QUESTION: Mr. Armstrong; some people say you are wrong because the Fed did not create “cash,” but rather made more debt available through the QE process and whether people hoard money is irrelevant. I do not agree with this statement for the Fed clearly bought bonds, they did not create debt. It seems some people have completely got this all confused. Can you clarify this.
ANSWER: This is a very strange question. I really do not know how in the world someone can say the Fed did not create cash but debt. The entire theory of QE was to increase the money supply in circulation by purchasing government bonds. That would then inject cash into the system since the Fed does not and cannot create debt for it has no such borrowing authority. If they are saying that the debt still increased because Congress always spends more each year, that is irrelevant and cannot be attributed to the Fed creating debt. Then to say hoarding does not take place or is irrelevant is just unbelievable. I do not understand the reasoning.
The Feb bought in government bonds. The banks sold their bond holdings to the Fed and then complained they would have no place to park their cash. They lobbied the Fed to pay 0.25% interest on excess cash parked at the fed beyond their required reserves. The Fed accommodated the banks defeating the entire theory of QE which is in part why it did not create inflation; the banks never lent the money out parking (hoarding) it at the Fed instead. Here is a chart of the Fed’s facility they created to satisfy the banks. It stands at about $2.4 trillion. The banks HOARDED the cash injected by the Fed and did not lend it out. The Fed has the power to create money known as the elastic money supply, but it does not create debt. There were no excess reserves before QE. Instead of stimulating the economy, the banks themselves have hoarded the cash and not lent it into the economy.
Then corporations also HOARDED cash to such a point they have engaged in a massive buy-backs of their shares. This too is counter-trend to the entire idea of “stimulus.” Corporations reducing shares and handing back cash is deflationary.
Now let’s mix into this madness Europe. Why is Draghai unable to create inflation in Europe with his outrageous QE program and negative interest rates? The answer is very simple. There is no real confidence on Europe to borrow money to start any business. So what are the banks doing there? The are shipping money over to their US branch which must be part of the Fed system and as such they then part the money at the Fed and collect 0.25%. When rates are negative, the have a great spread and no risk. This is not me making up stuff or speculating. I have spoken with banks in Europe directly.
So normally I would not bother to answer such a frivolous question. This should be as simple as black and white. This is exactly what Bill Gross is hoping for that the Fed will once again exchange bonds for cash and thus place a bid underneath the market that will support bonds. There are disagreements behind the curtain and it is not entirely certain the Fed would attempt something they themselves now realize failed. They just lucked out that the US economy is in far better shape than Europe. This is why Yellen met at the White House and has kept saying that interest rates have to be normalized. The central banks are trapped. When the economy turns down starting next year more aggressively, she knows that creating more “helicopter money” by this QE program will not work. The very first thing she MUST do is shut down the excessive reserve facility allowing worldwide banks parking money at the Fed. Only doing that will the banks be force to actually “stimulate” by lending money to real live people to create something. That seems to not be old-school.
Thanks to Goldman Sachs, you took an investment bank and allowed it to change the entire banking system from Relationship Banking transforming it into Transactional Banks. So now, normal banks think the way to do business is not to lend to real live people, but lend the money and the resell it to someone else. They have altered the face of banking forever. (I also sat on the board of a bank 30 years ago when large loans would be presented to the board and that was our decision to lend or not to that customer. Those days are gone).