Is QE money printing?
Answering an age old question
I’m obsessed with quantitative easing (QE), and have spent way too much time trying to figure out how it works. In particular, I’m interested in whether QE is actually money printing. There’s a lot of debate on both sides, and hopefully this article can provide a few answers. Let’s dive in.
How QE works
Primary dealers (large banks like Morgan Stanley or Goldman) buy treasuries (USTs) with repo market funding*. The PDs sell some treasuries to private buyers, for example a large corporation, and keep the rest of the USTs on their books. To do QE the Fed creates bank reserves which they credit to the PDs in exchange for treasuries.
Bank reserves are an inter-bank asset that are only accessible to institutions with an account at the Fed. The PDs can use bank reserves to settle between themselves, but the bank reserves cannot move into the banking system at large. That’s because, as stated, bank reserves are only accessible to the handful of institutions that have a Fed account. Emil Kalinowski famously called bank reserves laundromat tokens, because they do have some value but only within a very limited set of circumstances.
*I’ve spent more time trying to pin down exactly how PDs pay for treasuries than I spent studying for my SATs. As best as I can tell, treasury purchases are primarily financed via the repo market. However, this is a topic that I’m still interested in and I’m not convinced I have it all figured out.
What are bank reserves?
Bank reserves are what you might call “inert.” They must stay within the banking system and are only accessible to a small number of financial institutions. You cannot take bank reserves to the local liquor store to buy a bottle of whiskey. Bank reserves are not money!
Hugh Hendry explaining how bank reserves are not money. Start at 3:16
If bank reserves are not money, what are they actually good for? The PDs can use bank reserves to settle up at the end of the day. For example, Morgan Stanley buys an asset from Goldman for $100 million. MS could pay Goldman with bank reserves, since they both have an account at the Fed.
Bank reserves are also base money against which the large banks can lend. When financial commentators say that a bank is “well capitalized,” this can mean that they have a lot of bank reserves on their balance sheet.
Is it money printing?
When the Fed does QE they’re initiating an asset swap. The PDs already hold treasuries on their balance sheet, the Fed simply creates bank reserves and swaps them for the treasuries. The Fed isn’t actually adding more money to the system, they’re just trading their reserves for the treasuries. This “asset swap” dynamic is why people say that QE is not money printing. Are they right?
Well, yes and no. Here is my take on the subject. If you take a strict, 100% rational accounting view of the world, QE is not really money printing. It is an asset swap. This is why Jeff Snider will go to his grave saying that QE isn’t money printing. However, human beings are not computers. The financial system is created by humans and if you know people then you know that as a species we are very, very far from purely rational. It’s hardly as if every person in the world has sat down with a spreadsheet and a financial dictionary to dive into the mechanics of bank reserves and money creation.
If you only stare at a spreadsheet, QE is not money printing. However, to the extent that QE affects the psychology of market participants, and indeed the psychology of people the world over, QE is money printing.
When the Federal Reserve creates trillions of dollars of bank reserves and buys treasuries, this has a psychological impact on people. Investors change their decision making and newspapers write columns about how much money the Fed is printing. Although it may be difficult (impossible) to quantify, QE clearly affects how people behave.
Even though bank reserves may be inert laundromat tokens, when the Fed takes its balance sheet to $9 trillion there’s just no way that doesn’t have an impact on our society. You can get a lot of laundry done for $9 trillion.
Then there’s also the obvious truth that while QE may not have a great deal of influence in the real economy, it does appear to affect asset prices. I.e. asset price inflation. It’s unlikely that we would have ever seen such extreme market valuations if it wasn’t for QE. Indeed, we’re beginning to see what happens once the Fed reverses course and does QT. It’s not a pretty picture for the market.
The borrowed shirt theory
Here’s an analogy for how bank reserves can work their way into the system, even if technically they’re only an asset swap.
You lend your friend a shirt. He likes the shirt, wears it often, washes it and looks after it. Months go by. Christmas comes and goes, it’s a new year. Come spring you find that your wardrobe is lacking so you call up your friend and ask for your shirt back. Rather than saying, “sure no problem, I’ll bring it over tomorrow,” as you had hoped, he demurs. He puts you off and is altogether unenthusiastic about returning the t-shirt. When you confront him point blank about it he replies, “dude, I kind of thought you just gave it to me at this point. I’ve been wearing it forever you know, I didn’t think you would ever ask for it back.”
When the Federal Reserve pumps trillions of dollars of bank reserves into the banking system, the lines of ownership may become blurred. The banking system uses the reserves, becomes accustomed to them, acts differently than it would have had the Fed not done all that QE. As the reserves ooze through the system they become a part of the architecture and day to day functioning, so that when the Fed attempts to remove the reserves via QT it leads to tension. In theory the Fed should be able to ask for their shirt back, but in reality it may not be that simple.
Summary
From a hyper-rational perspective, QE is not money printing. However, to the extent that it affects everyone’s perception of markets and the world, QE can create some of the same outcomes as real money printing would.
That is my take on the matter. Other people have different opinions and that’s what makes it all so fascinating. I would just highlight that the very fact that we’ve been having the QE/money printing debate for more than a decade means that there’s not a black or white answer. The truth of the matter lies in that vast chasm of grey. If you have a different opinion on QE than what I’ve written, please share it below! I’m genuinely curious to hear what your take is.
Except during the pandemic, when it actually was money printing because non-bank entities were involved for the first time.