Fed Needs to Stop Asset Acquisitions for a Generation or So

Yves here. Readers will take issue with some of former Fed staffer and banking expert Walker Todd’s comments on monetarism and Fed policy, but he nevertheless reaches the right general conclusions. The monetarist orientation of his post is a bit more understandable when you keep in mind that the central bank is run by monetary economists.

Todd treats quantitative easing as “money printing”. That sounds appealing but isn’t quite apt. The Fed was swapping assets, in this case cash for Treasury bonds or mortgage backed securities held by the public. The central bank seemed to think this would be useful due to its belief in the discredited but nevertheless very much alive “loanable funds” theory. In simple terms, if you make interest rates low enough, people will save less and spend more, and businesses will borrow and invest more because money is on sale.

In fact, what has happened is that many of those people who swapped bonds for cash went out and bought other financial assets, goosing stock prices, lowering yields on risky debt, and sending money sloshing into emerging economies. There appears to have been a modest amount of economic lift from that due to wealth effect among the rich. But big companies for the most part didn’t invest. They borrowed cheaply and are holding wads of cash that they can use to keep propping up their stock prices. Similarly, banks haven’t done much small business lending, in part because institutionally many have exited that business, and smaller enterprises themselves haven’t been too keen to borrow because in most regions and sectors, the recovery isn’t all that robust.

The Fed appears to have recognized that QE was largely a failed experiment before it announced the taper last year, but the market reaction was so lousy that it backed off and then tried again with lots more “we’re watching the market’s back” assurances. Cynics among my readers contend that the GDP figures today benefitted unduly from a 0.9% reduction in the GDP deflator, which would provide financial markets with a tailwind when QE was being halted officially.

Given that we’ve had three QEs so far, Todd has reason to argue against repeating this experiment. Another thread of his argument echoes that of Audit the Fed, which was the product of a left-right alliance, that the Fed never gave Congress an adequate explanation of the logic and expected effects of QE so it could be held accountable for this experiment.

By Walker Todd, an attorney and an economic consultant with 20 years’ experience at the Federal Reserve Bank of New York and the Federal Reseve Bank of Cleveland. He has numerous publications on banking, central banking, monetary and property rights topics, including those related to international debt, the International Monetary Fund, and the regulation of the banking system and financial markets. Originally published at FreeBanking

The Federal Open Market Committee (FOMC) meeting that ended today (Oct. 29) marked the first chance for the FOMC finally to do the right thing since the onset of the great financial crisis in the late summer of 2008. That right thing consists of resolving not to add even another dollar to the Federal Reserve System’s balance sheet for at least the next ten years (and perhaps as long as 30 years) in the absence of officially declared war or national emergency. Thankfully, on an 11-1 vote, the FOMC finally adopted the initial step in that policy direction, agreeing not to make significant additions to the System’s securities portfolio, for the time being.

The great financial historian Charles P. Kindleberger (1910-2003), who taught at Massachusetts Institute of Technology throughout the postwar years, was struck by what he perceived as the tension between generally Keynesian monetary policy (ignoring quantities of money and focusing instead on interest rates and unemployment rates) and generally monetarist monetary policy (giving great importance to measurement of quantities of money, tax policy, and sustainable economic growth, with the market sorting out interest rates and unemployment rates). In his Keynesianism vs. Monetarism and Other Essays in Financial History (1985), Kindleberger wrote, essentially, that long periods can pass when Keynesian policies may be pursued with benefit or at least without noticeable harm but that, when the cycles turn and the monetarist policy becomes appropriate, the monetarist approach is “so very timely.” Here, reference to monetarist approaches should be understood to be attention to the quantity theory of money: Many Austrian-school economists and even some traditional Keynesians care about and pay attention to the quantity of money.

Thus, the FOMC majority could have concluded today that a Keynesian approach to the financial crisis had a nice, nearly seven-year run but that, with clear statistical evidence of diminishing benefit from the Fed’s experiment in expanding reserves to levels well in excess of anything that Kindleberger would have considered wise, it is time to stop. From here on out, probably for ten years or longer (perhaps up to 30 years), the FOMC should pursue monetarist approaches to policy in which, for every dollar of assets added to the System’s portfolio, another dollar is sold from that portfolio, even during emergency periods, and in which maturing assets are not replaced, with net shrinkage of the portfolio over time. The FOMC did not adopt this last policy step today, voting essentially to hold the size of the portfolio constant until further notice.

One cannot argue plausibly that necessary market liquidity would be reduced below sustainable levels by attention to the quantity of monetary base that the Fed creates. (Domestic monetary base = currency in circulation plus reserve balances held at the Fed; foreign exchange swap drawings in dollars, currently zero or near-zero, should be added to this amount to find total probable domestic claims against the Fed.) Currently, there are about $1.25 trillion of currency outstanding (with probably about 70 percent held outside our borders), plus about $2.7 trillion of reserve balances held at Reserve Banks. That is nearly $4 trillion of monetary base.

In 2007, the year before the crisis, a Fed balance sheet of “only” $929 billion sufficed to promote strong growth in a $14.5 trillion economy (nominal GDP). The Fed’s balance sheet was only 6.3 percent of the entire economy. After countless interventions in the economy and a never-ending series of Quantitative Easings (econospeak for money-printing) since then, the Fed’s balance sheet is nearly five times larger, but the economy is only 19.3 percent larger. The Fed’s balance sheet is now 25.5 percent of GDP.

One supposes that it takes a lot more money to make the world go around these days, but the economic outcome is far smaller than one would have expected given the amount of monetary input. If the Fed has an econometric model showing how much GDP growth it expects from each new dollar of monetary input, it should disclose that model to Congress now, and if the outcomes are suboptimal or as demonstratively inefficient as I think they are, then Congress should make the Fed stop using that model to drive FOMC policy choices, if the Fed refuses to do so voluntarily.

