Quantitative easing (QE)

[Dogstar]

Can someone settle a debate for me? The CEO of my company stated that quantitative easing is when the Fed buys Treasury securities in the primary market directly from the Treasury, as opposed to open market operations where the Fed buys Treasury securities in the secondary market from primary dealers (banks).

My understanding is that the Fed is buying Treasury securities on the secondary market from banks in both cases. The difference is that the duration of the securities. Quantitative easing is when the Fed is trying to manipulate long-term interest rates by buying or selling long-term Treasury securities. Open market operations is when the Fed is trying to manipulate short-term interest rates by buying or selling short-term Treasury securities.

Can someone please settle this debate? Any articles that would confirm the correct answer one way or the other would be appreciated.

Thanks,

John

[Catalan]

Quantitative easing is a catch-all phrase for package-type monetary policy set by the Federal Reserve.

[Dogstar]

Does the Fed ever buy Treasury securities directly from the Treasury?

I thought that was forbidden.

[vaduka]

It would induce no less of an economic disturbance if the securities are bought directly from the Treasury. But the Fed actually buys them from private dealers who have beforehand bought them from the Treasury. This is done for several purposes. One of which is for the whole charade to look like more in the sphere of the market.

[John_James]

I thought everyone and their mom had seen this one:

Quantitative Easing Explained

But if you need something more accessible:

What is QE2? What Does it Mean?

[Dogstar]

The Fed printing money out of thin air to buy treasuries from banks in the secondary market has the effect of putting money into circulation since banks can then lend that newly created money. The banks are essentially liquidating assets they own (Treasury securities) to purchase other assets (loans).

The Fed printing money out of thin air to buy treasuries directly from the Treasury in a Treasury auction is something entirely different.

[Dogstar]

I actually showed that first video to my CEO this morning. It states that the Fed does NOT buy treasury securities directly from the Treasury at auction. It states that the Fed buys treasury securities from “The Goldman Sachs”.

The second video is worthless. It doesn’t explain the difference between open market operations and quantitative easing since both are printing money out of thin air.

I need to know if this is a secondary market transaction or a primary market transaction.

[John_James]

Sorry. Didn’t fully realize what you were asking. Lemme try again:

Quantitative easing does not involve the Fed selling anything. That would be taking dollars out of the market. That is not “easing” in the sense the bank is calling it. Open market operations are roughly what you described. The difference is in the scope of what the terms are talking about…not the simple distinction between long term and short term rates.

The Fed uses what are called open market operations to control the Federal Funds rate, the rate at which large commercial banks lend cash to each other overnight to fulfil their reserve requirements to the Fed. The Fed sets a target for the federal funds rate and defends it by either withdrawing or injecting money according to the requirements of commercial banks. It injects by buying securities from the banks with freshly created checking deposits, or money. This injection increases the reserves commercial banks hold, allowing these banks to expand credit to businesses and consumers. The Fed withdraws money by selling securities to commercial banks and receiving money as payment, thereby reducing reserves and removing credit from the system…

-The Fed Bought What?

On the demand side of the market, the Treasury builds up loanable funds by marketing its securities. Without the Fed supplying loanable funds, the rate of interest on Treasury securities would be higher than it is (other things being equal). The Fed “monetizes” the debt, that is, it exchanges debt for newly created money, and then holds that portion of the debt off the market.

Banks benefit from these operations by brokering debt monetization. They buy Treasury securities, hold them to earn interest, then sell them to the Fed, which always stands ready to buy Treasury debt. Banks get a portion of their assets insured by the Fed, plus they receive a brokerage fee and capital appreciation of the securities when the rate of interest is pushed down by Fed actions.

To clear up confusion on how this process works, let’s consider an analogy. Suppose that an automobile manufacturers consortium takes over the Fed…

-Why the Fed Can’t Save Us

Quantitative easing differs in this way:

Normally the Federal Reserve buys government bonds passively to maintain its interest-rate target. With quantitative easing the Fed aggressively buys government bonds and other securities in large quantities.

So how does the Federal Reserve print money? First, it buys government bonds and other financial securities from big New York City banks. It pays for these bonds with newly created electronic money, using computers to change the records of the banks’ accounts at the Fed. If the banks want paper dollars, Federal Reserve Notes, the Department of the Mint at the U.S. Treasury prints and sends crisp new dollars to the Federal Reserve which forwards them to the banks.

