“Do Balanced Budgets Cause Depression?”—Patriotic Millionaires
Here’s what they *should* say why President Andrew Jackson, the seventh President of the United States, was bumped to the backside of the $20 bill:
He was moved to the back of the Twenty because he paid off the national debt…(Yes, you read that right).
As counter-intuitive as it sounds, paying off the national debt, running federal gov’t budget surpluses, a spending sequester, are all glaring examples of why that federal-gov’t-is-the-same-as-a-household groupthink has it all backwards. To pay off the national debt, President Jackson’s administration ran sustained budget surpluses for 7 straight years (meaning sustained public sector deficits was replaced with sustained private sector deficits)…
Two years later, the Panic of 1837, the U.S. economy went into a depression, banks became insolvent, business failures rose, cotton prices dropped, and unemployment dramatically increased…
That depression lasted for four years until 1841 when, the national debt went back to increasing again (meaning private sector deficits switched back to private sector surpluses), and the economy began to rebound…
Not convinced? Take a look at these dates:
These dates above were the 6 periods in American history when the US federal gov’t had substantial yearly budget surpluses meaning, at the very same time, and by accounting identity, the non-federal-gov’t (everybody else) was being subjected to ‘savings deficits’. Next look at these dates:
These dates above were the starting years of all six economic depressions in U.S. history. Now let’s put all the dates together:
1817-1821 federal gov’t surpluses and the 1819 Depression
1829-1836 federal gov’t surpluses and then the 1837 Depression
1852-1857 federal gov’t surpluses and then the 1857 Depression
1867-1873 federal gov’t surpluses and then the 1873 Depression
1880-1893 federal gov’t surpluses and then the 1893 Depression
1920-1930 federal gov’t surpluses and then the 1929 Great Depression
Here’s another example of federal gov’t surpluses having its fingerprints on economic downturns: The 2001 recession was also preceded by federal gov’t budget surpluses. The ‘Bush recession’ was triggered by the ‘Clinton surpluses’. In my opinion however, the economy was very strong during Clinton’s second term, not to mention that dot com internet stock hysteria was reaching full ‘silly-crazy’ stage, so in that particular case, those short-lived surpluses were justified, because they were analogous to tapping the brakes. Masterfully, that 2001 recession was a mild one because Clinton’s successor, incoming President George W. Bush, with both the Congress and the Fed Chair Alan Greenspan’s blessings, quickly resumed federal budget deficits with tax cuts passed on June 7, 2001 (a rare example of both monetary and fiscal policymakers being in sync and turning their launch keys at the same time)…
Alexander Hamilton, the first United States Secretary of the Treasury, who, it was also announced today, will remain on the front of the $10 bill, said in 1790, “A national debt, if it is not excessive, will be to us a national blessing.” (No mention of paying it off, in fact, he argued for the usefulness of safe, easily traded federal debt, that would provide a store of value, as collateral for deals, as a lubricant for business activity, making the economy more productive, which he predicted would help our new nation someday surpass England as a world power)…
Unless you truly need to slam the brakes on growth, and you actually want to slow down the velocity of those twenty dollar bills, sustained and prolonged federal gov’t surpluses throughout American history are a fiscal policymaking case study of What Not To Do.
Today, in the post-gold-standard era, and especially on tax day April 15 (April 18 this year because of the Emancipation Day holiday in Washington, D.C.), the present narrative that the US federal government must collect federal taxes in order to finance it, is analogous to the federal government saying that it must hitch horses to its brand-new 2016 Ford Pickup in order to pull it.
