Monday, September 28, 2015

Why QE, particularly QE 3, was contractory.

It all comes down to this.  To have an expanding economy you have to have an EXPANDING MONEY SUPPLY and or EXPANDING MONEY VELOCITY, which is turnover of the money stock.

The structure of our Central Bank system (CB) is that the non-banks (NB) are the customers of the CB.  The member banks of the CB are the intermediaries between the NBs and the CB.  NBs include you and me.  They also include the repo and wholesale bank funding markets. 

The intermediaries, the banks, having been flooded with QE money, stopped needing to borrow overnight.  The repo market participants were not needed as much and their profits dried up.  Same with money market funds that provide short term funding to the intermediaries which killed off their profits too.

                              >meaning that the velocity of money from these participants dropped<

Now for you and me.  Lower interest rates was the goal of QE which was to spur lending.  But lower interest rates for seniors caused a fall of income and they reduced their spending.  People saving for retirement increased their savings if they could, to make up for the loss of growth in their retirement funds.  Credit card rates did not go down and thus spending via credit card debt slowed down.

                                >meaning that the velocity of money from these participants dropped<

Bank lending is what increases the money supply.  The CB forcibly took interest bearing bonds away from the banks and replaced them with cash that paid a paltry .25%.  Banks, which are the intermediaries between the NBs and the CB, were supposed to lend more because they had all this cash.  But instead, the banks focused on spread management.  They didn’t think that lending more at low interest rate was a good idea as it reduced their spread between their cost of money and the interest income they could get, their profit margin.  They did have to reduce rates to their top corporate customers and lend them whatever they wanted.  For the rest, it resulted in:

                    >reduced interest in borrowing / reduced level of lending, which reduced the growth of the money supply<

Notice that even with QE 1, there was an upturn in anticipation of ending QE 1.
During QE 2, there was a down turn.  But notice that there was an upturn in anticipation of QE 2 ending.
QE 3 was anticipated and started a down turn in anticipation of it.  During QE 3 there was a decline.
Then the taper.  This was a yearlong period, 2014, that anticipated the end of QE.

The money supply skyrocketed at the end of QE 2.  The anticipation of and QE 3 was a disaster in terms of increasing the growth of the money supply.  Only the taper leveled things out.

Money velocity had already turned down due to increasingly lower interest rates.  Look how incredibly steep the turnover of money drops during the QE years when they dropped interest rates so low for the non-banks, which include you and me.

In summary, both money supply growth slowed due to less lending, and money velocity declined from the NBs, the non banks.  The exact opposite of what was desired.

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