Randy Wray — Flash From the Past: Why QE2 Wouldn’t Save Our Sinking Ship

Here’s a piece I published in HuffPost back on Oct 18, 2010. A flash from the past–three years ago–predicting that QE2 would prove to be as impotent as QE1 had been. And here we are, folks. No recovery in sight–at least once you get off Wall Street.

We’re now set–yet again–to go off the fiscal cliff. Some have begun to talk again of the Trillion Dollar Coin–an idea President Obama has again rejected. He fears it would get tied up in the courts. So what? That would take years to settle.

Or perhaps he doesn’t want to break the logjam. Politically, he’s winning while the Republicans self-destruct.

However, here’s a better idea. We’ve got museums and national parks shut down. Why not sell them to the Fed? We can find a few trillion dollars of Federal Government assets to sell–and the Treasury can pay down enough debt to postpone hitting the debt limit for years. Heck, if we run out of Parks and Recreation facilities to sell, why not start have the Fed start buying up National Defense? How much are our Nukes worth? That should provide enough spending room to keep the Deficit Hawk Republicans and Democrats happy for a decade or two.

Economonitor — Great Leap Forward
Flash From the Past: Why QE2 Wouldn’t Save Our Sinking Ship
L. Randall Wray | Professor of Economics, UMKC

Exxon vs the Fed

Who's more profitable, Exxon or the Fed?

Results are in...

Final score:

Exxon $252 bln
The Fed $321 bln

It's the Fed by a knockout!

And all that profit without having to drill a single hole or refine a single gallon of gasoline. Plus, no messy spills to contend with. Just clean, neat Treasuries. A whole lotta them. About $2.6 trillion worth to be exact.

But where'd that profit go? Nowhere. To the Treasury and out of the private sector. Wow! What a stimulus!!! Let's have QE3, and 4 and 5 and 6 for that matter!!

Who's buying them now? (con'd)

Bill Gross, I hope you are listening.

Today, the Treasury did their first post-QE2 3-year note auction that went off AT THE LOWEST INTEREST RATE OF ANY 3-YEAR AUCTION SINCE THE BEGINNING OF THE QE2.

Thank you, Matt Franko!

Matt Franko is a frequent contributor to this blog.

Bill Gross: "Who will buy them now?"

Bill Gross is looking more and more like the most confused and frustrated guy in the investment business. Remember his ridiculous "tweet" back in late June when he said to the world, "Who will buy them now?" He was referring of course, to U.S. Treasuries and fretting publicly (or hoping, since he is purportedly short the US bond market) that there won't be anyone around to buy bonds now that the Fed is ending its Quantitative Easing program. When he tweeted that, yields on 10yr Treasuries were 3.16%. Today the yield is 2.89% and guess what? No Fed.

Gross still doesn't understand that government spending CREATES the funds that are used to buy Treasuries and, therefore, there is NEVER a lack of funds (or buyers) for these securities. If Gross ever "gets it" it would be nice if he explained it to another misinformed clown, Rick Santelli of CNBC, who rants about this constantly. After nearly 20 years on the air covering the bond markets and screaming about "supply" and "lack of buyers" before every single auction, you'd think he'd catch on by now.

The sad part is that both these guys have influence on policy. We are all affected in some way by their ignorance.

Edward Harrison sums up QE1, QE2, and QE3

Edward Harrison of Credit Writedowns explains QE1, QE2, and QE3 from the Fed's announced perspective and his own views, which is consistent with MMT.

What are the differences between, QE1, QE2, and QE3?

Ed thinks that should QE3 come, it will be after the Fed has firmly established the the overnight rate at zero, when it will shape the yield curve by setting price rather than quantity, reversing the strategy of QE2.

If this happens it will be completely in line with MMT's position that the government controls interest rates as it chooses, and the natural rate of interest (overnight rate) is zero.

While this is admittedly an emergency measure, it demonstrates what MMT has been claiming as a feature of the federal government's monopoly power as issuer of a nonconvertible floating rate currency.

QE, inflation and walking under ladders. What these things have in common.

We've heard many so-called experts say that Quantitative Easing causes inflation because the Fed is "pumping the economy with money."

We know this is not true and that whole notion has been debunked here many times.

However, just from the standpoint of common sense one should understand that there is no connection between QE and inflation.

