Attention Fed Apologists- There’s Printing Money, and Then There’s REALLY Printing Money

Courtesy of Lee Adler of the Wall Street Examiner

One way that the Fed creates money is the indirect route. It buys MBS at a profit from the Primary Dealers and in so doing it credits their accounts at the Fed. Because the Fed has essentially cornered that market it has driven MBS prices to all time highs, so it is buying paper from the dealers which they acquired earlier at lower prices. With the increase in their cash from their sales to the Fed, using leverage the dealers then buy most of the the Treasury paper that the government newly issues that week. The purchase money is credited to the Treasury’s account at the Fed, increasing its balance in that account by the dollar amount of the newly issued paper.

Next, the Treasury immediately starts spending the cash it raised through the debt sales. Those billions of dollars in outlays hit millions of bank accounts in the US through the government’s payments to employees, vendors, and benefit recipients. The money the Fed created when it bought the MBS thus enters the banking system very shortly after the Fed credited the dealers’ accounts for those purchases.

To recap, the Fed credits Primary Dealer bank accounts when it buys MBS. The profits thus earned allow the dealers to finance the purchase of newly issued Treasury debt. The Treasury uses the cash it raised by selling paper to the Primary Dealers to pay its bills. The recipients of those payments deposit the money in their banks. Voila the Fed has indirectly printed a big slug of new money.

That’s partly why M2 growth is running near 8% this year with an economy growing at only 2%. The Fed uses the Primary Dealers as middlemen in the process of printing money indirectly. In the meantime, something inflates in price, if not consumer prices, then commodities, or stocks, or other financial assets like, uh… Treasuries and MBS! Yeah that’s it. That’s how we get financial bubbles. Another story.

But meanwhile something funny happened on the way to the bank last week. The Fed actually printed the money directly. Bernanke said he would not do that, and Fed apologists like the beautiful and brilliant propagandist Isabella Kaminska at the Financial Times claims he isn’t doing it.

Well, sorry Bernanke fans. I beg to differ. Like so many conomic theories, your twisted and tortured explanations of why the Fed isn’t printing simply don’t pass the common sense smell test.

The following paragraphs are from the current review of the Fed’s balance sheet changes in this week’s Professional Edition Fed Report.

Bank reserve deposits normally decline when the Treasury’s balance at the Fed rise as the money to purchase the Treasury securities is withdrawn from bank accounts and flows into the Treasury’s account at the Fed. Subsequent outlays by the Treasury are paid to bank depositors who deposit them into their bank accounts, which in turn causes bank reserve balances to rise. Treasury spending and the resulting deposits represent the creation of economic credits that show up in the economic data for that week. When the Treasury sucks up cash as it does when it collects quarterly taxes or sells new debt, the economy slows for a few days, but when the checks go out, things pick up again. You can see the resulting weekly fluctuations clearly in a wide variety of unadjusted banking and money supply indicators.

Last week, bank reserve deposits fell by $5.9 billion. Our mysterious friends “Other,” also withdrew $1.9 billion from their accounts at the Fed.

Among the Fed’s other liabilities, Foreign Official deposits were unchanged, leaving combined bank, foreign official and “Other” deposits down $7.8 billion. That covered the $7.8 billion increase in Treasury deposits. The Fed also increased its liabilities by printing $5.5 billion in Federal Reserve Notes (currency- a Fed liability), but reduced them by paying down $2.3 billion short term borrowings via reverse repos. There were a few other minor items in both directions.

Meanwhile, the Fed’s assets grew by $4 billion mostly from purchases of Treasuries. That equaled the net increase in liabilities, most of which came from the Fed’s issuance of that $5.5 billion in currency. So in essence what we have here is a clear cut case of the Fed literally printing the money in the amount needed to fund its purchase of Treasuries on the Asset side of its balance sheet. When you went to the ATM this week, a sliver of the cash you withdrew had paid for the Fed’s purchases of Treasuries. Voila! Money printing.

Fed Balance Sheet 10/3/12 - Click to enlarge and print

Fed Balance Sheet 10/3/12 – Click to enlarge and print

 

Currency Outstanding  -Click to enlarge

Federal Reserve Notes Outstanding (AKA Printed Money) – Click to enlarge

 

Get regular updates the machinations of the Fed, Treasury, Primary Dealers and foreign central banks in the US market, in the Fed Report in the Professional Edition, Money Liquidity, and Real Estate Package. Click this link to try WSE's Professional Edition risk free for 30 days!

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