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The Federal Reserve Has Never Printed 'Money': Part II

Summary

  • There has been no inflation because QE did not cause an outsized increase in the money supply.
  • QE did not do what the Fed intended and has caused many consequences, most notably an increase in bad debt.
  • The Federal Reserve is tightening the screws on a weak economy caused by an excessive amount of bad debt.
  • Tightening monetary policy will increase the forces of deflation and cause lower interest rates/lower growth, the opposite of what the economy needs and what the Fed intends to do.

Overview

The first part to this series covered the mechanisms in which the Federal Reserve conducts open market operations and how the Fed has never printed money, has no legal authority to print money, and unless legislation is passed, will never be able to print money going forward.

The Federal Reserve conducts open market operations or quantitative easing (QE) by crediting the reserves of primary dealers (banks) in exchange for securities, namely treasuries and mortgage-backed securities. Reserves are not considered money and are not part of M1 or M2 but rather are part of the Monetary Base. The reserves that the Federal Reserve does in fact create only become money once a bank decides to loan out those reserves or otherwise bring those reserves into the system in which the public has access to it, thereby increasing the money supply or M2. Due to the fact that bank lending never exceeded the historical average and that the velocity of money has been in rapid decline, inflation never materialized despite conventional wisdom. Many investors are unaware of these facts, still believe that the Federal Reserve printed money, and are still waiting for inflation to appear, citing each uptick in wages growth or CPI as the start of an inflationary run, only to be disappointed by a temporary head-fake that quickly subsides as the path to lower inflation and even deflation remains firmly intact.

The first part covers this process in great detail, and I strongly encourage you to read that part if you have not done so already. You can find the article by clicking here.

This second part will cover the unintended consequences of both zero interest rate policy (ZIRP) and QE as well as the structural and secular issues of that have been exacerbated by the consequences brought on by Fed

This article was written by

Eric Basmajian profile picture
16.01K Followers

Eric Basmajian is the Founder of EPB Macro Research, an economics-based research firm focusing on inflection points in economic growth and the impact on asset prices. He was previously an analyst at a quantitative hedge fund.

Eric leads the investing group EPB Macro Research where he applies investing strategies with the understanding that when there is an economic inflection point, company fundamentals don’t matter, technical trends break down and investors are blindsided. His analysis helps investors position their portfolios to avoid losses and maximize gains during changing economic conditions. Learn More.

Analyst’s Disclosure: I am/we are long TLT, IEF, GLD, SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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