Here’s another analogy regarding those federal taxes for Texas hold ’em poker fans:
Imagine a casino, not your ordinary casino, but one with the most action in the history of mankind, with many poker tables inside, and each of the separate poker tables are just like a separate local and state gov’t inside that casino, the federal gov’t. Then picture local and state taxes being like the “Rake”; and federal taxes being like the “Ante”, or more precisely, the federal taxes are like the “Small blind” and the “Big blind”. The players pay all rakes and blinds (federal, state & local taxes) with casino-issued chips (federal, state & local tax credits)…
The blinds are different from the rake. The blinds (the federal taxes) paid before dealing each new hand do not finance that poker table; instead, the rake (local & state tax) confiscated from the winning pot finances that poker table. This is because the casino (the federal gov’t) is the issuer of chips, while each of the poker tables throughout the casino (the state & local gov’t) are not the issuers of chips. The poker tables and the poker players are the users of chips…
The casino never worries about getting chips. Only the tables and the players worry about getting chips, while the casino has other, much more important things to worry about. The casino doesn’t get their chips from players from China, from Japan, not from anyone. Unlike the tables or the players, the casino issues the chips by fiat. The casino is who first enters the chips into existence. The tables get their chips from the casino. The players get their chips from the tables…
Rather than funding the poker table or the casino, those blinds prevent all poker players in the casino from just waiting to be dealt pocket aces, or never risking their chips unless they get a royal flush on the river card. The blinds are just making sure that all players, especially those few players with a lot of chips can’t just sit there, hoarding their chips, never calling a bet, and never slide anything into the middle of the table…
The rake ‘funds’ the tables, while the blinds ‘facilitate’ the tables. Local and state gov’t finances itself by raking some of your chips, but unlike that rake, the purpose of the blinds is not to finance anyone. That Big blind (that federal tax) players must pay once every round (every April 15th) is an imposed redistribution of chips. In addition, both those small and big blinds speed up the game, they increase chip velocity, by creating an urgency to play because those blinds remind the players that they will bleed their chips away if they stop trying to win more chips…
Most important, the rake and the blinds must be paid for,can only be paid for, with just those casino-issued chips (those federal, state & local tax credits). Throughout the casino, no matter which table you play on, you can only spend those casino-issued chips, which gives full monopoly control of the flow of those chips, full power over the entire chip dominion, to the casino, the sovereign issuer…
The users of chips, the local & state gov’t, as well as all the players, stay focused on either breaking even or winning. Meanwhile the issuer of chips, the federal gov’t, stays focused on growing the action, improving the casino, adding gaming diversity to the floor, or upgrading the facilities, which gins up enthusiasm for more people to play. The federal gov’t is also that ‘eye in the sky’ that watches for cheats or other criminal activity to make players feel secure…
In the post-gold-standard, modern monetary system, it’s important to understand the dynamics between the rake (collected by the non-sovereigns) and the blinds (imposed by the monetary sovereign). The purpose of the rake is to fund that table (local & state gov’t); and the purpose of the blinds is for the casino (federal gov’t) to create your need to keep trying to get more of those chips, which leads to more consumption using those chips, in a perpetual pursuit of profit and/or happiness…
It’s not those chips that the federal government needs from you today, it’s your work at the tables, your interactions with the players, and your spending of those chips that it always only needs.
Going back to the start of the Large Scale Asset Purchase (LSAP) program right after the Lehman bankruptcy on September 15, 2008, the reason why the bond ‘kings’, those hedge fund ‘stars’ and whomever else were predicting (were betting) that LSAP (‘quantitative easing’, ‘QE’, ‘QEII’, ‘III’, etc.), would cause a bond sell-off, massive inflation, sky-high interest rates, yada yada, were so wrong, was because, as we (hopefully) now know, there’s a big difference between the newly-created dollars that finance federal gov’t deficit spending (that add dollars to the private sector); and the newly-created dollars that financed the Fed’s LSAP (that did not add dollars to the private sector).
Although the Fed’s LSAP was an increase of $4.2T into the banking system, unlike federal gov’t deficit spending, it was not an increase that was injected into the private sector. Those ‘printed’ dollars created by the Fed were only injected into the Fed (were only added to the Fed’s balance sheet). That $4.2T was not a change in the amount of assets in the private sector. That $4.2T, the Fed’s LSAP, was only a change in the composition of assets of those previous bondholder’s balance sheets in the private sector (a change from their dollars having a high-coupon interest rate, to just being dollars that didn’t). Unlike federal gov’t deficit spending, which is money creation that is spent into the money supply, the Fed’s LSAP had nothing to do with the money supply at all. One reason why LSAP had no inflationary bias (like federal gov’t deficit spending does), whatsoever, was simple: The Fed was only SWAPPING newly ‘printed’ dollars going into the monetary base (not part of money-supply circulation), for the exact same amount of bonds (also not part of money-supply circulation), that were ‘unprinted’ out from the bond market. Another reason why LSAP had no inflationary bias (like federal gov’t deficit spending does), whatsoever, was simply because the Fed bought those high-coupon (high-interest paying) bonds from the banks. Meaning that the Fed (the federal gov’t) started collecting the interest payments instead of the banks (instead of the private sector). In other words, that $4.2T in dollar CREATION that the Fed added into the monetary-base part of the banking system, was also, counter-intuitively, a dollar DRAIN from the private-sector money-supply circulation part of the banking system. If you just understood that, then consider yourself ahead of 98% of the population, ahead of Nobel-laureate economists, ahead of all policymakers, and especially ahead of the Very Smart People in the mainstream media constantly barking fake ‘economic’ news and nonsensical (read: ideological) narratives over the airwaves using outdated, gold-standard-era mentality.
