A Benjamin Cole post
Many right-wingers predicted the Hyper-Inflationary Doomsday when the U.S. Federal Reserve undertook quantitative easing back in 2009. The Fed ultimately bought about $4 trillion in Treasuries and mortgage-backed securities, and we now see near-deflation on the horizon.
Meanwhile, economic growth in the U.S. picked up after QE, particularly when the Fed finally went to open-ended results-dependent QE3 in 2012. It sure looks like central bank QE and printing (digitizing) money works, at least when you have an underutilized modern-day economy near deflation (duh). My guess is the Fed should have done QE bigger, harder and longer.
Never to be chastened, the right-wing had to develop a new counter-argument to this heresy of a central bank printing money with good results. But the standard-issue right-wing hyperinflation-scare stories were in tatters.
Thus, the “banks just swapped Treasuries for reserves” argument was fashioned, with a side-dollop story that QE was mostly inert. The “economy recovered through natural forces, and see the 1921 recession” story line emerged.
Some right-wingers even say, “The Fed did not print money.”
But let’s examine the “with Fed QE, banks just swapped Treasuries-for-reserves” narrative. Does it hold water?
The Federal Reserve did buy $3 trillion in Treasuries—but not from commercial banks. The Fed buys their Treasuries from “primary dealers.” That is a list of 21 firms that includes Cantor Fitzgerald, Goldman Sachs, Jefferies, Nomura Securities, etc. These are government bond-dealers. Not commercial banks. Even with Glass-Steagall in ruin, these old business lines broadly hold up.
The primary dealers did not have $3 trillion in Treasuries in their own accounts or inventories, so they had to go into bond markets and buy $3 trillion in Treasuries, and sell those to the Fed.
The Fed, in fact, printed (digitized) $3 trillion and bought the Treasuries from the primary dealers. The primary dealers bought the Treasuries from the real sellers, who were people and companies. The primary dealers were intermediaries.
So where swelling commercial bank reserves come from? From the NY Fed: “So when the Fed sends and receives funds from the [primary] dealer’s account at its clearing bank [depositary institution, or commercial bank], this action adds or drains reserves to the banking system.”
Now, after QE, the real or ultimate sellers of the Treasuries —not the primary dealers—had the freshly printed (digitized) Fed cash in their hands.
The real, or ultimate, private-sector bond sellers could then buy other bonds, or equities, or property, or spend the money, or bank it.
Now, it happens at the time the Fed was conducting QE that commercial bank deposits in the U.S. also swelled.
To be sure, some of the people and companies selling Treasuries to the primary dealers simply banked the freshly printed money, causing commercial bank deposits and related reserves to swell. And such deposits could be said to be “inert.”
But the swelling in bank deposits had many fathers. Households were also paying down debts and saving more in bank accounts. Corporations were and are sitting on growing cash hoards. Then, there is an undetermined amount of global flight capital deposited and parked into U.S. banks, from the Mideast and Far East.
In short, the people selling Treasuries to the primary dealers put some of the freshly printed money into banks, but they also then bought equities or property or bonds or spent the loot. All good, all expected—and all stimulative to the economy. And as the economy had plenty of slack, stimulative but not inflationary.
John Cochrane, the brilliant University of Chicago econ prof, has long touted the desirability of commercial banks with trillions of dollars of excess reserves, and he may have a point.
But Cochrane also reprises that “banks just swapped Treasuries for reserves” theme. But he never explains where primary dealers obtained the bonds they sold to the Fed, or that primary dealers have accounts at depositary institutions.
It strikes me that Cochrane is providing a glib explanation, and obscures some very important facts on the ground: Like who are the ultimate sellers of the bonds purchased by the Fed, and what do they really do with the freshly printed cash they have in their pockets?