rise and unemployment payments decrease.
Note 4:
In an open economy ‘Loans to currency users’ could be split into ‘Loans to domestic currency users’ and ‘Loans to foreign currency users’.
If we assume that ‘Loans to domestic currency users’ is zero then the currency issuer is financing either a Public Deficit or a Trade Surplus or a combination of both.
Under the same assumption and given that the world as a whole is a closed economy the model for the world as a whole then MUST be that the currency issuers, on a consolidated basis, finance Public Deficits.
Now what happens in QE?
QE Variant 1: The cb buys tsy secs from currency users
Currency users book:
Debit (DT) : Reserves
Credit (CR): Tsy Secs
For Currency users this is merely an asset swap, Tsy Secs get exchanged for Reserves. No addition of nfa.
Currency issuer books:
DT: Tsy secs
CR: Reserves
For the currency issuer this is merely a liability swap. Reserves get exchanged for Tsy Secs.
QE Variant 2: The cb buys mbs from currency users.
When the mbs was issued from currency user 1 to currency user 2 they booked:
Currency user 1 (mbs issuer) :
DT: reserves
CR: mbs
Currency user 2 (mbs buyer):
DT; mbs
CR: reserves
When consolidating the currency users this nets to zero.
When the cb now buys the mbs from currency user 2 then:
Currency issuer books:
DT: Loans to currency users (MBS)
CR: Reserves
The selling currency user 2 books:
DT: Reserves
CR: mbs
After consolidation of the currency users remains:
DT: Reserves
CR: mbs (now due to and owned by currency issuer) (=Loan from currency issuer)
Note 5: When a currency user issues an mbs and another currency user buys it then currency users have a financial asset (mbs) and a financial liability (issued mbs). On a consolidated basis this nets to zero.
Reserves went from the account of the buying currency user to the account of the selling currency user.
It’s like issuing corporate shares or bonds (corporate debt). No addition of NFA.
When subsequently the currency issuer buys the mbs then this adds reserves for the currency users and then the mbs liability does not anymore net to zero for the currency users because it is not hold by another currency user anymore. So the mbs becomes visible as liability to the currency issuer.
So on a net basis it does not add financial assets. No addition of NFA.
@walter, Hey, I got confused in your post, so I drew out the T accounts as best I could figure them. Instead of posting them here, they’re at http://sites.google.com/site/jahufford/qe3/, I’d appreciate any comments
@joe,Your booking entries are correct as far as I can see.
What the bank can do with reserves instead of mbs is not different from what the bank can always do with reserves.
Personally I prefer to work with just 2 T accounts, one for the currency issuer (The State; cb+tsy together; the consolidated govt) and one for the Currency users (also Consolidated).
Just these 2 accounts with items I mentioned are in fact relevant for all possible transactions in the monetary system and keep the overall picture simple (I think).
As I drew it out above the totals of the asset and liability side match.
In your picture I miss what matches with what you call the 100 reserves (initially), both at the cb as well as in the bank.
I also miss the Tsy. Maybe not playing a role in qe3, but relevant in general when picturing the bookings in the monetary system.
@walter, I just chose the 100 reserves arbitrarily, gotta have some sort of initial state, but that’s a good catch. I think to make it balance completely, you would have equal equity on the liability side of the bank, and I don’t know what you’d do to the cb side.
I felt I needed at least one non-bank actor so I could show that as the loans are repaid, the reserves get sucked back out to the fed.
What do banks always do with reserves? I know they don’t lend them… I know they’re used to settle payments between banks, but when there’s plenty of excess reserves around, what keeps a banks from purchasing real things with them, say investing in actual real estate or just giving themselves bonuses and worrying about being short of reserves later??
How can the Fed force banks to swap Treasuries for cash? This is one part of QE I’ve never quite understood.
@Jason,
It’s a free market. The Fed just goes in and starts lifting offers (i.e. buying at the “ask” price). It’s not forcing anybody to do anything. It’s also not getting particularly good prices, since the Fed is a big fat whale in a sea of sharks. Bank trading desks are salivating over another round of QE, believe me.
@Jason,
It’s not forcing anybody. The people that are selling were selling anyway in the deepest and most liquid market there is.
What it is doing is keeping prices up. ‘Full Market Value’ when the Fed is in the market buying *is* going to be higher than FMV when it is not.
The effect of QE is that sellers get slightly more than they otherwise would have, and buyers have to pay slightly more than they otherwise would have (ie Tsy yields go down).
The entire impact of QE is the behavioural impact of Tsy yields being lower. What that is in reality is more psychological and frankly theological than hard numerical science.
they just offer a price high enough to change the indifference levels between holding the remaining securities and cash
the initial ‘sugar high’ is likely to wear off sooner. How soon this time, I can’t say.
Warren, I’m sure you know by now I’m in agreement with MMT ideas but each successive QE does provide this sugar high and as Tom Hickey calls it a placebo but it works each and every time.
The quote above seems to be arguing against itself. If it should wear off sooner, we should be able to look at QE2 and use the maximum time for the sugar high and say it could last at least that long (to use a metaphor you’re only as good as your last game)
As long as the QEs are sufficient distant apart providing sugar highs, why can’t they work indefinitely?
I recognise they do nothing for the real economy but given the media seems to be indentured to the finance sector does that really matter?
