Author Topic: How Long Can Fed Buy Everything?  (Read 3362 times)

neil9327

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Re: How Long Can Fed Buy Everything?
« Reply #20 on: May 21, 2020, 12:25:22 PM »

But even if it bought 100% of all the US Treasury debt outstanding that it didn't already own (19.3t - 4.0t = $15.2t), the only impact would be to increase the size of reserves held by the banking sector.

...

The reality is that the Fed isn't the major factor in money creation since it can only lend via swapping assets for bank reserves.  It is the US treasury and its deficit spending that is the major money creator.  All of the attention on the Federal Reserve is misdirected. 


wabuffo

The reserves will end up on the balance sheets of the large banks only after they have been spent by the government (the initial recipients of that money). This is the "deficit spending", and in the short term it does create broad money.

The problem, however, is that this process is inflationary, and tends to make investors (and indeed those banks) less willing to lend of their own accord, meaning that there is less cash available for investment - causing destruction of broad money in the longer term.


wabuffo

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Re: How Long Can Fed Buy Everything?
« Reply #21 on: May 21, 2020, 12:42:29 PM »
The reserves will end up on the balance sheets of the large banks only after they have been spent by the government (the initial recipients of that money). This is the "deficit spending", and in the short term it does create broad money.  The problem, however, is that this process is inflationary, and tends to make investors (and indeed those banks) less willing to lend of their own accord, meaning that there is less cash available for investment - causing destruction of broad money in the longer term.

Basically agree with this - US Treasury deficit spending creates new financial deposits in the banking sector (via Fed reducing reserves in US Treasury general account and increasing bank reserves by same amount). 

I wouldn't say that this process is necessarily inflationary unless deficits as % of GDP are greater than:
 - annual GDP growth (2-3% per year) as one yardstick, or
 - the annual increase in new gold supply vs above-ground inventory (~2% per year), as another possible yardstick.
Of course, this year we are going waaaay above these levels.  How high? No idea - but it will be over 10%, maybe approaching 15-20%.

But again the Fed is not doing any heavy lifting here - its all due to the US Treasury.  Even if the Fed gets all the attention and infamy.

wabuffo
« Last Edit: May 21, 2020, 12:57:23 PM by wabuffo »

vinod1

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Re: How Long Can Fed Buy Everything?
« Reply #22 on: May 21, 2020, 12:44:37 PM »
The size of the Fed balance sheet is irrelevant - we're already at zero rates. 

The Fed typically owns ~10-20% of the net debt issued to the public by the US Treasury (BTW this is a normal range for the Fed).  Per the May 6th Fed H.4.1 report, the Fed owns $4t of US Treasury debt out of $19.2t total US Treasury debt o/s. (you can find this number on the US Treasury Daily Report for May 6th).

But even if it bought 100% of all the US Treasury debt outstanding that it didn't already own (19.3t - 4.0t = $15.2t), the only impact would be to increase the size of reserves held by the banking sector.  Essentially the Fed would buy $15.2t of Treasury debt in exchange for $15.2t of new bank reserves via the US banks as intermediaries (as it must - since only federally-chartered banks, a few other financial companies and the US Treasury have accounts at the Fed).   Those bank reserves are deposits in accounts at F.R banks and can't circulate outside the Federal inter-bank clearing system.  They are really check and e-payment clearing accounts.

So the net effect would be to consume the balance sheets of US banks with reserves and drive all interest rates to whatever the Fed pays on excess reserves (currently zero).  US bank reserves on May 6th were $3.2t which corresponds to "Cash Assets" of $3.2t in the Fed's H8 report - "Assets and Liabilities of Commercial Banks in the United States".   

US banks total assets on May 6th were $20.3t.  Thus the Fed would force US banking sector cash balances to go to $3.T + $15.3t = $18.3t  This would essentially liquidate the entire US banking sector and turn it into a huge cash box ($18.3t/20.3t = 90% of bank assets would turn into cash on deposit at F.R. banks).   

I think in this hypothetical environment, what would the economy look like with a zombified banking sector and no available US Treasuries for anyone, anywhere?  It basically demonstrates that the Fed can buy anything it wants, but its only currency is a very specific one that you and I can't access. Therefore, it is taking out liquid assets (Treasuries, IG bonds, stocks?, baseball cards?) and replacing them with illiquid assets that must sit as a cash asset in the banking sector via a contra-liability account at the Fed.  The more the Fed balance sheet grows, the less safe, liquid assets exist for the rest of us.  I don't see how that helps the private sector and I think it actually hurts it.

The reality is that the Fed isn't the major factor in money creation since it can only lend via swapping assets for bank reserves.  It is the US treasury and its deficit spending that is the major money creator.  All of the attention on the Federal Reserve is misdirected. 

It also shows how disjointed monetary operations are when you have two players (the Fed and the US Treasury) that often work at cross-purposes and neutralize each other.

wabuffo

I quite did not follow how the last statement (in bold) follows from the rest of your message. Could you please eloborate?

To me it looks like Fed and Treasury seems to be working very well together. Fed is indirectly funding the Treasury. Since Treasury cannot all the bonds that it wants to sell without higher yields, Fed is buying them.

My understanding is quite limited, so please excuse my ignorance if something I say above makes no sense.