Why would someone who has been sitting in a safe and secure gov't bond suddenly turn around and invest those proceeds in something as speculative as commodities? Maybe on the margin some of that is going on, however, it is not going on in any size that would cause the runnups in materials prices that we have seen.

Moreover, it is important to remember that the Fed conducts monetary operations (buying and selling of securities) with the primiary dealers and it is the primary dealers who sell to the Fed. This makes them "short" and since they need inventory at all times to meet the demand from their customers, they turn right around and cover those shorts by buying government bonds again in the next auction or whatever. (BTW, that's why the auctions go off so well all the time. The Fed has provided the funds.)

The money going into commodities right now is cash that investors and hedge funds have been sitting on and they put it to work ON THE BELIEF that QE causes inflation. You can equate it to the behavior of people walking around ladders rather than under them, because they believe that walking under them is bad luck.

The end of QE and what it means for the market

How QE works.

Whenever Quantitative Easing is mentioned in the media we hear a lot of commentary about “pumping money in” or “injecting liquidity.” Critics decry the money printing by the central bank, etc.

It’s all wrong.

I’m telling you this not that you’ll ever get into one of these discussions with your friends (you may) or even if you did, whether you’d be able to convince them of the fallacies of these arguments, but sometimes it’s just fun to know stuff.

A lesson in QE.

The term quantitative easing applies to a policy whereby the central bank, in this case the Fed, purchases assets (usually government securities) to expand the level of reserves in the banking system and, where desired, target a lower interest rate somewhere along the yield curve.

In the recent QE that was announced last summer, the Fed desired to bring down the interest rate on bonds and so it bought 5yr and 10yr Treasuries.

These Treasury purchases are done in the secondary market with the Fed buying from the public. The Fed doesn’t buy from the Treasury (it’s often misstated as that being the case). In fact, the Fed is precluded by statute from buying bonds directly from the Treasury.

When the Fed buys the bonds it “pays” by crediting the seller’s bank with reserves. Bond purchases (or any asset purchase) results in an addition of reserves to the banking system. Bond prices rise as a result of the Fed’s purchases and yields (which move inversely to bond prices) come down or, at least that’s the intent.

Is the Fed injecting “liquidity?”

No. There is no “liquidity” being injected anywhere.

That’s because all that’s occurred is an asset swap—a Treasury for a reserve balance. Both are exactly the same thing in that they are dollar denominated liabilities of the Federal Government, the only difference being their term and the interest rate they pay: Treasuries have some term, i.e. 2yr, 5yr, 10yr, etc while reserves are zero maturity. Both pay interest, but at different rates.

Therefore, when the Fed conducts QE, it strips the public of one asset—a Treasury—and replaces it with another—a reserve balance. No new money is created.

Is this hyperinflationary or even inflationary?

You can clearly see that it is not. It does not create any “new money” as, say, government spending would. All it does is change the shape of the yield curve, i.e. change the net duration of the financial assets held by the public.

Why did commodity prices run up, then? And why did the dollar tumble?

Perception, pure and simple. There is a belief that QE equates to the Fed “printing money.” Investors and traders act on that belief and push up the prices of commodities and they sell the dollar.

Why didn’t the Fed’s plan result in lower bond yields?

Part of the reason is because QE was widely perceived as being stimulative and a lot of economists started ratcheting up their economic growth forecasts. Bond yields rose on those forecasts.

Another reason why QE did not bring yields down is because the Fed decided to limit the program to a specific QUANTITY of bonds rather than target a specific rate itself. In other words, if the Fed wanted the 10yr to be at 2.0%, say, it should have stated that target and buy as many bonds as necessary to hit the target and then maintain it. This is how it sets the Fed funds target. Instead, the Fed said it would buy $600 bln, without knowing whether or not that would be sufficient to get to its desired rate.

(Now you know how to set rates, in case anyone asks you to run the Fed one day. ;))

What happens now that QE is ending?

Probably nothing.

Operationally, the Fed will stop buying bonds and crediting the banking system with reserves. Rates may move higher because the Fed will not be in there buying, however, to the extent that market participants feel “stimulus” is being removed, bond yields may actually come down. And since QE adds nothing to economic demand, the end of QE takes nothing away, either.

Furthermore, if investors feel that the removal of QE will result in less “inflationary pressure” from the central bank, commodities, gold and oil may come down and the dollar may go up. If so, all this will do is change the composition of the market’s leadership.