The Fed courts a real danger of becoming, if it has not already become, the motor of a thoroughly corporatist political economy model for the United States, if not for the entire world. A central bank balance sheet equal to 25 to 50 percent of GDP was considered a hallmark of corporatism in developing economies that the World Bank was trying to reform in the post-1980 years. The Fed should be asked to tell Congress now, before the election next week, how great a percentage of GDP it wishes to hold on its balance sheet without seeking the approval of Congress.

Back to Kindleberger’s point: When the time comes around for the monetarist message, it is important for central bankers to heed that message. It is, indeed, time to stop printing money (technically, this is a collaborative exercise involving both the Treasury and the Fed and, behind the scenes, both the White House and Congress).

The following facts are clear: As of mid-2014, the Fed had expanded its balance sheet by $3.483 trillion since August 2007 (375 percent), with nearly all of the increase occurring since the onset of the crisis in September 2008. However, nominal GDP expanded by only $2.850 trillion over the same period (19.3 percent). In other words, only 81.8 cents of new GDP were created for every dollar of Fed-Treasury money printing, an exercise of remarkable inefficiency considering that, for the eleven years before the crisis, 1997-2007, about $13.88 of new GDP were created for every new dollar of money printing. Money printing is an inefficient way of creating GDP, after the crisis, but it has proved to be an efficient way of creating asset price bubbles.

Finally, if one wished to reduce the Fed’s role in the economy to the level that prevailed before the crisis, about 6.5 percent of GDP (the range was 5.9 to 6.9 percent over the preceding eleven years), the current size of the Fed’s balance sheet would support economic expansion to nominal GDP of $67.9 trillion, about four times the current size of GDP. Historically, it took 15 years for GDP to quadruple, 1969-1984, and that period included the high-inflation 1970s. In a period of lower inflation, after 1984, it took 28 years for GDP to quadruple again in 2012. That is why I proposed, at the beginning of this note, that we simply suspend the monetary policy operations of the Fed for a generation or so until the rest of the economy catches up to all the monetary base that recent Fed operations have created.

We still need banking supervision for as long as we have non-gold fractional reserves, we need the payments mechanisms operated by the Fed, and someone has to buy all that debt that the Treasury has for sale. But it is not clear that the Fed is the entity that should do any or all of these things. On the other hand, we have a large infrastructure investment in the Fed, and we might choose to keep it operating to perform these other functions. Just not monetary policy, not for a good long while, anyway.

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  1. mmckinl

    “The Fed appears to have recognized that QE was largely a failed experiment …”

    QE was a huge success for the owners of the Fed … trillions in liquidity, tens of billions in bank subsidies. There was no question that the Fed knew exactly how QE would work. Everyone has fallen for the myth that the Fed is just another stumbling, bumbling Federal Agency when in fact their corporate charter is bankster charter.

    1. Yves Smith Post author


      I have written repeatedly that the banks do not own the Fed. This sort of inaccurate statement allows critics to be dismissed. The OCC and Treasury are every bit as bank friendly by virtue of mere cognitive capture.

      The shares that member banks own are nonvoting preferred shares, with dividends of 6% of par value. All the critical decisions relative to the regional Fed banks, like the selection of presidents, are made by the Board of Governors, who are nominated by the President and approved by the Senate. The boards of the regional Feds are meme advisory boards, to have tea and cookies with the staff of that Fed and advise them of local economic conditions. They are a holdover from the days when there was no economic data to speak of.

      The Fed is a bizarre public-private hybrid. It is most assuredly NOT owned by banks.

      1. mmckinl

        And this ” failed experiment ” that gave the banks, over the years, hundreds of billions of excess profits?

        The idea that that the Fed was and is somehow unawares of the policy consequences that they pursue?

        Sorry … Not buying the “innocent” Fed theory …

        1. Greenbacker

          The Fed is a public/private hybrid like he said. They control our currency. It isn’t “their” money, they are playing with, it is “our” money. Their money is gold and will always be gold. In return, they charge us high interest on our debt which is why they don’t want high inflation destroying that investment.

          When they pushed Andrew Jackson to destroy the Bank of the United States, a anglo-controled institution of Philadelphia, they set in motion events which would lay the foundation of Wall Street. New York wanted the Bank of the US dead dead and deader. Rothschild and Astor were complete strangers to the US before Jackson’s treason. Unlike what “conspiracy” or “libertarian” sites tell you, there is not one noted involvement of European Jewish banking in the United States before 1833. Then we hear of their involvement, New York becomes the financial power and Wall Street is born. Jackson was a British Sympathizer with MVB, who was taught by the traitor Aaron Burr. The British were scared like hell of the US’s industrialization in the north and when Biddle talked about plans to help the south industrialize, they had to take action. They needed Jackson to take action. Jackson had his own beef with the Bank. They refused lose credit in the west and stopped speculation cold. He saw them as America rising to the challenge of his beloved British supervisors who he saw as his masters. It was why TJ wanted Crawford as President in 1824. He knew what he was. He knew, he knew exactly. Ben Franklin would have executed him on the spot.

          When Harrison tried to bring back the Bank, he was murdered.

        2. Ben Johannson

          QE did not give banks hundreds of billions in profits. That’s a ludicrous number and does not refllect the dynamics involved or the nature of quantitative easing, which is the equivalent of giving subway tokens to someone who will never use them and can’t trade them away. QE costs banks money in exchange for making them appear solvent.

