Thread by @jameslavish

*Money Printing*

A seemingly simple, yet confusing topic.

I mean, why even sell bonds to the public, when the Fed can just print more dollars and pay for whatever the government wants to spend?

The answer is simple but requires a little critical thinking.

Time for a Fed 🧵👇

If you’ve been on Twitter in the last week, you likely saw a video clip of Jared Bernstein, the Chair of the United States Council of Economic Advisers, ‘explaining’ bonds

(Yes, the group that advises the White House on economic policy)

Even so, he seemed to really struggle with the basic concepts and how Treasuries work

Let's be honest, these are hard concepts to grasp

So, let’s break them down, nice and simple, to understand.

🧐 Money Supply Basics

To understand 'money printing' we must first understand money basics. Or rather, 'money supply' basics

We will keep it super high level here and easy to understand.

Narrow Money

At the most restrictive end of the money supply measures, we have what is called narrow money, or M0 (‘em-zero’)

This includes only currency in circulation and cash kept in reserve by banks. M0 is often referred to as the monetary base

Moving up one notch, we have what is known as M1

M1 includes all of M0 plus demand deposits, plus any outstanding traveler’s checks

Demand deposits are simply liquid deposits in bank accounts that can be withdrawn by a customer at any time, i.e., customer checking and savings

Hold up, you say, banks don't actually have all this cash in the safe, ready for withdrawal, right?

Didn't we learn this with the bank collapses this past year?

Exactly

Banks don’t hold all your cash in their vaults. They use risk analysis estimate how much needs to be available at various branches in absence of a run at the bank

The rest is just 0s and 1s on a digital ledger that they keep

**Remember that 'digital' part for later.

In any case, M1 includes any cash that could be withdrawn (including those traveler’s checks), but stops there

Hence, M1 is often referred to as narrow money

Here’s how much M1 is out there in US Dollars:

I know what you're thinking:

What the heck happened in 2020 that cause the M1 money supply to skyrocket higher?

You got it: *Money Printing*

We will get to that in a bit, but let's first unpack the next level of money supply, the wider calculation of it, called broad money.

Broad Money

Moving our scope out a little bit, M2 includes all of M1 plus money market savings deposits, time-restricted deposits under $100K (i.e., CDs and money markets)

In other words, M2 includes all money that is held in cash equivalent accounts, liquid and semi-liquid.

Expanding to M2, here is the amount in USD out there today

You can see how the chart of M2 is much more gradual in its expansion after 2020, and how it takes a while to 'trickle down' into individual's accounts.

Why?

The Cantillon Effect

Named after Richard Cantillon, an 18th-century economist, the Cantillon Effect describes how those who receive new money first (ie, banks, government, or financial institutions) benefit, while others further down the line experience delayed effects.

Now let's explain what Jared Bernstein had so much difficulty describing (and apparently understanding himself)

The US Treasury Bond.

🤓 Treasury Bond Basics

In the most basic form of definition, a US Treasury Bond is a bond issued by the US government. This is no different than a bond issued by Apple or Microsoft or Tesla

It is the country (or company) borrowing money from people who buy the bond.

And what happens when you borrow money?

Right. You pay interest to the one(s) who lent it to you

Just like you pay the bank interest on your mortgage. You borrowed money from the bank to buy the house, you pay the bank interest for that loan.

Simple.

Now. We all know that the government has been borrowing a massive amount lately

This is because the government operates in a deficit (it spends more than it receives in tax revenues) and it makes up the difference by borrowing

This adds to the US Public Debt.

How much has the US borrowed, and how much does it owe everyone who lent that money to it?

Would you believe 34.6 Trillion Dollars? 😱

OK, OK, so who is buying all these bonds? I.e., who is lending the US all this money?

Well, let's have a look, shall we?

So, basically, you and me and others buying bonds directly in their IRAs, 401Ks, personal accounts, and indirectly through mutual funds & money markets (yellow), US banks (green), foreign central banks, ie, Bank of Japan, Bank of China, and other foreign buyers (brown)...