The Fed is presently sitting on approx $3.8T (of the 4.2) of bonds bought during LSAP on their balance sheet. Also on that balance sheet are the same amount of liabilities that were created by the Fed to finance the purchase of all those Treasury and mortgage-backed securities. There are two scenarios where those Fed liabilities will be reduced.
In the first scenario, the fast way (which the Fed has announced it is not going to do), a bank, similar to an Open Market Operation done pre-LSAP, forcibly purchases (is ‘assigned’) bonds presently impounded at the Fed that were bought during LSAP. In other words, the Fed would do the exact opposite of what the Fed did during LSAP (the Fed would ‘unwind’ the initial trade by ‘unprinting’ reserves and ‘printing’ those bonds held on their balance sheet back into the secondary market). Those bonds sold to the banks would be paid for by that bank’s reserves held at the Fed (meaning at the same time, the Fed’s liability balance of reserves are reduced). This has not happened, nor will it ever, unless the Fed decides to more aggressively ‘unprint’ reserves and simultaneously dump bonds on Wall Street. The Fed would only do this in the unlikely event that there is a sudden, unexpected US economic boom that is so strong that the Fed wants to ‘hit the brake’ and drive both short & long term interest rates higher.
In the second scenario, the slow way, the Fed reduces the amount of bank reserves (Fed liabilities on its balance sheet) by reducing the amount of bonds held (Fed assets on its balance sheet) without selling any of those bonds bought during LSAP to the banks, but by just letting the bonds mature themselves off the Fed’s balance sheet. As per the 09/20/17 FOMC statement, the Fed will start a reduction to “perhaps $1T in the coming years”. This Fed ‘normalization’ (only $10B every month at first) is done by simply not reinvesting $10B worth of any maturing securities (as they were doing before to maintain the same total par amount of bonds) and let the amount of bonds held on the balance sheet very gradually reduce. Going forward, the dollar amounts (assets) from the Treasury for the maturing bond’s principal that the Fed receives will cancel out the same amount of Fed reserves (liabilities).
Note: Fed liabilities also include cash currency in circulation. In a third scenario, reserves are reduced when they are converted to cash currency. More specifically, when banks in aggregate reduce their reserves at the Fed only to the extent that they initiate new lending and the public demands more physical cash currency, these reserves flow into the economy as new banknotes. However, note that those dollar bills (cash)—aka ‘federal reserve notes’ (FRNs)—are still liabilities of the Fed, so that change in the composition from reserves to dollars doesn’t change the total amount of Fed liabilities.
As of the end of December 2018 (the end of Q1 of federal gov’t FY2019), as the Fed’s balance sheet reduction continues, most of the Fed’s assets are those $3.8T in U.S. Treasury bonds (2.2T) and Mortgage-Backed Securities (1.6T) bonds bought during LSAP. The other side of the Fed’s balance sheet, most of the Fed’s liabilities include $1.661T of formal bank reserves of commercial banks (both Interest On Required Reserves & Interest On Excess Reserves held by depository institutions) earning 2.50%; $0.245T of non-formal bank reserves of all the rest of the financial institutions (OverNight Reverse RePurchase agreements) earning 2.25%; and $1.668T cash dollars in circulation (Federal Reserve Notes outstanding).
Here are the running balances since the credit crisis started:
Consolidated Statement of Condition of All Federal Reserve Banks—Liabilities
‘Formal bank reserves’ = Other deposits held by depository institutions
‘Non formal bank reserves’ = Reverse repurchase agreements
‘Dollars’ = Federal Reserve notes, net of F.R. Bank holdings
Federal Reserve Bank Balance Sheet Liabilities
FORMAL BANK RESERVES
NON FORMAL BANK RESERVES
IORR & IOER
Dollar bills and coins
Overnight target FFR ‘ceiling’
Overnight target FFR ‘floor’
‘cash’ in circulation
(as of 09/18/19 = 2%)
(as of 09/18/19 = 1.75%)
(the natural rate is 0)
Note that on 09/19/2019, in a sign of ‘normalization’, for the 1st time since the aftermath of the credit crisis (since 12/30/2010), there is more ‘cash’ in consumer’s hands (in money-supply circulation) than reserves in the banking system (in the monetary base). Two days earlier, Fed overnight repo ‘operations’ were started (due to payments and regulatory issues causing repo markets to act as if the level of reserves had become scarce—affecting the overnight Federal Funds Rate).
