On Friday, after that bad jobs report came out, economists across Wall Street ratcheted up their odds of the Fed engaging in Quantitative Easing at its September meeting this coming week.
We reported at the time that an analyst immediately blasted out this animated .gif out to clients as an indicator of what was about to happen at the Fed.
The funny thing is, we later learned, there were TWO analysts at separate banks who included the identical animation in their blasts to clients.
Both men will be kept nameless to protect the guilty.
That being said, we wanted to point something else: While the picture might be cute and lolzy, it’s false. And by false we mean, it’s a terrible metaphor for Quantitative Easing.
Quantitative Easing is the Fed’s approach to easing monetary policy ever since interest rates got to zero, and it couldn’t lower rates anymore. Essentially the Fed goes out and purchases US Treasuries and Mortgage Backed Securities.
As such, the Fed’s Balance Sheet (the assets it now owns has ballooned). It looks like this. Its assets have gone from under $1 trillion to nearly $3 trillion, and for the first time, it owns lots of long term government debt and agency securities (meaning mortgage debt backed by Fannie and Freddie).
You can click the image to enlarge.
Photo: Cleveland Fed
But immediately you should see the problem.
In the .Gif, the kid is just throwing money out the window. Nothing is coming back.
On the other hand, The Fed goes out and buys securities, meaning it puts money in banks accounts, but it’s also taking something back.
And what it’s taking back are the most liquid, cash-like securities there out there. So if the Fed buys $500 billion worth of Treasuries, it’s almost a perfect swap of $500 billion in cash (kind of) for $500 billion in assets that are basically cash.
This is a big deal, because if you’re swapping cash for cash-like-instruments, no new money is really entering the system.
Here’s proof. The red line is the Fed’s ownership of US Treasuries and mortgage backed securities. The blue line is the amount of currency in circulation. The Fed’s balance sheet exploded, but currency in circulation went nowhere.
Let that sink in. According to some people, the Fed has “printed” or “injected” over $2 trillion into the economy and yet, currency hasn’t changed its path at all. Maybe the gif is wrong.
It’s too bad that that .gif is wrong, because what the economy needs is money to help stretched households dealing with the debt overhang of the credit crisis, but that’s the domain of fiscal policy. The Fed does not have the ability to just create money for nothing and throw it out the window.
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