          1. jgordon

            The banks certainly did reap rich rewards from “purchasing” treasuries, holding them for a week, and then transferring them to the Fed–all with vast and myriad management fees involved. Which the Fed gleefully paid out to the banks for this service. From all this there are certainly now many more bank executives with new yachts and gold-plated swimming pools. From your comment, I take it you did not consider that to be of any significance. Although those enjoying their new yachts may disagree.

        3. diptherio

          Strictly as a matter of law, Yves is correct that the Fed is a public-private hybrid. As a practical matter, the Fed, along with the rest of our national government, acts almost exclusively in the interests of our elites. Sort of like how, as a constitutional matter, citizens have the right to assemble to petition their government for redress of grievances, but in practice such actions are often met with pepper-spray and mass-arrests. So there’s the technical aspect and the practical aspect, and they don’t necessarily line up.

          While I think many of the readers here would agree with you that the failings of QE have been largely in the “feature-not-bug” category, your reference to the Fed charter implies that you are making a technical claim about that document—one unsupported by the facts—that only serves to make your critique more easily ignorable. I think Yves is so insistent on us being clear about the technical ownership structure so that our critiques of their policies cannot be written off as the rantings of cranks who don’t understand what they’re discussing.

          As for the question of whether or not people at the Fed ever really believed that pushing on a string could be effective, I’m with you. I don’t think they can be that dense…but I have been wrong before…

        4. Yves Smith Post author

          Wow, you REALLY don’t understand how the Fed works.

          The Fed’s profits are swept to the Treasury.

          A 6% preferred stock means you get ONLY 6% of par value, no more, and much if not all of this preferred stock was issued decades ago, so the par value is very much eroded by inflation

          1. Jim Shannon

            So… just as ALL Profits are swept to the Treasury for We The People;
            And….ALL losses are PAID IN FULL by We The People;
            TARP and QE covered up the Corruption on Wall Street!
            FAKE securities were traded and We The People have paid dearly!!!!!!!!!!!!!!!!!!!

        5. Yves Smith Post author

          Straw man. Are you incapable of honest argumentation?

          Go read Bernanke’s 2002 speech on deflation. He did pretty much everything he said he’d do except helicopter drops. Bernanke is a monetary economist using a bad theory, the loanable funds theory.

          Never attribute to malice that which can be explained by incompetence. And I don’t consider incompetence to be an excuse for an institution as powerful as the Fed.

      2. not_me

        It [the Fed] is most assuredly NOT owned by banks. Yves

        The question then is why ALL citizens may not have accounts at the Fed for the risk-free storage of and transactions with their fiat instead of government deposit insurance for the banks? Why aren’t we all banks as far as the Fed is concerned, or better, why aren’t banks mere people as far as the Fed is concerned?

          1. not_me

            Yes, a bank for banks with the morally absurd ability to create new fiat to lend or give (eg. interest on reserves) them.

            1. Ben Johannson

              There you go again. You start with the premise the Fed is owned and controlled by banks and when Yves responds you switch to a normative argument on “moral” currency, whatever that means. This is the same pattern used by climate denialists: repeatedly switch topics in the hope that something will eventually stick and they can “win”, even though the process is illogical.

              1. not_me

                I simply gave a obvious moral judgement on a undeniable fact, that central banks create legal tender, not for the general welfare only or for those who need it but for the banks and the so-called creditworthy, which always includes the rich.

                And FYI, I agreed with Yves.

                1. zapster

                  Fiat is what is left over after all your gold has walked away and left you with nothing but the notes and the silver.

                  From Wikipedia “Cross of Gold Speech” page:

                  In the early 19th century, the economic disruption caused by the Napoleonic Wars caused United States gold coins to be worth more as bullion than as money, and they vanished from circulation.
                  In 1890, the Sherman Silver Purchase Act greatly increased government purchases of silver. The government pledged to stand behind the silver dollars and treasury notes issued under the act by redeeming them in gold. Pursuant to this promise, government gold reserves dwindled over the following three years.
                  Cleveland tried to replenish the Treasury through issuance of bonds which could only be purchased with gold, with little effect but to increase the public debt, as the gold continued to be withdrawn in redemption for paper and silver currency. Many in the public saw the bonds as benefiting bankers, not the nation. The bankers’ feeling was that they did not want loans repaid in an inflated currency—the gold standard was deflationary, and as creditors, they preferred to be paid in such a currency, whereas debtors preferred to repay in inflated currency.

                  So, once all your gold is gone, what have you got left? Fiat–which is far less deflationary than gold, and so bankers hate it when governments spend it into existence, because then people have cash, they pay off their debt, and the banksters lose. Fiat is by far the most egalitarian money system we’ve come up with.

                  The problem is, people like you try to convince everyone that spending fiat into existence is somehow bad, and so we now treat dollars like gold–and they’ve become so expensive that they’re taking on characteristics of gold. Hoarding dollars has become far more lucrative than using them to build stuff and sell stuff and hire people. We’re running a virtual gold standard. KInda looks like bitcoin, now that I think about it…

                  1. not_me

                    people like you try to convince everyone that spending fiat into existence is somehow bad,

                    NOT AT ALL! Fiat should ONLY be spent or distributed into existence, never lent or borrowed (ie. from a central bank) into existence.

                    Please understand that I hate central banks but inexpensive fiat is the ONLY ethical money form for government debts.

                    1. zapster

                      So, how many retirees do you know that are in repayment to the Fed for their SS checks? Oh right, those are drawn on the Treasury. Ok, how about those Federal Reserve Notes in your wallet? How much interest are you paying on those?

                      Who is “lending” fiat into existence? Private banks lend–so does Walmart, the local car dealership, and anybody else that accepts an IOU. Would you have it illegal to write IOUs? Really?

