QE Parameters
- $40 trillion a month in QE for 24 months, no matter what, announced upfront.
- 3-month bills at 0% rolling everything over each month while adding a new $40 trillion each month.
- Zero percent interest paid to banks on excess reserves.
What Would Happen?
- Hyperinflationists and inflationists would come out of the woodwork on the announcement screaming inflation or worse.
- In two years, M1 would rise by $960 trillion dollars, nearly a quadrillion dollars.
- Since M1 is currently about $18.7 trillion, M1 would thus rise by about 5,000 percent.
What About Inflation?
Q: What would a 5,000% increase in M1 over the course of two years under the parameters as outlined above do to inflation?
A: Not a thing
There is a stimulus impact of holding down short term rates, but the Fed was already committed to holding rates to zero indefinitely anyway. Other than what is needed to hold the short-term interest rates to zero, any additional amount does nothing at all.
I suppose there could be a temporary knock on psychological effect over the size of the announcement but that would be short-lived.
Today’s question has the same answer as that of a thought experiment question I posed a decade ago.
Q: What would happen if someone invented a counterfeit machine so good the US Treasury could not tell the difference, then printed $100 trillion in bills, then buried the cash in the ground?
A: Nothing
What About Lending?
A quadrillion in excess reserves or QE induced deposits would not spur lending because banks do not lend from reserves or deposits.
A quadrillion in short term bills would do nothing to long term rates and it would not put any money into anybody’s hands to spend.
Loans and Leases vs Deposits
Please note The Fed Wants to Stimulate Bank Lending, Charts Show the Fed Failed.
The Fed crammed money down the throats of commercial banks via QE policy although the banks have little demand for loans.
What About Tapering?
At the end of two years the Fed could shrink M1 by 98% and again nothing would happen.
I suspect the best way to avoid any psychological impact would be to suddenly do a reverse repo of a quadrillion in 0% yielding bills one fell swoop unannounced. As long as banks had the excess reserves, the sudden cash drain would not do anything either.
This is quite a bit different than tapering long-term bonds at some non-zero interest rate which would force up long term rates.
On a 98% decline in money, those who define inflation solely as an increase in money supply should then be screaming deflation, but they wouldn’t be.
Instead, the entire episode would have the hyperinflationists hiding under a rock.
Inflation Is Always and Everywhere a Monetary Thing
Milton Friedman famously said, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
In my example, M1 would rise by a quadrillion, there would be zero increase in output, but literally nothing would happen that would impact anyone.
We need to rethink QE-induced increases in money supply.
Q: At the short end, is massive QE much of anything at all?
A: Other than what is needed to peg the short end to zero, no, it’s nothing.
What the Examples Show
- How hard it is for the Fed to produce CPI inflation via QE.
- How silly it is to measure inflation as a measure of M1 money supply alone.
Money Supply Recap
Our thought experiments imply that QE is not really money. It won’t be spent or lent.
Effectively then, one needs to subtract the growth in the Fed’s balance sheet from the growth in M1 to get a better picture of money.
There is an inflationary impact of QE but that stems from suppression of interest rates. It would not take a quadrillion to suppress rates. The Fed is doing that with minimal amounts.
Note to the Fed: Any QE beyond what it take to hold rates to zero does absolutely nothing at all.
There is a tapering issue, but not on the short-term parameters I imposed.
Huge Monetary Risk
My observations are in line with a comment Lacy made last year.
Please recall Bond Bull Lacy Hunt Warns of a Huge Monetary Risk
LH: “There are folks who want to make the Fed’s liabilities legal tender. Now, if that happens, then the inflation rate would take off.”
Note that the QE related M1 deposits are not legal tender. They cannot be spent or lent. Thus, they are not really money in the first place.
The Fed’s balance sheet needs to be subtracted from M1.
Helicopter Drop
Discussion of a “helicopter drop” by the Fed is nonsense.
The Fed cannot give away money and would not if it could because it is beholden to the banks.
Congressional free money is another matter indeed. So are government deficits. The real “helicopter drop” was Covid-19 stimulus first by Trump then by Biden.
In three rounds of stimulus, one under Trump and two under Biden, Congress did give away trillions of dollars that did get or will get spent as opposed to trillions in QE that didn’t and won’t.
Those giveaways certainly contributed to speculation and price inflation. So did interest rate suppression but the latter mainly to speculation.
Hello Fed, Inflation is Rampant and Obvious
My post Hello Fed, Inflation is Rampant and Obvious, Why Can’t You See It? states the present inflation case.
Inflation is very understated but it is primarily manifested in asset bubbles, not prices of consumer goods.
Any Fed induced inflation was already baked in the cake and another quadrillion or even 100 quadrillion of short-term QE wouldn’t add anything to the mix under the parameters I outlined.
If the Fed targets long-term rates it will be in response to a faltering economy or declining price inflation.
