The Hidden Motive Behind Quantitative Easing

220px-Marriner_S._Eccles_Federal_Reserve_Board_Building Foreign individuals and businesses long ago cut back on their purchases of U.S. bonds. Their place was taken by foreign central banks. The central banks simply created money in their own currency and used it to buy our bonds.

The Federal Reserve always knew that we couldn’t rely on foreign central banks to buy our bonds forever. This may be the main reason it began the program called quantitative easing, in which the Fed created money out of thin air specifically to buy back U.S. debt.

Quantitative easing may have been intended to be a kind of insurance policy. If foreign central bank buying of U.S. bonds collapsed, the Fed would already have a program in place to buy them back itself.

The Fed  said that quantitative easing was meant to create U.S. jobs, but this never made much sense. Even a hard core proponent of QE, Fed official William Dudley ( formerly of Goldman Sachs), admitted that the Fed’s own economic models could not explain how creating money out of thin air and using it to buy U.S. bonds would increase employment. Some link to rising stock prices could be demonstrated, if only through the cheap financing of corporate stock buy-backs, but then rising stock prices could not be shown to create jobs either.

One inference from this was that chairman Ben Bernanke, and now new chairman Janet Yellen, were just taking wild stabs in the dark. A more reasonable inference is that they had another reason for QE, one which they did not want to acknowledge.

Viewed in this way, the 2008 bail-out should be viewed not as a bail-out of Wall Street, but rather  as a bail-out of Washington. The Federal Reserve feared that the market for government bonds was about to collapse, which would lead to soaring interest rates, and a complete collapse of our bubble financed government.

The Fed did not have the option of creating money and buying debt directly from the Treasury. That would be illegal. The Treasury must first sell its bonds to Wall Street, after which the Fed can then use its newly created money to buy them back. Hence, in order to rescue the Treasury, the Fed felt it had to rescue Wall Street.

This is a simplification of what happened, and only part of the story, but it is the untold part of the story, and in all likelihood the most important part. The Fed was in a panic in 2008, but not primarily about what might happen to Wall Street, and certainly not about what might happen to Main Street. It was in a panic over what might happen to government finance.

This interpretation is strengthened by new information contained in former Treasury secretary Hank Paulson’s recent book. He revealed that Russia tried in 2008 to persuade China to join in a collaborative effort to dump U.S. bonds in order to bring down the U.S. financial system. Although China refused to do so at the time, its government would clearly like to end dollar dominance, and has  been paring U.S. bond purchases.

At the moment,  Janet Yellen’s worries about finding buyers of government bonds can only be getting worse. For much of last year, foreign central bank purchases of U.S. bonds in aggregate fell. As of October of 2013, they had been negative for three and six months. Then they turned up a smidge, only to fall again, so that the last three months show a decrease of just over 12%.

It is known that Russia withdrew its U.S. bonds from custody of the Fed after the Crimea invasion, and has either been selling or could sell at any time. It will no doubt try again to persuade other countries to join in undermining the U.S. bond market and replacing the dollar as the mainstay of world trade.

Under these circumstances, it should not be surprising that the Fed is today taking only baby steps to reduce its program of creating new money to buy U.S. bonds. This program is probably not just meant to revive the economy, which it has not done and cannot do. It is more likely designed as a desperate and in the long run counterproductive effort to finance the U.S. government and save today’s dollar dominated financial system.

Comments

  1. “the Fed is today taking only baby steps to reduce its program of creating new money to buy U.S. bonds.”

    And is the Fed really even taking those baby steps, or does it have a hidden way to buy U.S. bonds… via Belgium?

    “Since last August, Treasury debt attributed to Belgium by official US data has surged from $160bn (to reach $341.2bn) – and this rapid growth means that the country, with a gross domestic product of $484bn, presently ranks after China and Japan as the third largest foreign holder of US Treasury debt.

    Traders say reasons for Treasury holdings to climb so sharply in the home of the European Commission may reflect the secret buying of top-rated sovereign debt by other countries using Brussels as a financial centre.

    ‘We know it’s not Belgium buying, it’s way too much. We need to look at that country’s custody services,’ said Marc Chandler, ‘We suspect that the increase in Belgian holdings may be the product of another entity moving their holdings into the nation rather than Belgium itself purchasing such a vast amount of Treasuries.’ ”

    http://www.ft.com/intl/cms/s/0/a1de1546-c489-11e3-b2fb-00144feabdc0.html#axzz2zU1WNnMJ

  2. Additionally, never underestimate what these people believe (remember the trillion-dollar coin)?

    http://davidstockmanscontracorner.com/why-yellen-should-leave-us-screamen/

    In a speech to the Economic Club of New York today, Dr. Yellen delivered a serving of pie-in-the-sky that would have made Greenspan look circumspect and Bernanke appear at least partially sober. She actually espied two years down the road a point at which the battered and ruined US economy would enter the promised land of inflationless full employment forever, world without end:

    Yellen noted that the central bankers and many economists see a return to full employment and stable prices by the end of 2016. This would be the strongest economy in a decade: “I find this baseline outlook quite plausible,” she said.

    That’s hideous. The US economy has not remotely entered a sustainable full employment zone since Greenspan took the American economy permanently into bubble land at the turn of the century. And the two year forward economic forecasts of the Fed Chair persons and their merry bands of money printers have been ridiculously wrong.

    Sure, it might be an act and play for useful idiots. But I don’t think so.

  3. Additionally…

    “The Fed said that quantitative easing was meant to create U.S. jobs, but this never made much sense.”

    It doesn’t need to make sense. It just needs to make sense to the people who take the decision. Just go to the usual websites then check the op-eds, then check the comments. THIS IS WHAT PEOPLE ACTUALLY BELIEVE.

    “This interpretation is strengthened by new information contained in former Treasury secretary Hank Paulson’s recent book.”

    Why should we trust what Hank says?

    “He revealed that Russia tried in 2008 to persuade China to join in a collaborative effort to dump U.S. bonds in order to bring down the U.S. financial system.”

    Citation needed. Was that before or after the Georgian pratfall? It could be standard Putin bashing which has been à la mode the last decade. Why would old Putin want to do that (actually, how old IS Putin and does he live forever)? It might well have hurt him mightily.

    “Although China refused to do so at the time, its government would clearly like to end dollar dominance, and has been paring U.S. bond purchases.”

    “Bond purchases” are toxic as the interest rate is in no relation to the risk. Who knows whether the US will still exist when the bond expires. The problem is, what can you buy with containers of dollars … foreclosed housing?

  4. “The central banks simply created money in their own currency and used it to buy our bonds.”

    Hold on! That doesn’t make any sense at all.

    Apart from the question of “why would they do that”, they need dollars, not $FOREIGN_CURRENCY to buy “our” bonds.

    “They” (which is to say, mainly China and the oil-exporting countries) do have dollars because “we” buy stuff produced by “their” companies, which either accept dollars (which are later exchanged against $FOREIGN_CURRENCY at $FOREIGN_BANK) or demand payment in $FOREIGN_CURRENCY (which must thus be bought in exchange of dollars at $FOREIGN_BANK).

    $FOREIGN_BANK accumulates dollars, which it after some time decides to exchange against Uncle Sam’s IOUs, thus guaranteeing a bit of incoming cash flow.

    Now, it is true that China prints Renminb to keep international prices low and thus exports going (which just means it both bleeds itself to death and mutates into an economically unsustainable model) but this is not equivalent to “The central banks simply created money in their own currency and used it to buy our bonds”. Not at all.

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