                      And have you ever looked at *why* everybody has central banks? It’s because not having them gives the banks too much power and they eat people alive. That’s why the conservative farmers in North Dakota started a *government* bank. If you read the history, it’s shocking how much *worse* it can get. The government has no profit motive. Neither does the Fed, or the regional fed banks. They are limited to no more than 6%, as Yves pointed out, and they return everything extra to Treasury.

                      Our problem is congress, not the Fed. Congress controls the budget, it decides who gets the money and how much, and it’s not the average citizen because of who we elected.
                      The Fed is the wrong target. The target should be the meme that “gummint spending bad”. It’s the only money that we don’t have to pay back. To me, that’s a good thing.

      3. EconCCX

        I have written repeatedly that the banks do not own the Fed. @Yves

        You’re making an argument from governance. According to the US Code, the shareholders have first liability for the debts of the Reserve Banks. That’s why USG must sell the Banks a bond or a coin, or convey some of the Banks’ own liabilities back to them via taxation before it may write checks against its Reserve Bank account, the TGA.

        12 U.S. Code § 502 – Liability of shareholders of Federal reserve banks on contracts, etc.

        The shareholders of every Federal reserve bank shall be held individually responsible, equally and ratably, and not one for another, for all contracts, debts, and engagements of such bank to the extent of the amount of their subscriptions to such stock at the par value thereof in addition to the amount subscribed, whether such subscriptions have been paid up in whole or in part under the provisions of this chapter.


        (Notice that I’m providing a document to support my argument. Hope others will do the same, else they’re merely stringing words together.)

        1. EconCCX

          The power of the Reserve Banks to issue Reserve Notes and augment Reserve Balances as liabilities of their shareholders enables those shareholders to lay claim on real world assets in exchange for digits and pieces of paper, redeemable only for more of the same. It’s the engine of financialization.

      4. beene

        “The Federal Reserve System has both private and public components, and was designed to serve the interests of both the general public and private bankers.

        Nationally chartered commercial banks are required to hold stock in the Federal Reserve Bank of their region; this entitles them to elect some of the members of the board of the regional Federal Reserve Bank. Thus the Federal Reserve system has both public and private aspects.”


      5. Jack Thread

        Interesting sub-thread. Check out any official legislative web site: You’ll most likely find a helpful diagram and a succinct textual description of how a measure becomes a law, a resolution, or a memorial. What you won’t find are words like lobbyist, vested interest, party boss, campaign donor, re-election, ideology, or page scandals. Yet it is an open secret that these are among the issues that drive the legislative process. We can be as pedantic as we want about describing how the Fed is purported to work while realistically we should allow some elbow room when describing how it actually works.

        I’m pretty sure if the proponents of the Federal Reserve Act promised that within 100 years it would preside over an almost 100% devaluation of the dollar and would wind up monetizing debt that had as much chance of being repaid as Saddam Hussein has of regaining suzerainty over Iraq, the bill might not have passed. In fact, it might have not have made it to the first reading.

        While we can quibble endlessly over what the Fed is supposed to do, it might be an easier question to ask whether they have even approximated their stated purpose. If I remember correctly, their original mandate was to implement the Real Bills Doctrine. Never happened. I might be wrong about that, but I also seem to remember that the head of the New York Fed was a sort of Byzantine General whose reckless behavior went a long way towards bringing about the Great Depression. The rules changed drastically during the New Deal, and have changed many times since then, so impressions that might have held true in the past are no longer valid. There is more to wonder about agreement over how the Fed works than there is about disagreement.

        Perish the thought that we might make congressional staffers roll their eyes, or arouse the ire of economists whose models have the same predictive ability as which way a sailcat points after having been thrown by the tail, but we might be ever so slightly justified in questioning a system that seems to be failing at an exponentially increasing rate. I’m pretty sure that if society is to evolve, the current central bank model is going to be one of the things left behind.

    2. washunate

      Agree with the comment generally, but you need to be more precise about those last few words.

      The Fed is not a bankster bailout conduit because the banksters directly charter it or own it or whatever. Rather, the Fed is a bankster bailout conduit because the government is a bankster bailout conduit.

      The Fed is just doing its job as one of many organs of the state implementing public policy.

  2. Moneta

    In simple terms, if you make interest rates low enough, people will save less and spend more, and businesses will borrow and invest more because money is on sale
    They should hire more people who study in social sciences, but of course they’d have to start by putting some value on those studies…

    With zirp, conservative people will be even more conservative and the only ones going into more risk are:
    – The conservative who don’t grasp the true risk
    – The speculators

    So at the zero bound, you end up with incredible risk mispricing.

    1. Ben Johannson

      . . .businesses will borrow and invest more because money is on sale.

      Businesses are almost entirely insensitive to low interest rates when deciding whether to make investments.

        1. Ben Johannson

          It’s important to differentiate between investment and speculation. I reject the corporate-spawned notion that buying back their own stock is an investment, as the act does nothing to improve productivity.

          1. MaroonBulldog

            Corporations that buy back their own stock are not making any investment, but they are not speculating, either. They are just distributing cash to shareholders in a manner that has different tax consequences to shareholders than declaration and distribution of a dividend would.

            1. Moneta

              Why should companies that are distributing their cash and not reinvesting see their share price go up? Because investors are buying their stocks like they choose a can of tomatoes.

              Incredible mispricing of risk going on right now.

      1. nothing but the truth

        “businesses are insensitive to interest rates” etc

        are you a businessman? does not seem like it.

        1. Lambert Strether

          Businessmen whose animal spirits are quickened by cheap money are probably not that numerous, and probably not the sort of businessmen we want to encourage in the first place.

