On the Myth of Exploding U.S. Money Supply

[japes]

If the Fed buys Treasury notes, it does not increase the money the government has to spend. That was determined by how many notes the Treasury issued- not who bought them. The Fed buys their notes from brokers on the open market- not direct from the government either. What the Fed buying the treasuries DOES do is free up money from somebody else who would have made that treasury purchase to put their money someplace else. If the Fed is simply purchasing Treasuries, that will increase the money potentially circulating. M2 measures money actually circulating- the $1 trillion (in the example) still could increase M2- even if it does not do so right away.

This has been explained to me before and for some reason I can't get it through my head. Let me try this with a question one more time.

I understand banks buy T-notes directly from the Treasury and this does not create any new money. I understand the Fed buys T-notes from the banks with new money (created out of thin air). This does not cause dollar inflation yet since the dollars are sitting in bank reserves and not out in the economy...

Now here's where it gets hard for me to understand. If the banks then use their reserves (new money created out of thin air) to buy more T-notes from the Treasury does this not inflate the dollars in circulation when the government spends it!? I understand this is not using a money multiplier by employing fractional reserve banking but it *should* still be causing *some* inflation since banks are using new money to buy Treasuries. This new money eventually finds its way into circulation when the Gov't spends it on wars, roads, SS, etc.

 

[Jordan]

EDIT: I guess everyone beat me to the answer..LOL

It seems like (in your example) at least $1 trillion has been added to the money supply (inflated). Doesn't the Treasury put that money into circulation? The Treasury doesn't just sell T-bonds and put the money in a bank account. They pay SS checks, federal employees, etc. right?

How did the money go from the bank reserve level to the Treasury? It didn't.

Banks use money in circulation to go buy $1 Trillion in Treasuries.

$1 T moves from Banks to US Treasury.

Fed gives $1T to banks to buy those Treasuries. But the banks are given money at the bank reserve level. How does the amount of circulating money increase? It doesn't, and it hasn't.

 

[Jordan]

I urge you to go back and look at Mogambo Guru's post again---more specifically what gonegolfin' said; it doesn't appear you've read it, at all.

Actually, I did. And what he says is that that QE necessitates inflation, but this isn't true right now, and in fact, the rate of inflation has been mostly zero since people have been screaming bloody murder ever since QE1. No one has once shown how bank reserve money is going from bank reserves to money supply in circulation, and it's for a very simple reason: you can't.

The money supply with which we interface is not growing, and demand for funds even at ridiculously low rates is still negative. Until that reverses, then there is no inflation.

Obviously, keeping rates low does often create some price inflation, especially in asset classes that can be used to generate an income. Gold, for example, is a generally negative carry asset, but seeing as it can be purchased and used for covered call income generation, it has become very popular. Oil fits in this mold, as well. As a speculator, it makes more sense to purchase previously negative carry assets during periods of low interest because more income can be derived from the particular asset than is spent purchasing it on margin. This ultimately results in higher prices for commodities, even though there is no net change in the currently available supply of money...the supply of money that you and I can spend.

 

[japes]

Fed gives $1T to banks to buy those Treasuries. But the banks are given money at the bank reserve level. How does the amount of circulating money increase? It doesn't, and it hasn't.

Do/Can banks use those reserves to buy Treasuries? If the answer is "yes" then that's how the inflation happens. I still have not gotten an answer on this and I've asked it on different thread and in different ways. I guess I'm still missing something.

Another confusing thing about all this is why the Fed is doing it in the first place. Maybe my assumptions are wrong but I think the Fed is doing all this QE so some inflation will happen. They want banks to employ the fractional reserve mechanism by loaning out money (inflating it). Then on the other hand they're telling us not to worry about all these reserves causing inflation. Well, what is it? Do they want the reserves out in circulation or not?

 

[jclay2]

All right Jordon, Here is how QE works:

Fed Buys a trillion in Bonds. Gives some primary dealer newly printed money for government iou. Once this is done there is now 1 trillion more in the money supply than previously. Of course once this new money enters the banking system (at least for now) it is not loaned back out. However, that does not disregard the fact that you have increased the money supply by a trillion. Understand?

 

[VBRonPaulFan]

How did the money go from the bank reserve level to the Treasury? It didn't.

Banks use money in circulation to go buy $1 Trillion in Treasuries. <-- The gov't now has an additional $1T in financing to spend

$1 T moves from Banks to US Treasury.

Fed gives $1T to banks to buy those Treasuries. But the banks are given money at the bank reserve level. How does the amount of circulating money increase? It doesn't, and it hasn't.

That is the part you're not taking into account. The government needs that money to finance its operations... it uses that in a relatively short period of time. The fed is acting as a short term insulator of equity being sucked out of private markets by temporarily creating money for government operation. If the fed wasn't picking up those treasuries, banks probably wouldn't buy them, so the government probably wouldn't have enough revenue coming in without huge foreign borrowing to keep their doors open.