-What QE2 Means To You

That’s basically it. You’re saying the second video doesn’t explain the difference between OMO and QE…but that’s the thing…there is no difference as far as how it actually works. The difference is more or less in just the quantity of securities that the Fed buys.

Does this clear it up?

[realistTheorist]

The net result is the same whether the treasuries are bought directly or indirectly. If directly, the newly printed money goes to the government’s account in the bank. If the government spends it, it goes to someone else’s bank account. At the end of the day, both transactions end up in exactly the same place. The only difference is the payments of commissions to third parties, but this minor in the grand scheme of things.

Scenario 1: Bank: $100 → buy treasury by credting govt. account $100 → sell to Fed → get $100 new money
(Net: bank gets back the money it spent buying treasuries, the govt. account has $100 new money)

Scenario 2: Simply jump to the net result of scenario 1

[JeffB]

As I understand it you are exactly right. It is illegal for the Fed to purchase treasuries directly. But I’ve seen at least one article on ZeroHedge that showed the Fed was purchasing many of them within 3 hours of issuance from dealers which could be shown by the (serial?) numbers. There have been similar articles on Seeking Alpha.

Professor Antal Fekete, who I believe is an Austrian economist, though perhaps an offshoot from the beliefs of the von Mises Institute, wrote the following in his Open Letter to Ron Paul to Impeach Bernanke:

“…Another thing the Fed is not allowed to do legally is to
purchase Treasury paper from the U.S. Treasury directly. It must be purchased
indirectly through open market operations. If you don’t put the Treasury paper
through the test of the open market before the Fed is allowed to buy it, the
presumption is that the market would reject it as worthless, or would take it only
at a deep discount. The law does not allow the F.R. banks to purchase Treasury
paper directly from the Treasury because that would make money creation
through the F.R. banks a charade, reserve requirements a farce, and the dollar a
sham…”

Sarel Oberholster, another Austrian economist, I believe, (I’m an economist by training, a financial engineer by talent, a banker by profession, a trader by interest and a father by chance.), had written an article on “The Independence of the Fed” in which he concluded:

“…the Fed must be seen as controlled by Federal Government, indivisiably part of Federal Government. The pretence of independence is no more that that, a pretence.”

I sent him an email with a copy of Fekete’s open letter asking for his opinion on it. He was kind enough to reply, relevant portions of which are reprinted below:

I have read the “open letter” but the argument is not clear to me… Thus it would be a challenge to argue that the Central Bank has no right to purchase government stock outright.

The much promoted “independence” of the FED is supposed to be the inherent protection against the Fed abusing its ability to create money to fund government stock purchases in a closed loop between the FED and government. QE2 has been carefully designed to avoid outright purchases of government stock on initial issue thus avoiding the closed loop and Fekete cannot attack them on that basis. Bernanke carefully explained that the FED will purchase bonds from the market, i.e. secondary market purchases and though this is interpretation of its legal framework with generous latitude and achieves the same effect as direct purchases from government, I suspect it is technically within the powers of the FED.

The clever part was exactly to use the very cost inefficient secondary market purchases to achieve the QE2 objectives to circumvent the charge as Fekete attempts. It is actually better for taxpayers and savers that the FED to do a direct purchase in a closed loop as the manipulation via secondary purchases means that primary dealers are handed freebie profits and margins with the sale and repurchase of bonds taking place via them. Such freebie comes at the expense of taxpayers and savers.

This is exactly why the pretend “independence” is harmful. It fails to give protection and in fact does the very opposite of its purpose as it empowers political abuse without consequences or controls.

Fekete does not understand financial engineering and QE2 is pure financial engineering to legally achieve all the purposes that the FED and government desired. Using SPV, SPI or similar entities to achieve the independence is equally pure financial engineering. Almost everything about the FED is financial engineering to disguise the very simple mode of operation, creating money to suit the purposes of government.

Dr. Chris Marenson, author of “The Crash Course”, had a couple of articles detailing some of the tricks it appeared the Fed was using to monetize the debt via things like swapping debt with foreign governments etc., though that probably isn’t quite as relevant as the recent ZeroHedge article about how they’re rather blatantly getting primary & secondary dealers to buy treasuries for them and then selling them to the Fed within hours for a quick profit. But anyway, if interested here are two of his articles: *The Shell Game - How the Federal Reserve is Monetizing Debt *and The Shell Game Continues…