But hold up

What's that blue area?

You got it.

The US Federal Reserve itself.

How do they possibly own all those US Treasuries, you ask?

Well, the money printer, of course

Let me explain.

🫣 How Money is 'Printed'

If you have been following me, you know all about the Federal Reserve monetary tools QE and QT

If not, or if you need a quick refresher, these stand for Quantitative Easing (QE) and Quantitative Tightening (QT).

In periods of financial distress or recession, like the Great Financial Crisis, we saw the Fed use QE with a sort of shotgun approach, buying up US Treasuries and MBS (Mortgage Backed Securities) with reckless abandon

And QT is when the Fed sells them back to the market.

During the GFC QE, the Fed bought over $1.5T of these assets over the course of a couple of years (and then kept adding for a few more years)

Flash forward to 2020, and the market distress of the lockdowns, and the Fed added a cash *bazooka* to its artillery

That's a jump of over $5 Trillion in just 2 years. Look at the difference from 2009 to 2020.

BAZOOKA BOOM

But how did they do this?

Simple.

No, there is not an actual physical money printer spitting out bills (though I do like the Powell meme). 😅

In reality, it's much less exciting

Basically, the Fed, as the US Central Bank, has the unique ability to create money

When the Fed uses QE to purchase securities like Treasuries, it does so by creating bank reserves out of thin air

This is a digital process of money creation.

Here's how it works:

• The Fed announces its intention to purchase securities and the amount it intends to buy

• Primary dealers (big intermediary banks) then buy these securities in the open market on behalf of the Fed

...

• Once a purchase is made, the Fed credits the reserve accounts of the primary dealers with newly created money and puts the Treasuries on its own balance sheet

• This crediting increases the total reserves of these banks, injecting liquidity directly into the banking system

In essence, the primary dealer acts as a broker and settles the trades, sending this new-found capital to the seller of the Treasuries and sending the Treasuries to the Fed, and *voila*

More cash enters the system.

Just press a button and Wham-O

*New Money*

Imagine you are playing a game of monopoly where all the money has been distributed and is already in the game

Then a new player shows up to the game with a fist full of money from a Monopoly game from *his* house. And he just starts buying property left and right.

What has happened, is he has added new money to the game that was not there before

He *expanded the money supply*

And so, Park Place and Boardwalk just got way more expensive.

And this is effectively what the Fed is doing when it institutes QE and buys bonds in the open market

The Fed adds money to the markets that was not there before, injecting liquidity into those markets.

Look at how the M2 money supply (blue line) rises along with the expansion of the Fed's balance sheet

And that, my friends, is classic money printing

Nothing more and nothing less.

As for the "why don't we just print money and skip the whole QE and Treasury borrowing system" question,

If we did this, we would fully transform into what is known as a 'Banana Republic', where blatant and excessive money printing to fund gov't deficits leads to hyperinflation.

Imagine a world where the Treasury (Congress, really) just spends as much as they want, and the Fed just prints however much is needed to allow for that spending.

Unchecked. Unabated. Unabashed.

Prices would rise exponentially as the expansion of the money supply skyrocketed (Park Place and Boardwalk would go for millions, billions, then trillions), people would lose confidence in the USD as a store of value and at some point, a means of exchange.

The streets would be littered with them, as it would require wheelbarrows of USDs to pay for anything, prices changing by the minute.

(If you think this is hyperbole, go to Venezuela or Lebanon and see for yourself)

It would lead to loss of confidence, chaos, and a rapid path to hyperinflation.

The collapse of the US dollar.

No no. The Fed and Treasury will do anything to obfuscate and deflect any attention to the infinite ink-cartridge money printer.

They will sell bonds instead.

Even if to themselves.

I mean, if the country's 'Chief Economist' himself is confused by the system, it's a pretty good bet that most everyone else is, too.

And the show can go on.

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