So given sufficient difference apart why can’t the confidence fairy work indefinitely? Just like orthodox economics has an ascendancy over other strands of economics many of which have proved the orthodoxy flawed but has not resulted in a paradigm shift.
@Senexx, what is absolutely clear is that over the successive QEs more and more investors and commentators believe less in the effectiveness of QE . Their reasons differ greatly and not many quote MMT on it but they no longer buy the QE story .
If Warren’s reasoning is the correct one then all QE doubters , irrespective of their reasoning , will be proved right and as their number increases it will eventually influence where the market goes ..Just as the current believers of QE are having their run ..
In time this will lead the market to discredit the Fed’s actions.
In his press conference Ben told us that asset bubbles are a worthy tool for helping the economy create jobs . Where have all the critics of asset bubbles gone ?
right, it can work until it doesn’t
Senexx,
Markets don’t work that way. After “x” times, the market would do the exact opposite of what you expect. That is 100% guaranteed.
Jason
Hence the qualification of given a “sufficient distance apart”.
@Senexx,
To paraphrase Keynes, “given sufficient distance apart, we’re all dead.” 🙂
I assume this means your anticipation of rates normalizing in the next few months is off the table.
definitely some new info introduced here.
i wouldn’t be short bonds here, or long either.
@WARREN MOSLER,
Any view on your old friends the BTP Warren?
If the ECB buy the front of the curve they should, eventually, drag 10’s in?
agreed.
“It works to strengthen the dollar and weaken demand, reversing the initial knee jerk reactions described above.”
Cash cannot be repo’d, t’s can. Due to the size of the repo market, is this another way that credit ($) gets removed from the market?
@bob,
Here is a slice of a comment from a market strategist on QE :
“We comment more below on the QE move, but first, we need to explain what our short term views are on the financial markets now that the FED seems to be unleashing unlimited QE and the ECB has set itself up to do the same as soon as a sovereign requests a bailout. The unlimited nature of the current policy response from the two biggest central banks is a real escalation and something that we were not expecting. If we have truly moved into a new era of unlimited money printing, financial markets are unlikely to suffer a major decline from current levels.”
If they all begin to think that way will the market oblige or surprise?
not in the context of this analysis, just by narrow definition maybe
@WARREN MOSLER,
http://ftalphaville.ft.com/blog/2011/11/25/765031/manufacturing-quality-collateral/
She’s done other writing on this issue and is a fan of warren’s work.
“Too many cross currents today for me to make any bets- maybe next week…”
eur/usd has now ended up 5 weeks in a row.
Momentum was strong though. And as Cliff said some things, or maybe better “notions”, fundamentally changed in the ez.
I get the impression that foreign reserve holders like China also make some portfolio shifts.
Last week I saw also some Korean official on tv, very worried about qe3 and the usd.
Today serious interest from China to buy a european financial.
Koo gets it.. maybe he should have remained as Fed economist
http://mikenormaneconomics.blogspot.se/2012/09/zero-hedge-richard-koo-explains-its-not.html?utm_medium=referral&utm_source=pulsenews
The government is already taking the default risk on agency MBS, so adding to their purchases doesn’t change the fact that the Treasury has guaranteed Fannie and Freddie. To the extent that more agency MBS becomes available, then the govt is increasing their default exposure.
If the Fed really wants to make a difference, they should buy up the remaining $1 trillion in non-agency MBS and offer more attractive loan modification terms. They can also ask the banks to package their $4 trillion in raw loans and purchase those as well at par and allow for more aggressive modifications. The Fed would take a hit of about $1 trillion, something that can’t be done through fiscal policy in this environment. Whether or not you like the policy, it would put an end to the housing crisis, unlike purchasing agency RMBS.
i prefer a fica suspension to stop taking funds from people working for a living than singling out a narrow group of homeowners.
@WARREN MOSLER, FICA suspension, middle class tax cut, no tax increases…all good. Housing and the ancillary businesses associated with housing remains the overwhelming drag on employment and economic growth.
so if we all had nice houses that lasted forever we couldn’t be fully employed doing something else?
@Ivan, It would take 20+ years to wean labor (carpenters, plumbers, etc) off the new construction trade. New family formation and population growth, along with upward mobility, creates demand. Japan’s shrinking population has created a near permanent drag on growth.
doesn’t explain the output gap
@Ivan,
“so if we all had nice houses that lasted forever we couldn’t be fully employed doing something else?”
But this is not the situation we’re in. A contractor knows that there will be a market for new houses and renovations again, so he’ll just sit around waiting out the downturn until there’s work for him. He won’t go out and learn a new skill.
Also, a big problem with housing is that homeowners have become immobile, particularly those who are underwater on a mortgage. If they are workers, then it is harder for them to move to where the jobs are.
Of course, my solution is different from Ivan’s. I would just streamline the foreclosure process to get delinquent borrowers out of their houses as quickly as possible. If you want to provide government assistance to them afterwards so they can get on with their lives, that’s a completely separate issue and something I would support, in theory. But we shouldn’t create a moral hazard by rewarding people for becoming deadbeats.
There was an article on Bloomberg today about how the housing market in the West is hotter than Georgia asphalt, and in the East, it’s moribund. The difference is the foreclosure process, which is mostly gummed up in the East (e.g. NY, NJ, FL – all “judicial” foreclosures states), in contrast to the “non-judicial” foreclosure states in the West (e.g. CA, AR, NV).