I guess I could be wrong, that's how I see it.

 

[heavenlyboy34]

Actually, I did. And what he says is that that QE necessitates inflation, but this isn't true right now, and in fact, the rate of inflation has been mostly zero since people have been screaming bloody murder ever since QE1. No one has once shown how bank reserve money is going from bank reserves to money supply in circulation, and it's for a very simple reason: you can't.

The money supply with which we interface is not growing, and demand for funds even at ridiculously low rates is still negative. Until that reverses, then there is no inflation.

Obviously, keeping rates low does often create some price inflation, especially in asset classes that can be used to generate an income. Gold, for example, is a generally negative carry asset, but seeing as it can be purchased and used for covered call income generation, it has become very popular. Oil fits in this mold, as well. As a speculator, it makes more sense to purchase previously negative carry assets during periods of low interest because more income can be derived from the particular asset than is spent purchasing it on margin. This ultimately results in higher prices for commodities, even though there is no net change in the currently available supply of money...the supply of money that you and I can spend.

Depends on what kind of inflation you're talking about. Price inflation is definitely occurring from all the stats I've seen as recently as today. And since wages are stagnant or declining, this makes the problem much worse.

 

[cubical]

Actually, I did. And what he says is that that QE necessitates inflation, but this isn't true right now, and in fact, the rate of inflation has been mostly zero since people have been screaming bloody murder ever since QE1. No one has once shown how bank reserve money is going from bank reserves to money supply in circulation, and it's for a very simple reason: you can't.

The money supply with which we interface is not growing, and demand for funds even at ridiculously low rates is still negative. Until that reverses, then there is no inflation.

Obviously, keeping rates low does often create some price inflation, especially in asset classes that can be used to generate an income. Gold, for example, is a generally negative carry asset, but seeing as it can be purchased and used for covered call income generation, it has become very popular. Oil fits in this mold, as well. As a speculator, it makes more sense to purchase previously negative carry assets during periods of low interest because more income can be derived from the particular asset than is spent purchasing it on margin. This ultimately results in higher prices for commodities, even though there is no net change in the currently available supply of money...the supply of money that you and I can spend.

Assuming the banks keep their money on as reserves at the fed, money in circulation does not increase, but they are increasing that reserve to astounding levels. If/when something happens and banks all want out there would be collapse link has never been seen.

 

[Jordan]

Tons of responses, no answers, just what-ifs. @jclay2 especially, yes, I get it. I realize there is more money in bank reserves. I would appreciate if you realized that the money hasn't gone anywhere for...oh, more than a year? And because of that, the supply of money is not growing.

Come on people, admit it: the money supply with which we interact is not growing. Until banks start lending, there will be no growth in the money supply. And consumers don't seem to be too interested in borrowing.

 

[cubical]

Tons of responses, no answers, just what-ifs. @jclay2 especially, yes, I get it. I realize there is more money in bank reserves. I would appreciate if you realized that the money hasn't gone anywhere for...oh, more than a year? And because of that, the supply of money is not growing.

Come on people, admit it: the money supply with which we interact is not growing. Until banks start lending, there will be no growth in the money supply. And consumers don't seem to be too interested in borrowing.

What are you talking about? That is the answer. The banks still have the cash and it will come out eventually. Why sit around until it happens?

 

[cubical]

Also, why are loans the only way money can enter the market? Why can't banks buy assets outright?

 

[Brian4Liberty]

Why do bank reserves have to sit in the "vault"? Why can't they be invested somewhere like equities, derivatives, commodities, real estate, etc ? (and banker bonuses).

Also, why are loans the only way money can enter the market? Why can't banks buy assets outright?

Apparently there is no answer to this question...

 

[jclay2]

Tons of responses, no answers, just what-ifs. @jclay2 especially, yes, I get it. I realize there is more money in bank reserves. I would appreciate if you realized that the money hasn't gone anywhere for...oh, more than a year? And because of that, the supply of money is not growing.

Come on people, admit it: the money supply with which we interact is not growing. Until banks start lending, there will be no growth in the money supply. And consumers don't seem to be too interested in borrowing.

Although the loaning process is needed to truly expand the money supply at a rapid rate, the presence of reserves at banks is brought upon by depositors who exchanged their government iou's for cash (increase in the money supply). If I print a bunch of 20's in my basement and deposit it in my bank account, the money supply will increase regardless of whether the bank loans my deposit out.