Explanation of What’s Happening Now
1. Free Money – Congress gave out trillions and it was spent
2. Supply chain disruptions due to Covid
3. The Fed suppressed mortgage rates by targeting the long end of the curve, my example did not
4. Pent up housing demand
5. Crop failures in Brazil https://t.co/x0g33UNmwa
— Mike “Mish” Shedlock (@MishGEA) May 5, 2021
Looking Ahead
Looking ahead, what’s the Fed going to do for an encore if asset prices decline?
Nearly everyone is looking for significantly increasing price inflation. I am one of the few expecting otherwise.
For discussion that includes some big barbs at the Fed for blowing bubbles, please see Don’t Worry, the Fed Says the Recent Jump in Inflation is Transitory.
In case you missed it, please see The Fed Can’t Trigger Hyperinflation, It’s Not Even a Monetary Event
Hyperinflation is best thought of as a political event that results in loss of faith in currency after which massive printing follows, not the other way around.
Mish
increase in output, but literally nothing would happen that would impact
anyone.”
Yes I believe you’re right. Mish is just using hyperbole to make his point that QE itself has little power to create inflation, since banks can’t force people to take out loans.
This is my sense as well. It is not QE per se but the government spending that QE enables. Mish alludes to this when he points out the stimulus package
What’s more, although QE in lesser amounts, ie the purchase of secondary market Treasuries only adds to reserves at the Fed, government knowledge of the existence of a QE program makes additional government borrowing easier. If the Government knows that the Fed will purchase any new debt at below market set yields, they’re free to raise funds, more funds, than they would otherwise be able to. That money will be spent. If QE wasn’t in operation, yields would be higher and the government would have to consider how viable new borrowing would be at given rates. Therefore QE allows the Government to effectively borrow as much as they want at whatever yield they effectively set. As this hasn’t caused inflation to date, I presume there have been other deflationary forces in the economy offsetting it, something Mish has previously mentioned.
I’m going to disagree with you a bit on this.
From the below link which is well worth reading
“The situation changes under QE because QE, by definition, involves the central bank supplying (massive amounts of) excess reserves. This would normally push the overnight interest rate down to, or close to, zero. This is not a problem because QE is usually used as an easing policy after interest-rate ammunition has been exhausted–that is, it is combined with and comes on top of zero or near-zero interest rate policy.”
So what we are looking at with large QE is an attempt to floor rates at 0. Zero rates implies money has no time preference, or that it is worthless in terms of investment return, where even were it a positive real rate on price deflation it would be a set rate across the board for every kind of business activity, a centralised monotonous rate, which would be impossible to use in constructive business calculation. In other words it would simply imply an ultimate monetisation and destruction of the market economy.
This would also involve taking onto the balance sheet assets, and we will limit this here to government debt though as other central banks have shown a move into private assets is possible also (so making the central bank complicit in their success by exposure to possible loss from them). We stick to government debt though because it is first stop and simpler to understand:
“LH: “There are folks who want to make the Fed’s liabilities legal tender. Now, if that happens, then the inflation rate would take off.”
Note that the QE related M1 deposits are not legal tender. They cannot be spent or lent. Thus, they are not really money in the first place. “
I disagree, almost all legal tender is based on ? It is based on government debt on the central bank balance sheet. That is to say that central bank fiat money is based on its assets of government debt. The fed liabilities are actually what is legal tender. A bank note (or reserve) issued by the fed is a liability on the fed balance sheet.
Correct me though if wrong.
So QE as stated in the article really implies already the total destruction of the US economy and market has taken place, a meltdown probably because everyone is withdrawing all the cash they can due to loss of confidence in the system. They tried this before the great depression remember, maybe it wasn’t enough then, maybe they should have promised to monetise everything…. but that money would eventually be worth close to zero.
At least, that is my view – most likely the result would be government takeover of business, price setting, rationing, in open format, or social upheaval and revolution.
Terrific post, learned a lot. One thing Mish did not address and I wish he would is money velocity. In past inflationary periods money velocity rose. Since 2000 mv has dropped and the latest readings are as low as what we saw in the 30s. Mish, how can we have inflation with record lows in money velocity?
The proceeds from the new issuance would give the government a lot of new spending power. I suspect they’d be more supply bottlenecks and rising prices.
QE in that amount would imply new issuance in large amounts, as there isnt that much outstanding for them to buy, right? And to me the question isnt what affect that has on lending, as that is a ‘locally’ concerned statement. The question is what affect does it have on the FOREX market, if your conversation is about potential hyperinflation. I may be an investing newbie, but my spidey sense would be tingling and tell me to pour every dollar I have into shorting USDX.
$40 trillion a month. There aren’t enough US Treasuries outstanding for that are there? I guess they’d be a lot of new issues.
Comment upgrade postponed again.
This time to Thursday
Q: What impact did a rise of 4 trillion in M1 from 14T to 18T have on lending?
A: None. why would another 10T matter? 100T?
Not quite. The bankers would find a way to shuffle the money around and pay themselves hundreds of billions of dollars in fees and commissions.
there is literally nothing to pass around.
“I suppose there could be a temporary knock on psychological effect over the size of the announcement but that would be short-lived.”
How can you be so confident how the market would react psychologically? Logic does not seem like the guiding force in the markets.