On 10/08/19, Fed Chair Powell said “Reserve balances are one among several items on the liability side of the Federal Reserve’s balance sheet, and demand for these liabilities—currency in circulation—grows over time. As we indicated in our March statement on balance sheet normalization, at some point, we will begin increasing our securities holdings to maintain an appropriate level of reserves. That time is now upon us.”—Fed Chair Powell
On 10/15/19, the Fed begins a technical ‘program’ buying $60B/mo in Treasury bills to ensure ample reserves in the banking system—emphasizing IT IS NOT a change in monetary policy. A week earlier, the monetary base went back to having more reserves than ‘cash’ in the money supply.
On 12/11/19 after the FOMC unanimously (10-0) decided to maintain the target range for the federal funds rate at 1‑1/2 to 1-3/4 percent, Fed Chair Powell said “To reduce money market pressures that may occur at year-end, we will conduct repo operations spanning year-end. The key to our strategy is to supply reserves in the near-term through overnight and term repo [‘repo operations’]; and at the same time, we’re raising the underlying level of reserves through Treasury bill purchases [‘technical program’].”
P.S. This post has been updated from the original 2016 post.
“The public has a large appetite for our currency which was well less than a trillion before QE started and now is moving up towards two trillion.”—Fed Chair Jerome Powell, Economic Club of Washington, D.C., January 10, 2019
This is more evidence why the Fed is bullish.
“As per the Fed minutes from the December meeting, the Fed is now trimming its holding by $50B each month [to ‘normalize’ their portfolio gradually] over a number of years. It has now shed more than $380B of Treasury and mortgage bonds. However, formal reserves at the Fed [assets of the formal banks / liabilities of the Fed] are declining at a much faster pace [dropping to $1.661T on 12/26/18 from a peak of over $2.738T in 2015]. The Fed has made some technical adjustments to keep reserves from declining too fast and the minutes show policymakers may do so again.”—Investing.com, Minutes of the Federal Open Market Committee, December 18-19, 2018
So do the math, a drop of $1.077T (2.738 – 1.661) in formal reserves since the peak in 2015 minus the $380B (see scenerio #2) of the Fed’s bonds that were shed so far means a difference of approx $697B that was used by the banks for something else, like to convert to cash currency (see scenario #3). According to the Fed’s balance sheet, approx $355B of it was.
Meaning that people are using ATM machines more (people want more ‘walking-around money’), so for the past 4 years, banks have been exchanging their reserves for approx $355B in cash to fill up their ATMs—that get spit out by their depositors—faster than the Fed expected. Note: Not trying to make a thesis out of all these $20 bills (that aren’t being spent on huge capital-expenditures, like on oil rigs), but keep in mind that consumers don’t significantly increase their ‘impulse purchases’ unless they are feeling significantly more confident about the economy.
It’s understandable that (because of QE) there are a lot more formal reserves held at the Fed today ($1.661 trillion) than there was in June 2008 (only $55 billion)—three months before Lehman Brothers filed for Chapter 11 bankruptcy on September 15, 2008.
However, the takeaway here is that there is now more cash being spent in the money supply than is being held as formal reserves in the monetary base (which is another step closer towards ‘normalization’); and also, there is a lot more cash—2x more— in the hands of consumers and getting passed around right now today (1.668 trillion dollars in cash currency) than there was (779 billion dollars) on October 10, 2007, a full year before the credit crisis began—the day after the Dow Jones Industrial Average peaked on the New York Stock Exchange with a then-record-high closing price of 14,164.
Even better, there is no housing boom, or any over-investment today like there was back then (and another reason why the Fed remains bullish).
