Comments on: How QE works A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: beowu1f Sat, 06 Nov 2010 05:11:17 +0000 Alea is incorrect. The Dept of Treasury’s Bureau of Printing and Engraving prints paper money on behalf the Fed (and netting 4 cents a bill regardless of denomination). The US Mint is a separate Treasury agency that coins money. Coin money is a different kettle of fish, the Fed buys coin from the Mint at face value. The Mint’s costs stay in its Public Enterprise Fund, the Secretary of Treasury sweeps the profits into miscellaneous receipts (31 USC 5136) So every dollar coin that costs 12 cents to mint adds 88 cents to general revenue.

The Secretary is granted authority to mint platinum coins of whatever “specifications, designs, varieties, quantities, denominations, and inscriptions” that he prescribes (31 USC 5112(k)). As we saw with the dollar coin, a coin’s face value bears no relationship to its cost of production. Remember too, coin seigniorage is booked as revenue, not debt. A trillion deficit could be covered tomorrow by the Secretary directing the Mint to coin a $1 trillion piece (or ten $100 billion coins, easier to make change) and then showing up at the drive-in teller to make a deposit (the interest on reserve payments enable the Fed to peg the federal funds rate without having to sell Treasuries to drain excess reserves).

By: sditulli Fri, 05 Nov 2010 13:10:46 +0000 Market prices aren’t that efficient. Will cheapen up an issue into treasury auction and bid up into FED. Traders will make money.

I think the money does end up in the middle class. It finances government spending at low rates so the government can borrow more without taking on interest expense allowing more spending into government programs.

By: sarah333 Fri, 05 Nov 2010 02:39:32 +0000 purely speaking the supply of publicly avaible tresurys are going to stay the same because the amount of debt issued by tresury over same period equils about the same as deficet

to put this in smaller scale easier to understand terms lets say that you get social secuity check for 1000 dollors and you use that money to buy 5 year tresury bonds the net effect is money just cycles though econmy but if fed buys the bills for 5 year you cant buy them you have to buy something else stocks for instance etc

all the feds doing is preventing the us goverment from needing to burrow from privte sector for funding over next 6 or so months

By: Greycap Thu, 04 Nov 2010 22:17:11 +0000 McKenzieG1 has not said anything to contradict the earlier comments. Everybody agrees that the equation is something like:

more money + fixed assets = higher asset prices.

The issue is that relative asset prices can change and if they do it can make a difference to the effectiveness of the program.

By: Bernanke Thu, 04 Nov 2010 21:46:34 +0000 I think I agree with McKenzie here. My Money and Banking class was a long time ago, but isn’t the Fed creating high-powered money, that the banks can in turn lend and lend and lend, using the fractional reserve banking system?

To date, the problem has been lack of loan demand or unwillingness on the part of the banks to lend, thus velocity has declined and M2 or M3 or whichever M is real money has not grown.

The Fed is hoping that using helicopter drops of money would eventually pursuade the banks to lend and money supply would increase and thus the economy grows.

Am I missing something here?

By: McKenzieG1 Thu, 04 Nov 2010 20:43:41 +0000 Isn’t the focus on treasury bond pricing here missing the forest for the trees?

The economically significant aspect of QE is that the Fed is creating $600 bln in fiat money ‘ex nihilio’ and pumping it into the money supply. Treasury bond purchases are just the distribution mechanism. However many parcels of bonds get passed around, the net result at the end of the day is that M0 is $600 bln bigger than it was before.

By: Greycap Thu, 04 Nov 2010 19:24:12 +0000 “… those investors are probably just going to take the proceeds and invest them in agency debt …”

Actually, what the Fed hopes is that the (most) investment will displaced into the (US) equity markets. The idea is that by lowering the cost of capital, projects near the margin of profitability would become attractive.

But as you say, the Fed has no control over what investments are substituted for treasuries. It could be agencies, as you suggest, or it might be that the market views a 5Y treasury to be the best substitute for a 2Y treasury. In that case, the effect would be to flatten out the curve a little further along the term-structure. If the price of risk is not affected by the Fed’s actions (i.e. corporate spreads unchanged), that would still reduce the cost of financing, for those companies in a position to take on leverage.

But there are a number of heroic assumptions here. It might be that investors views are changed by the Fed’s actions such that they invest in BRIC equity markets (“leakage”), or gold, or other commodities.

By: Hapablap Thu, 04 Nov 2010 19:02:40 +0000 Something I don’t think I’ve seen anyone mention, but I think is important, is that this also allows Treasury to continue borrowing astronomical amounts of money without spiking interest rates. That borrowing turns into government spending, and that’s where the “printing” actually happens. Treasury exchanges bonds for cash with primary dealers, primary dealers exchange bonds for cash with Federal Reserve. End result is Treasury has cash, Fed has bonds. Now treasury can keep paying unemployment benefits and building bridges to nowhere.

By: Derrida Thu, 04 Nov 2010 18:45:59 +0000 I don’t think that Fed is using the wealth effect argument to justify QE2. It’s too minor in their scheme of things. Besides, if you are primarily concerned with the wealth effect, then you choose less liquid assets, like stocks. HKMA bought HK stocks in ’98 to great effect. TFF, since the most immediate threat prior to QE1&2 was disinflation and defaults, holding cash/near-cash actually looked like a good trade in real terms for a while. Only by having a real threat of inflation can you get people out of the fetal position and lending again.

I agree with Felix that the elasticity of demand for loans at this point is negligible at this point, mostly because corporates have little compelling opportunities and households are deeply under water. Although the fiscal route sucks, it does address the real economy. The really interesting side is what all this does to the EM economies that have lashed themselves to the dollar boat and facing sirens of local inflation.

By: KidDynamite Thu, 04 Nov 2010 18:29:28 +0000 TFF – i think the goal is that unattractive riskless yields (0% savings accounts, for example) force capital into return-seeking asset classes which creates inflation.

Yes, the Fed is “threatening” inflation in some sense, yet everyone knows that they’ve been unable to achieve it. Now they have to Just Do It – if they can’t achieve it with interest rate policy, they will actually physically buy assets and inflate their price!