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My only real interest is in tracking primary data to learn what it can tell us about the direction of the stock and bond markets. As a rule, I don’t read anybody else’s work except Doug Noland’s. Doug has a unique and valuable perspective.
There was another analyst that I would read from time to time, but I gave up on him. That person says that QE Isn’t money printing, among other things that seem increasingly detached from the facts.
I see his headlines and tweets from time to time. Last I noted he was arguing that there’s no inflation, or can’t be, because the Fed isn’t printing money. Or something equally incomprehensible.
The Fed doesn’t exchange bank reserves for assets. It buys assets from Primary Dealers by creating a credit in their accounts at the Fed. The Primary Dealers have accounts at the Fed that are hybrid deposit/trading accounts. The Fed buys US Treasuries or MBS paper from a dealer and to pay for it, instantly creates a deposit in the dealer’s Fed account. This is money that did not exist before, but it does exist the instant that trade takes place and the Fed pays for it.
Initially, this deposit is not bank deposit. It’s certainly not a reserve. It sits on the Fed’s balance sheet in a Liability line item called Other deposits. These Other deposits consist almost entirely of the accounts of the Primary Dealers at the Fed.
After the Fed’s purchase (Permanent Open Market Operation or POMO), paid for with new money to the dealer, the dealers then use that cash to trade with counterparties. The dealers use the payment from the Fed, which the Fed just imagineered (printed) into existence to buy other assets from other parties. That transfers the deposit from the dealer’s account at the Fed to the trade counterparty’s bank account at the Fed.
It’s that second step that transfers cash to the receiving bank, and moves the liability from Other deposits to “Other deposits held by depositary institutions,” which are, in essence, the excess reserves of the banks. They’re excess because the reserve requirement is constantly zero. Any bank can do whatever it wants with that cash. There’s no requirement that it be held on deposit at the Fed.
A bank’s “reserves” may be currency or a deposit at the Fed. To the bank, it is simply a cash asset.
It’s the result of the transmogrification of Fed printed money into a Primary Dealer cash asset held at the Fed (a Fed liability called Other deposits). Then when the dealer trades with someone else, that money gets transmitted into a Fed bank deposit liability on the one hand, and the third party bank’s cash asset on the other hand. Money always exists as a double entry. A credit to the holder’s cash assets, and a debit to the bank deposit liability and in turn the bank’s cash asset/Fed deposit liability.
It’s false to say that banks can’t spend reserves. They can and they do, constantly all the time. What is true is that reserves can’t leave the system until the Fed sheds assets. The total reserves on the Fed’s balance sheet are a constant, but they flow from bank to bank within the Federal reserve system. A bank can exchange that cash for any alternative asset it wants.
But these arguments are all second order effects, as I’ve pointed out repeatedly through the years. The first order effects are the ones we are interested in because they’re the ones that drive stock and bond prices. Those first effects are the Fed’s trade with the Primary Dealer, where the Fed creates new money to pay the dealer. The dealer then uses that money to accumulate more inventory, mark it up, and distribute it at higher prices.
When the Fed doesn’t print enough money to absorb enough of the financial assets being created by the US Government, other governments, corporations, or other creators of financial assets, then prices decline. We are in the early days of that process. If the Fed ever truly attempts to reduce its assets again, as it did under Yellen, the result will be market chaos.
I have written about this process for the last 21 years here. Last February I wrote an explainer which I’ve made freely available and have promoted extensively.
FREE REPORT – Proof of How QE Works – Fed to Primary Dealers, to Markets, To Money
I am only interested in tracking primary data published by the Fed itself and the US Government itself. This data is primarily the Fed’s weekly balance sheet, the weekly balance sheet of the US commercial banking system, the Fed’s daily data on its money printing operations, both permanent and temporary, and its weekly data on Primary Dealer positions and financing.
In 55 years of following the markets closely I have found that the 3 rules that matter most in correctly identifying the near term to intermediate term direction of stock prices to be:
- Don’t fight the Fed
- The trend is your friend aka, Don’t fight the tape
- News is noise
As I see it, my job is to stay relentlessly focused on these concepts, and the primary data that enables us to visualize them in action in the real world.
For those who find my approach wanting, there are billions of other opinions out there to choose from. As my sainted father used to say, “Opinions are like assholes. Everybody has one.”
If my considered opinion is not to your liking, find another asshole.
Banks Aren’t Lending
Not only is it irrelevant and immaterial, it’s simply false to say that banks are not lending.
Furthermore, what does bank lending to consumers have to do with stock prices?
Bank lending has nothing whatsoever to do with reserves. Remember that required reserves are currently ZERO. Banks lend to the extent that there’s loan demand. Apparently there is.
Now, is it true that when the Fed pumps 3 trillion dollars into dealer accounts in a year, that banks can’t lend that much? Why, yes. Yes it is.
Why are the banks mostly buying safe assets? BECAUSE THAT’S WHAT IS BEING SUPPLIED. The loan demand is coming from the US Treasury. What are Treasury securities? They are loans to the US Treasury. That’s who is borrowing. The Fed is buying those assets from the dealers as they are being created week in and week out. The dealers buy more assets from counterparties. Bank accounts swell.
Are businesses and consumers also borrowing? Yes. Are they borrowing as much as the US Treasury? No. Not even fractionally.
Who cares? What possible relevance does that have?
In this business we’re only interested in the direction of stock prices. We are only interested in the first order effects of QE on stock prices. The Fed sends the new money direct to Primary Dealers. Bank lending has zero, zilch, nada to do with it. The fact that banks use cash to acquire Treasuries is simply not relevant. It’s not material. It’s after the fact. The money is initially created when the Fed does a trade with a Primary Dealer. The Primary Dealer then does another trade IN THE MARKET. It pays for that by sending cash to a counterparty, whereupon it enters the banking system.
The bank cash asset is only created after there’s been a market transaction where a dealer purchases some financial asset. Alternatively, the dealer can lend the cash as margin or repurchase agreements (short term loans collateralized by government paper or MBS).
Meanwhile, what are the banks supposed to do with the cash they get from these infusions, anyway? Nothing? They lend to the extent that there’s demand. They put the rest into whatever paper is available. What paper is available? Treasuries.