          1. zapster

            In real-world businesses where the aim is rolling out a product, loans are generally short-term, and interest rates are far less important than the anticipated profit of getting your gizmo out by Christmas, or getting enough product to meet that huge contract due in 6 months. Interest rates are mainly interesting to entities that make their dough playing interest-rate arbitrage games, or those with long-term investments like homeowners. Your average manufacturing facility is likely to pay it off in 6 months or a year, after the product launch or the mass layoffs if it squelches.

            1. nothing but the truth

              none of you have a clue about business.

              if your business lives day to day and has practically no financing requirements, you may be somewhat possibly somewhere close to the truth on a sunny day when the stars are right.

              most businesses require assets that require financing.

              stick with economists. wrong almost all the time and always passing judgements on others, except on your own field.

              1. zapster

                I owned a business for over a decade, and have managed other businesses as well. Sure, some require assets, and between depreciation and other little details they make out like bandits on the tax breaks which effectively cancels the interest rate. Vulture funds sacrifice entire companies to a) skim the debt they can load onto it and b) farm the tax breaks.

                The fact is, serious businesses run on short-term loans, and they don’t give a rat’s what the rate is unless it’s extortionary; they care about whether they can roll it over if needed.

                Been there, done that. You’re out of ammo.

                1. nothing but the truth

                  were you running a consulting business?

                  i run both and the “real” business decisions on asset acquisition/replacement vs another year or repair depends a lot on interest rates.

                  and the assets that banks care about like real estate are extremely interest sensitive. which is why rates will not rise, IS-LM crap is nonsense.

                  1. zapster

                    and the assets that banks care about like real estate

                    Which is why I said “long-term rates” up there. Yes, there are businesses–real estate, of course–that do play interest rate arbitrage, and I did also mention that.

                    For non-FIRE businesses though, which I referred to as the financial sector, it’s not a big issue. Neither are taxes or regulation, for that matter. What matters is the potential for profit.

          2. nothing but the truth

            so now it is not about a correct understanding of business, it is about political goals of what society should be like.

            great. if 2+2 != 5, then it should be?

  3. Gil Gamseh

    “Walker Todd”? Hmm, white shoes, bow tie and seersucker suits. #ThePrivilgeofPrivilegeisanExquisiteThing

  4. washunate

    Todd treats quantitative easing as “money printing”. That sounds appealing but isn’t quite apt. The Fed was swapping assets, in this case cash for Treasury bonds or mortgage backed securities held by the public. The central bank seemed to think this would be useful due to its belief in the discredited but nevertheless very much alive “loanable funds” theory.

    Yves, I know what you mean here, and you are probably trying to walk the tightrope between MMT and views that are more openly hostile to the record of the various bank bailouts over the past couple decades. But outside of academic economist-land, that’s what people mean when they talk about ‘money printing’ or the ‘printing press’ or whatever. They are talking about the government creating currency units and then using those currency units to pay above market prices for various financial assets, especially Treasury and mortgage-backed securities.

    To characterize that as merely swapping one asset for another I think fails to capture the heart of the dissent, either in terms of its philosophy or its intensity.

    Furthermore, this wasn’t done because of the loanable funds theory. That is all part of the kabuki to get people to argue about irrelevant trivialities. The reason the Fed bought trillions of dollars of securities is so that it could pay above market prices. It was a government bailout, not a lending program.

      1. zapster

        Well no, it’s actually deflationary because it’s removing the Interest income. A higher price doesn’t offset the long-term deflationary loss of income.

        And have you noticed the flood of money into treasuries–which pay *less* throughout all this? That’s why QE hasn’t worked all that well. The shortage of *safe* assets and wage/demand suppression is leaving nothing but commodities and treasuries to invest in out there, essentially. And you can see the effect of that deflation, coupled with congress’ sequester idiocy in steadily declining.. everything.

        1. washunate

          Interest rates aren’t independent of price, though. When you change the price, by definition, the interest rate will change.

          If you want to define buying MBS as deflation, that’s fine. It doesn’t change the meaning of how people use phrases like printing money, however.

    1. fresno dan

      October 31, 2014 at 10:20 am

      I have a tendency to see it the way you explain it.
      It also raises questions that I wish someone would answer
      1. It is said that this is an asset swap (apparently assets the FED has against MBS and other bank assets ((loans?)) – so where does the FED get these apparently “new” assets? That is, if the FED balance sheet was about 1 trillion, and now it is about 5 trillion, where did the 4 trillion come from?
      2. If you are buying something that nobody else will buy, aren’t you essentially raising the price of that thing?
      Its a funny thing about the free market and the rich – when the average home loan borrower’s asset (i.e., their house collapses in value…..well, that’s the market and nothing can be done) Now if the FED was buying homes directly from underwater homeowners, I would see where this would help the average American. But somehow, homes get foreclosed (or not, depending if its advantageous to the banks), the average American is in a real hole because they were conned into paying WAY too much for a house, that was abetted and instigated by bankers, and our whole mechanism for taking care of this is to make sure the banksters most involved in this disaster remain solvent and not prosecuted for obvious financial crimes, as most stridently advocated by NYFED bankster enabler Timmy Geithner and paragon of justice, Eric Holder.
      Now I really don’t understand a lot of this. But I suspect it is very much what the film critic Roger Ebert described as a McGuffin – something that doesn’t have anything to do with anything but merely exists as a distraction.
      Does the FED REALLY exist to make sure we can never use fiscal policy and government projects to effectively combat unemployment and inequality??? Because everybody is yammering about interest rates and not the unemployment or labor participation rate???
      3. Because if this is as described by the DEFENDERS of QE, i.e., an asset swap, how does that do any good? I take it to me these asset swaps are equivalent to 20 George Washington singles exchanged for 1 Andrew Jackson 20? If not, than how do these assets ACTUALLY differ? And if the assets really don’t actually differ in value, why is one more preferred than the other? You know, SUPPOSEDLY in capitalism, if something is more preferred, you get…..wait for it……keep waiting……a higher price.