“I don’t see anything on the horizon that suggests the possibility of a recession in the near term is at all elevated. Recessions are most often caused by two things. One is inflation that is high enough that the Fed has to hit the brakes—we don’t see that. The other is the more common reason, that we’ve seen recently, seen in the last several cycles, it’s the mounting financial imbalances, like asset bubbles, housing bubbles, dot-com bubbles—any excessive leverage like we saw in the sub-prime mortgages, and we don’t see that either.”—Fed Chair Jerome Powell, Economic Club of Washington, D.C., January 10, 2019
Some more color from Fed Chair Powell in his post-FOMC Statement and press conference today:
*FED MAINTAINS BALANCE-SHEET ROLL-OFF AT $50B A MONTH *FED SAYS IT’S PREPARED TO ADJUST BALANCE-SHEET NORMALIZATION
When a Treasury bond on the Fed’s balance sheet ‘rolls-off’, that ‘debt’ is not paid-off; but instead it simply means that it goes from the Fed’s balance sheet to someone else’s balance sheet. More specifically, the bond matures, is ‘rolled-over’ and is purchased by someone else in the private sector in order for the bonds to go back to whence they came—(back to their normal ‘pre-crisis’ home).
As bonds ‘roll-off’ the Fed’s balance sheet, it lowers the amount of Fed reserves because the principal amount of the maturing bond is paid, and those dollars (assets) that the Fed receives for that maturing bond ‘nets-out’ with the Fed’s reserves (liabilities) that were created by the Fed to buy the bond in the first place.
In addition, in a sign of consumer confidence, the amount of cash being pulled out of bank ATMs has been higher than previous estimates of a year ago. Since banks convert their reserves (assets) held at the Fed into cash to fill their ATMs—even though these dollar bills in circulation still remain as Fed liabilities—this lowers the amount of bank reserves held at the Fed (that the Fed uses to implement monetary policy) faster than the Fed expected. This is why the Fed is mentioning a balance-sheet normalization ‘adjustment’—because the Fed may soon slow it down (and the Fed just wants to telegraph this ahead of time in order to not spook the markets).
The great news is that all this means that ‘normalization’ (getting back to a normal, or ‘non-crisis’ amount of both Fed & bank reserves) will be completed sooner—another bullish sign (that the Fed is handling monetary policy with perfection).
In hindsight, note that in 2015, you can see that the amount of formal bank reserves peaked. Perhaps that was a good indicator (albeit that nobody was looking at or talking about) that the economy was truly getting stronger. Those reserves were decreasing because more and more reserves were getting converting into cash for ATMs; and that’s not talking about an increase in the financial economy’s assets (like stocks, bonds or real estate) by the 5% (which could be a false positive), that’s talking about the functional economy’s ‘base’, the consumers, the spenders (the 95%).
If you’re looking for an indicator that could be telling you when the economy has really recovered, maybe all you need to know about is All About That Base.
Fed Chair Jerome Powell testifying on Capitol Hill — Wednesday, Feb. 27 2019:
“Pre-crisis, there was a small amount of reserves and we could manage the [target overnight] Federal Funds Rate (FFR) by making small adjustments in the quantity of reserves [by buying and selling Treasury bonds with Open Market Operations]. In the current era [in the post-Gold standard, post-LSAP, post-Stress Test era] where the demand for bank reserves is so high [due to the new requirements that banks must hold more liquid capital in reserve], we would have to be a large presence [we would have to be managing rates—be trading Treasury bonds with Primary Dealers—in the marketplace much more actively]; so instead, using administered rates [paying interest on the bank’s reserves at the Fed], is very fundamental for the way we manage our policy now [the way we keep the overnight FFR at our target]—it seems to work well.”—Fed Chair Jay Powell
For the first time since the 2008 crisis, the Fed cuts rates and will end bond runoffs earlier.
“In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee (by an 8 – 2 vote) decided to lower the target range for the federal funds rate to 2 to 2-1/4 percent. The Committee will conclude the reduction of its aggregate securities holdings in the System Open Market Account in August, two months earlier than previously indicated [rather than September as previously planned].”—Fed Chair Jay Powell
In the press conference after the FOMC Statement (after lowering the target range for the federal funds rate to 1-3/4 to 2 percent), Fed Chair Powell answered questions regarding the recent ‘liquidity crunch’ of reserves (causing a spike in repo rates).
Fed Chair Powell: Let me say a few words about our monetary policy operations. Funding pressures in money markets were elevated this week and the effective Federal Funds Rate (FFR) rose above the top of its target range yesterday. While these issues are important for market functioning and market participants, they have no implications for the economy nor the stance of monetary policy. This upward pressure emerged as funds flowed from the private sector to the Treasury to meet corporate tax payments and settle purchases of Treasury securities. To counter these pressures, we conducted overnight repurchase operations yesterday and again today. These temporary operations were effective in relieving funding pressures and we expect the Federal Funds Rate to move back into the target range.