The problem is that these bank reserves are high powered money. Meaning a small amount of it can cause a lot of inflation when banks are active in lending. Because the Fed is now in a state of QE into infinite, they must put high powered money into the system every single year. Just 1 trillion in high powered money is enough to double prices (when the full effects of fractional reserve banking are felt). And even though banks are not lending, that additional money still causes inflation (although not as much because of low lending). If the m3 money supply is 9 trillion and the fed does QE for 1 trillion, you should expect prices to increase by 11% at a minimum (aka no bank lending at all). So until the Fed stops QE for more than a couple weeks or months, you don't have any real argument.

 

[Jordan]

Also, why are loans the only way money can enter the market? Why can't banks buy assets outright?

They can convert to currency and withdraw the money, which is inflationary in the sense that it increases the amount of money that you and I use, but if banks choose to withdraw their excess reserves then the potential for the money multiplier to come into the picture is greatly reduced.

That is, to remove $1 trillion in reserves means a reduction of $9.999999999T from potential M2 money supply. Also, a current positive rate of interest on excess reserves means there isn't that much interest in removing funds from the Fed.

New loans can be made up to the excess of an individual bank's reserves, but as stated a million times, no one is borrowing.

Finally, though rare, one tool so many forget the Fed can deploy is the ability to adjust reserve requirements. Given that many central bankers have begun to use this tool, it wouldn't exactly be the "holy shit" moment so many say it would. Also, with bank reserves higher than normal, such an increase would not cause a massive liquidity crunch, nor would it necessitate that banks reduce capital they have at work. Instead, banks with excess reserves would find it profitable to lend to other banks.

If it is only half-time for inflationists, as gonegolfin says, then it is only half-time for the Fed, too.

 

[hugolp]

How did the money go from the bank reserve level to the Treasury? It didn't.

Banks use money in circulation to go buy $1 Trillion in Treasuries.

No, they dont.

Here is where you are getting it wrong. The banks loaning money to the government increases the money supply. In your example only the banks buy the debt so the money supply increased a lot. This is not the case in reality, there are other buyers, but still there is some monetary inflation.

$1 T moves from Banks to US Treasury.

Fed gives $1T to banks to buy those Treasuries. But the banks are given money at the bank reserve level. How does the amount of circulating money increase? It doesn't, and it hasn't.

And as repeated previously, saying that right now banks are not lending so QE is not inflationary is not explaning the whole story (and it is ignoring the government spending part). When banks start to lend they will be able to use their reserves to loan and it will be inflationary. And btw, now excess reserves are going up again, but for some time they were going down, so the money was being used. Consumer credit is up.

The key here and the only justification that is left to you to say that QE is not inflationary is discussing if the Fed will be able to remove all this liquidity (or a big part). And the answer is no. It does not want to and even if it wanted it wont be able to.

 

[cubical]

They can convert to currency and withdraw the money, which is inflationary in the sense that it increases the amount of money that you and I use, but if banks choose to withdraw their excess reserves then the potential for the money multiplier to come into the picture is greatly reduced.

Why? The money doesn't disappear if a bank buys something like gold. It is transferred to someone who can do whatever they want with it, like deposit it into a bank.

 

[VBRonPaulFan]

Tons of responses, no answers, just what-ifs. @jclay2 especially, yes, I get it. I realize there is more money in bank reserves. I would appreciate if you realized that the money hasn't gone anywhere for...oh, more than a year? And because of that, the supply of money is not growing.

Come on people, admit it: the money supply with which we interact is not growing. Until banks start lending, there will be no growth in the money supply. And consumers don't seem to be too interested in borrowing.

Okay, so what does the Treasury do with the $1T payment it got from the banks for T-Bills? Throw it in a huge pool and let the employees bathe in it?

 

[japes]

Okay, so what does the Treasury do with the $1T payment it got from the banks for T-Bills? Throw it in a huge pool and let the employees bathe in it?

I think Geithner wipes his a$$ with it...and sends a few rolls over to the Bernanke to do the same. I don't know how else this gov't can waste so many dollars so quickly.

 

[Mogambo Guru]

I think Geithner wipes his a$$ with it...and sends a few rolls over to the Bernanke to do the same. I don't know how else this gov't can waste so many dollars so quickly.

In The Know: Should The Government Stop Dumping Money Into A Giant Hole?
http://www.theonion.com/video/in-the-know-should-the-government-stop-dumping-mon,14289/

 

[JasonC]

I haven't seen anyone mention the effects of increasing the bank reserves on the actual banks themselves. What would happen to most of the big banks if they were not given the newly created money to be put in their reserves? Would they have gone under? I'd say that most of them would. Is this increase in the money supply, despite not being loaned out, propping up our major financial institutions that would have otherwise gone under and allowed the economy to, in part, restructure along more sustainable lines? I just find it silly that anyone would argue these monetary injections do not have any impact on our economy and do not artificially prop up the price of most equities. Inflation does not show up right away and is spread out first over different higher-order stages of production and raw materials. This process takes time, especially when we just had an enormous bubble pop.