      1. Paul Niemi

        The $4 trillion came from the Fed creating reserves that it used to credit the accounts of the banks that sold it the assets. They just enter an amount in a ledger. The banks keep the excess reserves on deposit at the Fed, or they can lend money against the reserves to you and me. Loanable Funds says the interest rate for loanable funds should fall with an increase in supply of loanable funds, until demand for loans equals supply of loanable funds, but the surplus of loanable funds that exist in theory because of excess reserves shows that doesn’t always work.

  5. Paul Niemi

    Yves’s analysis is correct about the effects of QE. I would add the Fed has never come up with a way to let both interest rates and quantity of money float together, so as to provide the necessary liquidity while not blowing bubbles in asset prices. Under Paul Volcker, the Fed targeted quantity of money and let interest rates float. Under Alan Greenspan, the Fed targeted interest rates and let quantity of money float, and the other central banks followed suit. Under Ben Bernanke, the Fed targeted interest rates and added QE. How should interest rates be set? Not by “pushing the red button” to create reserves until the overnight rate hits the target. Anyone remember the prime rate, or money market accounts? RIP. I used to open the newspaper and the prime rate was in a box. It represented the rate at which banks lent to their best customers. It constituted the real interest rate, which was the average return to capital over time, plus the expense of lending the money and obtaining the reserves and a sliver for bank profits. At the prime rate, businesses pay a little more to borrow money than to raise cash by selling stocks. What happens when the interest rates are held artificially below the real interest rate? Evidence that that boosts the economy over doing nothing is lacking, but so long as interest rates are targeted and not allowed to float, they will always be driven down to zero for the appearance of doing something to boost the economy. This is the encroachment of politics into money. And it blows bubbles, causes crashes, causes inflation, makes the rich richer and the poor poorer, outsources jobs, scavenges assets, makes dogs howl, babies cry, etc. How to have both floating interest rates and floating quantity of money? Here’s a suggestion for the Fed: instead of pressing the red button to hit the target rate for reserves, auction reserves to banks daily by accepting the highest interest rate bidders, but end each auction at a randomly selected time, so as to prevent banks from bidding up interest rates at the end of each auction. If a bank did not get its desired reserves that day, it can borrow them from other banks overnight. That is an intervention that cannot be gamed. It would restore the markets, lead to real price discovery, and stabilize what has become economic nonsense.

      1. not_me

        If you define capitalism as government-subsidized private credit creation for the sake of the banks and the so-called creditworthy, which always includes the rich, then it’s no wonder it can’t work for very long.

        1. zapster

          Which is incorrect. The private sector can create credit whether there’s a government or not. In fact, without government, that’s the *only* thing it can do. It has no choice. And the taxes private banks charge on their money are much higher than the taxes the government charges for it’s money.

    1. fresno dan

      That helps my understanding a little bit (not that it is not an excellent explanation – the fault lies in my lack of brains) but I would note LIBOR. It seems to me the banks will conspire to take advantage of the government and the sheep …I mean market.

      1. Paul Niemi

        LIBOR is a good example of banks linking interest rates for a variety of instruments to estimates reported and colluding in the estimates. It refers to funds banks lend each other, but that is distinct from how the Fed influences interest rates. A bank makes a loan and credits the borrower’s account. It then needs to obtain a certain amount of reserves from the Fed, which the Fed creates and lends to the bank for collateral. It is at this point, where money is created, that interest rates have been held at zero, with all borrowers getting all the reserves they want. My question is how to devise a system for distributing reserves that would let the markets determine the interest rates charged for reserves, instead of targeting an arbitrary interest rate and pushing out reserves until the interest rate came down to the target rate? This while not limiting the quantity of money created, so long as the borrowers are creditworthy. When there are a limited number of buyers at an auction, and they are always the same, and the product purchased is of unlimited supply, the dynamic tends to the largest buyers setting the price, or the crowd all bidding low, or waiting to the end. However, it occurred to me that if the buyers did not know the time at which the auction would end, they would be more likely to tender honest bids up front, resulting in good price discovery. None would wish to be left empty handed, failing to put in a good bid before the end of the auction. So, instead of targeting the interest rate or the quantity of money, the Fed could use a high bid auction for distributing reserves and the variable would be the duration of the auction, set at random day to day and undisclosed.

  6. Moneta

    Let’s say I have the choice between 3 types of assets:
    -One that does not depreciate
    -One that depreciates over 40 years
    -One that depreciates over 10 years

    I’m going to be looking at different rates of return on that asset… on the 40yr one, I will be looking to get at least 2.5% per year so in year 40 I can replace it. On the 10-yr one I will be looking to get at least 10% so I can replace it in year 10.

    Asset life has been shrinking thanks to planned obsolescence over the last few decades. I doubt interest rates and ROR reflect any of this at the current time. For example, with mortgage insurance all house are being mortgaged at essentially the same rate and valuations do nor really account for the expected depreciation over the next few decades.

  7. John Mc

    Dogma need not stifle understanding here folks… The role and culture of the Federal Reserve is but one series of problems in the morass of crony capitalism. Criticism is fine, but raging against the ‘dying of light’ seems a bit too much. Issue noted, many here do not like the fed.