Steve Liesman CNBC: I’m wondering about how concerned you and the FOMC were about how the NY Fed operated during this recent liquidity crunch in the markets. We talked to many traders who said the corporate tax date payment was known well in advance. It was known that September could be a potential crunch time. You closed Monday at the top end of the Federal Funds Rate. Tuesday came along and there wasn’t an announcement of a second operation until 4 o’clock in the afternoon. Was the NY Fed listening to markets well ahead, going back a year, when there were blowouts in the overnight rate at the turn of the year?
Fed Chair Powell: We knew about the stronger demand for cash to pay corp tax payments and settle purchases of Treasury bonds, we were very much waiting for that, but the response surprised us. It surprised market participants a lot too. Even though people were writing about this weeks ago—it was a surprise because the response, the strain in the money markets, was stronger than we expected. So to answer your question, no, I’m not concerned because this has no broader implications for the economy, our outlook, nor our ability to use our tools to keep overnight rates within our targets. Since we’re talking about this, let me take a step back and say that earlier in the year, after careful study, the committee announced a decision to administer monetary policy in an ample reserves regime. We’ve been operating in that regime for a full decade. We think it works well. The main hallmark of that regime is that we use adjustments in our administered rates—the IOER and the IORR rates—to keep the overnight federal funds rate in the target range. It’s specifically designed so that we do not expect to do frequent Open Market Operations for that purpose (of keeping the FFR within target). Going forward, we will be monitoring market developments and accessing the implications for the appropriate level of reserves.
Steve Liesman CNBC: Do you think you underestimated the amount of reserves necessary for the banking system?
Fed Chair Powell: We’ve always said that the level of reserves needed is uncertain. We have spent a lot of time trying to assess that level and resume [and return to normal] organic [non-emergency] growth of the Fed balance sheet.
“Reserve balances are one among several items on the liability side of the Federal Reserve’s balance sheet, and demand for these liabilities—notably, currency in circulation—grows over time. As we indicated in our March statement on balance sheet normalization, at some point, we will begin increasing our securities holdings to maintain an appropriate level of reserves. That time is now upon us.”—Chair Jerome H. Powell, at Trucks and Terabytes: Integrating the ‘Old’ and ‘New’ Economies 61st Annual Meeting of the National Association for Business Economics, Denver, Colorado, October 08, 2019
“Let me stress that these are very important operational matters but are not likely to have any macroeconomic implications.”—Fed Chair Jay Powell
During his post-statement 12/11/19 FOMC press conference (after the Fed unanimously decided to maintain the target range for the federal funds rate at 1‑1/2 to 1-3/4 percent), Fed Chair Powell reiterated that those many voices over the airwaves now seizing upon the Fed’s ‘repo’ as being some kind of a ‘problem’ with ‘the system’—was overblown. “The purpose of all this is to make sure that our monetary policy decisions will be transmitted to the FFR, which in turn affects other short-term rates,” Powell added. Perhaps folks with ‘Repo-madness Madness’* should simply take the Fed’s words at face value (instead of getting sucked into that social-media vortex where everybody gets all hot and bothered by anything).
*’Repo-madness’ madness: In mid-September, there was a significant rise in the overnight repurchase agreement (repo) rate. Liquidity which actually existed didn’t flow into the repo market, affecting the Fed’s target overnight rate (the Federal Funds Rate) causing it to also ‘spike’ higher. A funny thing happened between the time that Federal Reserve Chair Janet Yellen announced they were ending their credit easing program (‘QE’) in October 2014 and when the Fed started doing their repo market operations (‘Not QE’) in September 2019. More on that later; but first, taking what the Fed says at face value, here’s what they have been doing the last 10 years:
‘PRINTING MONEY’: Emergency (full pedal to the metal) monetary policy that INTENTIONALLY increases the quantity of money in money-supply circulation, stops the bleeding, helps pull the economy out of recession and provides accommodation that prevents deflationary forces from spiraling out of control (to encourage inflation). For example, what Fed Chair Bernanke did in 2008 when he provided emergency loans with ‘toxic’ assets as collateral (aka the ‘Maiden Lane’ transactions to bailout firms—not with a solvency problem but with with a liquidity problem—pay their bills to keep their lights on). This a form of ‘printing money’ because it is central-bank creations of reserves being added to the banking system that are also INTENTIONALLY entering (increasing) the money supply:
Scott Pelley (’60 Minutes’ MARCH 2009 episode): “Is that tax money that the Fed is spending?” Chair Ben Bernanke: “It’s not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed. It’s much more akin to printing money more than it is to borrowing.” Scott Pelley: “You’ve been printing money?” Fed Chair Bernanke: “Well, effectively, yes…we need to do that because our economy is very weak and inflation is very low.”