Vinod
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SHDL

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Re: How Long Can Fed Buy Everything?
« Reply #23 on: May 21, 2020, 01:47:08 PM »
Yep, hard to predict the timing of when the fed hits major problems

I'm not sure what this means exactly?  What "problems" will the Fed "hit"?  Nothing it does affects anything except interest rates. It doesn't affect the supply of money at all.

wabuffo

I think bci23 has his/her own thoughts on this, but I’m hearing quite a few people voice concerns about how quickly money supply has been going up recently:

https://fred.stlouisfed.org/graph/?g=r1v3
https://fred.stlouisfed.org/graph/?g=r0TQ

Their main concern is that if this trend continues we are going to have a lot of inflation (or worse).

(You are right of course that the connection between the size of the Fed’s balance sheet and money supply is much more subtle than one might expect.)

wabuffo

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Re: How Long Can Fed Buy Everything?
« Reply #24 on: May 21, 2020, 01:49:34 PM »
To me it looks like Fed and Treasury seems to be working very well together. Fed is indirectly funding the Treasury. Since Treasury cannot all the bonds that it wants to sell without higher yields, Fed is buying them.

Vinod, the US Treasury is having no problem selling US Treasury Bonds to the public and doesn't need the Fed to buy any of them (in fact, the Fed is prohibited from buying any of the Treasury's debt directly - it must buy the debt from the open market).  The Fed is buying them for its own purposes. 

That's why I used the example in an earlier post about how the Fed, in carrying out its QE program, is converting long-term US Treasury debt issued at fixed and low yields at issuance into short-term reserve liabilities of the Fed at variable yields that could go a lot higher than the yields of the bonds the Fed just purchased.  If you combine the interest expense paid by both the Fed and the US Treasury as basically federal government spending - the "savings" are being dissipated.

So in total, they are un-coordinated since the Fed is partially reversing the debt management strategy of the US Treasury.

wabuffo
« Last Edit: May 21, 2020, 01:51:20 PM by wabuffo »

Spekulatius

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Re: How Long Can Fed Buy Everything?
« Reply #25 on: May 21, 2020, 03:58:05 PM »
Here is the most impotent question - when do we know when the gradual shifts to the suddenly? or in other words, when do we know when the gig is up?
Back then in 2008 folks were suggesting a failed treasury auction, but I don’t think that would be it. Besides they I think I have seen it happening with Bunds and it actually wasn’t a big deal.

I do think one of those things could happen:

1) short term interest rates shoot up
2) USD devalues suddenly against other currencies , most likely Euro or Chinese yuan


There are probably other unpleasant things but I am not sure which one that might be.

I also wonder if in the future the status of the USD as a reserve currency could be diminished , most likely due to the Chinese yuan picking up some market share. For that to happen, the Yuan would need to be freely convertible and also float against the USD (it is now pegged). That would also mean that the Chinese would mean to run their economy differently and give up their mercantilistic ways. At some point,the trade warnt why is going to fan up might force this issue anyways.

In any case, the Chinese economy is op going to be the largest economy I the world and with 1.4B people, their current is destined to be a reserve currency. I don’t think they have a choice, the only way this is not going to happen is if the Chinese economy blows up.
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Viking

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Re: How Long Can Fed Buy Everything?
« Reply #26 on: May 21, 2020, 06:15:32 PM »
My guess is the path of the virus and the economy will be key. If the virus news gets better (vaccine) then the economy can start to heal and everyone (including the Fed) continue to muddle along (like we have for the past 10 years).

If the virus news gets worse and the economy remains in depression levels of activity then we will be in uncharted waters. We know the Fed will continue to do ‘whatever it takes‘. We also have a President who also will do ‘whatever it takes‘ to get reelected in 5.5 months (via the Treasury). If more and more unconventional levers are used then the risks of unintended consequences increase.

Because the virus is impacting all countries my view is nothing will change in the near term (the next year) in terms of the US and its place in the larger order (reserve currency etc).

My big picture concern is if we see hyperinflation down the road (that wipes out peoples savings :-)

LC

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Re: How Long Can Fed Buy Everything?
« Reply #27 on: May 21, 2020, 06:31:18 PM »
There is an element of trust in being the reserve currency, in being the lender of last resort, in being the "safe" asset.

China's problem is nobody trusts their regime. This is going to need to change for them to take over in the minds of market participants.

I actually thought with COVID they would position themselves to address this but it has not really been the case.
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rb

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Re: How Long Can Fed Buy Everything?
« Reply #28 on: May 22, 2020, 06:00:33 AM »
There is an element of trust in being the reserve currency, in being the lender of last resort, in being the "safe" asset.

China's problem is nobody trusts their regime. This is going to need to change for them to take over in the minds of market participants.

I actually thought with COVID they would position themselves to address this but it has not really been the case.
Yea, main problem with replacing the US dollar as the reserve currency is that you don't really have what to replace it with. The only real contenders are the RMB and the Euro.

The RMB? Yeah, no! The Chinese would have to run their economy in a vastly different way for this to be a feasible option. Maybe one day that will happen, but that day is a very long time from now.

The Euro? This may have looked as a reasonable option around the GFC. As in you could talk about it and not sound crazy. But I think this option is a non-starter after the Euro Crisis.

So you can say that the US dollar is and will continue to be the reserve currency for the foreseeable future because it is the least bad option out there.

meiroy

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Re: How Long Can Fed Buy Everything?
« Reply #29 on: May 22, 2020, 06:15:16 AM »

It can be replaced with chaos.