    It is this type of Dogma which led Greenspan to make so many errors. Einstein reminds us that we need to see problems a new, that the people who created the problems were unlikely to solve them. Greenspan has said as much – “I was right 70% of the time and not 30%” (paraphrased) — having been a broker during the 1990’s, this 70-30 split is the best position from which to foment lies (using the credibility of the majority to slight shift resistance for control and influence).

    We are better than this. In this case, the enemy is not the fed, it is accuracy.

  8. Chauncey Gardiner

    So the question in my mind becomes what to do given the limited effectiveness of Friedman monetarism and the loanable funds model after six years of QE-ZIRP, deregulation, and neoliberal austerity and privatization policies in Europe, the UK and the U.S.? (Yes, I am mindful of the run-up in asset prices, wealth concentration in the hands of a few, and misery for some that has flowed from this policy set.)

    It’s Halloween 2014, over six years after the financial collapse. Perhaps our policy makers should listen to and reflect upon a ghostly voice from the past: John Maynard Keynes, and particularly his ideas on deficit fiscal spending by governments at the zero-bound. Not suggesting this is the only solution, rather part of a set.

    Just my thoughts as an interested layman and voter, if the latter still has meaning.

    1. Carla

      “and misery for some that has flowed from this policy set.”

      And misery for some? For SOME?

      Think, man.

  9. craazyman

    Notes from the Perimeter

    As long as we’re giving the Fed advice, let’s say this: Sell your bonds and buy Gold!

    How can all this money printing make the price of gold go down? That’s not the way it’s supposed to be. The price of gold was supposed to be north of $2000 per ounce right now. Very far north. Instead it’s heading for the tropics. It’s heading for Cancun.

    Why is that? Something’s happening here and what it is ain’t exactly clear. It’s not true QE hasn’t made jobs, QE has made lots of jobs but they’re all in foreign countries. QE has bled jobs, jobs and robots. They’re poppling up in foreign countries. QE is a vapor that gets emitted like a disco smoke machine and it congeals into jobs and robots in foreign countries. That’s what’s happening. Are there smoke machines anymore? That was a long time ago. Disco. All those people are dead. That woman who played in Saturday Night Fever, she starred next to John Travolta. Then later in her life she worked as a secretary to pay the bills. That was before QE. Even QE wouldn’t have helped her, I bet. IT would have made it worse for her, since she’d have had no job at all.

    What is the QE vapor made out of? It’s made out of an idea of order and it flies into vacuums of disorder. Or at least vacuums where a lower order prevails. Or at least lower costs. And why lower costs? Because there’s more economic entropy. The general idea is that entropy will decrease and order will increase as the QE fumes propagate the idea of order that produced them. This is subtle but quite significant. This is why gold is going down. Because the expectation is that global entropy will decrease as the fumes of QE propagate an idea of order. Now that QE is being stopped, the idea is that the idea of order will nevertheless persist. The seed has been planted. Theoretically.

    If the Fed bought gold now, they’d directly refute the idea of order contained in QE. In theory anyway. So they have to avoid buying gold at all costs, that’s what they think. The idea is, now, whether the idea of order contained in QE will in fact take hold. It might. But if not, then all hell will break loose. They probably said this back in the Aztec days too. When you’re in the middle of something, it’s hard to see the perimeter. And if you do, nobody would believe you anyway.

  10. susan the other

    Well, looking at this historically, during the centuries that capitalism was on the rise, this sentence jumped out at me: (interference in the order of things is needed only when) “officially declared war or national security” is the case. OK then. Who needs “officially” if we are achievieng the same industrial stimulation unofficially? (Can anyone say ISIS?) What we are doing is preserving the illusion of the importance of capital as money in itself. But it is not intrinsic to itself. Money is not gold. That’s so laughable it’s not funny. Money is people. Period.

    1. craazyman

      It absolutely shocked me to hear that actress had to go work as a secretary. I remember sitting in a movie thee-ate-er as a kid watching in wonder at that Goddess up on the screen did the disco dancing thing. Jesus that was big time! New York! Fame! Stardom! Sophistication and glamour! It would have been reasonable for her to live in Beverly Hills in the house the Beverely Hillbillies lived in. But not with that old black car or the shotgun. More like — with a Jaguar car or a Mercedes Benz.

      How could it come to be that she worked as a secretary after she starred in that movie? I wonder if she ever took the subway into Manhattan and went to a night club and danced. That would be incredible to imagine. AFTER making that movie. Then having to take the subway in to go out dancing as a secretary in a nightclub, lower on life’s scale than the dancer she pretended to be in a movie.

      That’s like living in reverse time and reverse imagination. Your life journey going in reverse, your soul falling through time down into something unbelievably inconceivable. Faak it amazes me to think about that. Going up and dancing with her and chatting her up over a vodka tonic and then hearing she was That Actress. Oh man. That’s too much for my tender sensibility to even think about. It’s dizzying, just thinking about it. I think I’d have fainted right there.

      If that can happen. Anything can happen. Why should QE do anything? Good or Bad? The things that do things are their own things. Just like that actress, how can you even understand something like that? It’s impossible.

  11. John Yard

    QE succeeded in lowering the dollar vs it’s major trading partners to generational lows. This exported deflation to our major trading partners. Notice that the recovery in Europe was choked off by QE3, as the euro rose beyond 1.35. It is no accident that the priority for the euro and yen is to devalue. Of course, all parties will deny currency devaluation – the elephant in the room.

  12. not_me

    and someone has to buy all that debt that the Treasury has for sale. Walker Todd

    Uh, no. Fiat can easily be interest-free since it is the ONLY means to extinguish tax liabilities, Federal, State and local, as well as pay fees, fines, etc.