‘CREDIT EASING’: Accomodative monetary policy intended to help the economy—but only by lowering LONG term interest rates and NOT by intentionally increasing the quantity of money in money-supply circulation. The federal gov’t is NO longer needed to increase inflation that way because the private sector has gotten back on their feet (the economy is out of the emergency room and recovering), with inflation moving towards the Fed’s target. For example, the ‘Large Scale Asset Purchase’ (LSAP) program—aka ‘QE’—that Fed Chair Bernanke did starting in December 2008, which did not change the money supply nor is it ‘printing money’ because LSAP is not lending to banks. A credit easing is just swaps of newly-created reserves for existing AAA-rated long-term bonds with banks. It was just a change in the composition of bank assets—and not a change (not an INTENTIONAL increase) of the quantity of money in money-supply circulation. An increase of dollars in the banking system (an increase of newly-created reserves in the monetary base), YES; an increase in ‘M1’ money supply (an increase that has an inflationary bias because it enters circulation), NO.
“This fear of inflation is way overstated. One myth that’s out there is that we’re [that this is] printing money. We’re not printing money. The amount of currency in circulation is not changing. We’re not changing the money supply.”—Fed Chair Ben Bernanke, ’60 Minutes’ (follow-up) interview with Scott Pelley in 2011
‘REPO MARKET OPERATIONS’: An organic (a non-emergency) Fed balance sheet expansion (increase of dollars in the banking system) which—unlike ‘printing money’ or ‘credit easing’—is neither an accommodation for the economy nor any change whatsoever of monetary policy. It is only intended to increase money in the monetary base to facilitate short-term lending (overnight settlement) and keep the SHORT term overnight ‘Federal Funds Rate’ (FFR) within the Fed’s target and prevent repo market spikes caused by dollar scarcity. For example, what the NY Fed did in September 2019 of over $100 billion (and is still doing until year-end to the tune of $500B total) to pump newly-created reserves into the monetary base.
‘TECHNICAL PROGRAM’: In addition to their repo operations, a month later the Fed began (restarted) regularly-scheduled Fed purchases of short-term Treasury securities as well, so that there will be ample reserves in the banking system (until there is no further need for Fed repo market operations).
Think of Fed repo operations today as simply being the same as the routine Fed Open Market Operations of yesteryear.
Keep in mind that we are in a new IOER regime (we are in the Interest-On-Excess/Required-Reserves age).
All those years before (in the pre-Interest-On-Excess/Required-Reserves age), when the Fed did Open Market Operations (to keep their overnight FFR in their target range), nobody ever thought much of that (because it was one of the tools that the Fed routinely used).
Anything new is a work in progress, so there’s going to be adjustments along the way. The Fed was surveying banks about their reserve needs all along. Meaning that the Fed was expecting a shortage of reserves (a liquidity spike) may happen since the beginning of the year.
These Fed ‘Repo Market Operations’ are the same as routine Fed ‘Open Market Operations’. That’s why the Fed calls it ‘operations’ (routine maintenance) and not a ‘program’ (emergency fix).
Before, when the Fed didn’t have ‘administered rates’ (when the Fed wasn’t paying interest on overnight bank reserves), the Fed often did Open Market Operations (the Fed bought short-term Treasury securities in the bond market to ‘add’ reserves to defend their target Federal Funds Rate).
Now, the Fed does Repo Market Operations (the Fed buys short-term Treasury securities in the repo market to ‘add’ reserves to defend their target Federal Funds Rate).
Which is also NOT to be confused with the Large Scale Asset Purchase programs—aka ‘QE’—where the Fed buys LONG-TERM Treasury securities with the specific intention of lowering long-term rates to provide accommodation to borrowers (and not buying short-term Treasury securities to simply add reserves to the banking system to provide liquidity to banks).