    As for the payment system, that should be handled by the US Treasury or a Postal Savings Service; it belongs in the monetary sovereign proper, not some public-private partnership monster such as a central bank.

    We are supposed to have separation of Church and State. How is it we do not have separation of private credit creation and State? Is Mammon an exception?

    1. skippy

      Fun fact… double entry bookkeeping accounting is based on biblical ethos, in pre-modern Europe, double-entry bookkeeping had theological and cosmological connotations, recalling “both the scales of justice and the symmetry of God’s world”.

  13. nothing but the truth

    “the fed is not printing money because it is swapping money for (worthless debt) assets”.

    the explanation given is like saying that a cup is not full of water because it is full of H2O.

  14. zapster

    “the fed is not printing money because it is swapping money for (worthless debt) assets”.

    Which, according to an article I saw recently, they’re making a fair amount of income on that debt and plan to reinvest it in more assets. The sordid fact is that the Fed *has* been making money on all of these investments, which is not actually a good thing. The interest income is removed from the private sector, which is deflationary at the same time it’s spurring investment binges as the now-holders-of-cash cast around for investments to replace the lost income. The real sector is out; nobody is buying anything because they’re all broke. The investors really don’t have a lot of viable choices, so it’s back into Treasuries, back into bonds, back into the alphabet soup of private financial scams and commodities markets.

    If you want something else to happen, you have to give them an out. Give them better investments–like a solvent main-street market with money to spend. Make it worth their while to put the money where we need it to go.

    1. John Zelnicker

      One quibble: The profit the Fed realizes from those interest payments after covering its expenses is returned to the Treasury and is counted as government revenue in the same sense as tax collections – it reduces the deficit. The Fed can’t reinvest those interest payments. They can reinvest the principal received when those securities mature.

      1. zapster

        Well, in aggregate it returns the profits to Treasury at the end of the year, iirc. In the meantime, they can do with it what they like, including using it to purchase more assets. The only consideration is whether it meets their policy goals.

  15. PeterP

    This article is just bad. I don’t think anybody has has read enough MMT to understand at least the mechanics of banking and balance sheet interactions can learn anything from it. It is just a rant againt a big balance sheet, but why big is bad is not proven (because it isn’t bad – it is neither good or bar, largely irrelevant).

    1. zapster

      Absolutely. If democrats had any sense they’d start fighting the idea that there’s something wrong with spending, rather than trying to pretend that they’re “serious” by starving the economy of working capital. :\

  16. Chauncey Gardiner

    “Luckily”, the Bank of Japan yesterday announced they would be increasing QE by 1 trillion yen ($725 billion) per year. In an amazingly coincidental move, this amount is only $75 billion short of the amount that a Citigroup exec said earlier this week would be necessary to maintain stock market prices at current levels. Surely we can count on the Fed and/or ECB and Bank of England for at least $75 billion per year to push up stock prices under the global carry trade.

    Concurrently it was reported that the $1.2 trillion assets Japanese Government Pension Investment Fund said that it will put half its holdings in local and foreign stocks and start investing in alternative assets as it seeks higher returns.

    Wonder how this is all tied into the TPP negotiations and the ideas of some regarding a “new world order”?

    1. human

      The proliferation of new bubbles never ceases to amaze me.

      At this point do we spell it Ponzi or ponzi?

  17. Rosario

    Okay, I’ve been itching to ask this question of the comment community for quite some time so I figured this is a good monetary policy related post to ask it. What of the political/social reality of exchange as it is defined by political/private powers? I hear a great deal of theory, but little of that theory’s presentation in the natural environment. For example, there seems to be an incredible amount of argumentation surrounding the Fed’s “ownership”. I’m sure there is a clear “factual” (i.e. legal, contractual) definition of the Fed, but by my observation, it doesn’t seem to make much of a difference when you look at the reality of Fed policy in the streets. It appears to not only be disastrous, it also appears to purposefully benefit the wealthy. So then this becomes less an issue of the theory and more how it is applied and who is applying it. Who networks with who at the Fed? Is the institution incestuous, as it were? Are these people from places/positions of power and/or associated with similar individuals. I’m more convinced our economic problems are more issues of politics, policy, and philosophy and much less the theory of monetary policy as we could apply any theoretical framework desired in any manner of convoluted ways and the result would be more or less problematic if it is “corrupted” by the ever present self serving human hand. Can one create an incorruptible “social” theory (since markets are society). I’m open here, and would appreciate everyone’s perspective.

    1. financial matters

      I like the public bank model such as the Bank of North Dakota. States are able to take better control over their revenues without having to involve the basically corrupt too big to fail banks.

      For individual depositors, a national postal savings bank guaranteed by the federal government would seem to work for simple savings accounts.

      For long term investing in important projects such as climate change the state can take the lead. Here I think Mazzucato and Wray have some interesting ideas to use finance for capital development.


  18. Demeter

    IMO, if it’s too complicated to explain in an orderly and logical fashion, then it’s a con. That covers the Federal Reserve banking system, Obamacare, and American foreign policy, the Big Three in government. If I were able to get enough people to agree, we would take all three down, and institute some of the sensible alternatives that have come out in the Commentary.

    If it doesn’t work right, then as one trained in engineering, I would go back to the drawing board (after firing the ones who produced this kludge) and the first principles of the goal. This is where a Constitution would really come in handy….if we still had one in working order.

    The problem is much larger than the sum of its parts. The solution will likely involve fire and the sword. We were supposed to be past all that barbarism. Hah!

  19. Tony Frank

    The fed is little more than a bureaucratic bunch of sleazy politicians who take their orders from the financial mafia and are incapable of doing the right thing about any item of importance.

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