That one (that LSAP program) was an emergency measure and this one (this technical program which the Fed has restarted in addition to their repo operations) is an organic, meaning non-emergency—yet still a ‘very important’—matter:
“Let me stress that these are very important operational matters but are not likely to have any macroeconomic implications. The key to our strategy is to supply reserves in the near-term through overnight and term repo [‘repo operations’]; and at the same time, we’re raising the underlying level of reserves through Treasury bill purchases [‘technical program’]. The purpose of all this is to make sure that our monetary policy decisions will be transmitted to the overnight Federal Funds Rate, which in turn affects other short-term rates.”—Fed Chair Jay Powell, 12/11/19
So what happened between the time that the Fed announced it was ending their credit easing program (‘QE’) in October 2014 and when the Fed started doing their repo market operations (‘Not QE’) in September 2019?
On 09/18/19, for the first time since the aftermath of the financial crisis (since 12/30/2010), there was more ‘cash’ in money-supply circulation than there were reserves in the monetary base. The Fed was expecting this:
“Reserve balances are one among several items on the liability side of the Federal Reserve’s balance sheet and demand for these liabilities—currency in circulation—grows over time. As we indicated in our March statement on balance sheet normalization, at some point, we will begin increasing our securities holdings to maintain an appropriate level of reserves. That time is now upon us.”—Fed Chair Powell, 10/08/19
There are many moving pieces that caused the ‘disappearance’ of reserves (the lack of liquidity) that may have undermined soundness in the repo markets. As per the Fed, the main ones were ‘payments’ issues ($1T budget deficits means more liquidity is needed by banks to buy Treasury bonds / record-breaking economic expansion means more liquidity is needed by corporations to pay federal taxes); and, also as per the Fed, ‘regulatory and supervisory’ issues (i.e. bank’s preference for reserves over Treasuries to comply with new capital requirements). As per a recent BIS quarterly report released last week, repo problems in the US were caused by large changes in Treasury’s cash balance, withholding of liquidity by Global Systemically Important Banks (in particular by US ‘Big 4’ banks) and use of repo markets to finance investments by large liquidity accounts (Hedge Funds). In a 12/17/19 interview, Treasury Secretary Steven Mnuchin told Lou Dobbs where a lot those reserves—reserves converted to cold hard cash—$1.5T to be exact, have went:
“Literally, a lot of these $100 bills are sitting in bank vaults all over the world.”
As per the Federal Reserve, there are more 100 dollar bills than any other denomination of U.S. currency and the bank estimates that last year, 80 percent of all those C-notes were in circulation in foreign countries.
“It’s interesting that, in an increasingly digital world, the demand for U.S. currency continues to go up,” Mnuchin added.
How the Post-Gold Standard, Post-Quantitative Easing, POST TT&L ACCOUNT, Modern Monetary System Really Works:
As per FED Notes, a national debt-ceiling disturbance, those seasonal receipts into the Treasury’s TGA account at the Federal Reserve Bank (which fully-replaced Treasury’s TT&L accounts at commercial banks) and the dollars that are paid in federal taxes no longer staying in the commercial banking system (as they did prior to the financial crisis) are more (of many other) moving pieces that caused the reserve ‘shortage’ which spiked repo rates (aka ‘repo madness’) in the fall of 2019.
“The changes in Treasury cash management outlined in this note have strengthened the connection between fiscal flows and the short-term level of reserves. Recent events have provided further evidence of this link, extending beyond reserve levels and into money market rates. In the third quarter of 2019, the TGA rose by roughly $140 billion following the resolution of the debt ceiling impasse and seasonal receipts. The consequent drain in reserves coincided with notable volatility in money market rates.”…”A dollar paid to the Treasury in taxes directly reduces the amount of reserves in the [commercial] banking system by one dollar, while a dollar paid by the Treasury directly increases the amount of reserves in the [commercial] banking system by one dollar.”—FED Notes, by Huther, Pettit and Wilkinson, 12/16/19
In other words, since the demise of those TT&L accounts at commercial banks, all dollars paid to the Treasury in federal taxes/all dollars spent by Treasury for federal expenditure no longer ‘drain’ into/’drain’ out from the same place—from the commercial banking system—but now instead all ‘drain’ through the TGA account at the Federal Reserve Bank (which may leave repo traders high & dry; however, should not be confused by MMTers as a dollar ‘destruction’).