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The Fed feels compelled to begin unwinding its $4.5 trillion balance sheet. My question is why and if they left it as is forever what problem would that cause? The Fed’s heavy balance sheet is always talked about as being a big problem but no one ever says why. I have asked this question many times to many people and have never gotten even close to a good answer.

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Posted by John M. Wilkins
Posted on 04/05/2017 4:43 PM
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I agree 100%. If we have an inflation problem, putting some of these assets back on the market could be used as a new tool. Or they could just toss these bonds in the trash and forget about them.

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Posted by Dennis
Answered on 04/05/2017 5:07 PM
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    Cullen, Why is buying these assets in the first place not just the same as a typical corporate “buy back” of our so-called “National Debt”.

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    Posted by Dennis
    Answered on 04/05/2017 5:10 PM
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      As to the “unwinding” of the Fed’s balance sheet, we know that the Fed has been reinvesting the proceeds of many of the securities it’s been holding (as they mature) – which means the Fed has continued to buy Treasury bonds, notes, and bills on a regular basis. As they slow down those purchases, will their diminished presence in the market mean higher rates (lower prices)? Seems to me that they will likely move gradually on reducing their reinvestments. I think that means that if they don’t reinvest, then the proceeds go back to the Treasury. I don’t see them selling the bonds back to the market, but I’d like others to share their opinions.

      I’m also reminded of an op-ed piece in the WSJ by David Malpass, wherein he said (as I recall) that the “money” that the Fed created to buy all those securities (carrying out QE) was in fact “debt” – that had to be paid back. Perhaps I misunderstood his point – but that seems completely wrong. (The op-ed was run over a year ago.)

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      Posted by Steve W
      Answered on 04/06/2017 9:40 AM
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        Unwinding the balance sheet is said to be “monetary tightening.” And the Fed said they are not going to “sell” assets, but jus not invest when they mature. So I guess when they mature, the Treasury simply prints a now bond and sells it in an auction, therefore taking money out of the economy. If all this is true, why couldn’t the fed simply continue to raise interest rates? Wouldn’t that have the same effect? Perhaps unwinding will increase the yield on long bonds faster, steeping the curve.

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        Posted by John M. Wilkins
        Answered on 04/06/2017 1:09 PM
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          > Steve W
          If the Fed does not re-invest it does not result in proceeds to go to the treasury , as the bonds mature what happens is that the Fed liabilities reduce.

          > John Wilkins
          The Treasury selling bonds does not take money out of the economy , it spends the money with the recipients of government spendings.

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          Posted by Dinero
          Answered on 04/06/2017 3:22 PM
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            Perhaps the reason some people believe the Fed’s large balance sheet is a problem is because the have the mistaken notion that banks lend out reserves which could cause inflation. Of course banks do not lend reserves and even if they did the Fed could raise the interest rate paid to banks that hold them.

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            Posted by John M. Wilkins
            Answered on 04/06/2017 3:35 PM
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              Dinero

              “If the Fed does not re-invest it does not result in proceeds to go to the treasury, as the bonds mature what happens is that the Fed liabilities reduce.”

              Sorry, I thought that when a bond “matures” you’re supposed to get back the full face value. “Maturity Date – This is the date on which the borrower will repay the investors their principal.”

              Those funds come from the US Treasury right? Is this the reason that the Fed “liabilities” are reduced–because the Treasury sent moolah to the Fed? This I don’t get.

              If the Fed said: “don’t bother giving us the principal back” (note that the Fed already returns the interest on the bonds back to the Treasury), then that would be the same as the Fed/Treasury buying back its own debt. But Cullen and the Fed have said that they will just “roll over” the bonds. In other words, replace the matured bonds with new ones and continue to pass the interest earned on the bonds back to the Treasury. So were it not for “bookkeeping” the bonds are “on the shelf” and “in effect” in the trash if they never stop “rolling over”. Uncle Sam’s liability is on the books and counted wrongly (IMHO), as part of our so-called “National Debt”.

              That part of our so-called “National Debt” is sitting on a shelf at the FED, with whom the Treasury has a kind of husband-wife shared liability.

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              Posted by Dennis
              Answered on 04/06/2017 4:18 PM
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                Dinero –

                Thanks for the correction. I was thinking that since the Fed (by law) turns over a certain portion of its profit to the Treasury, that it would also turn over bond principal proceeds.

                Here’s a quote from Cullen back in December 2015: “Well, if the Fed holds bonds to maturity and doesn’t reinvest the principle then the funds just sit as assets for the Fed and don’t impact the real economy. There’s no reason why this should be inflationary since it doesn’t have any impact on the private sector’s balance sheet. So no, I don’t see any reason why QE becomes inflationary at any point.”

                So, if the Fed doesn’t reinvest the proceeds, and decides to just sit on the assets for a while, are we to just think they’re saving the money for a rainy day?

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                Posted by Steve W
                Answered on 04/06/2017 5:03 PM
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                  > Dennis
                  > Steve W

                  A lender does not make proceeds from the principle they lent to the borrower being paid back, from the borrower, to the lender, the proceeds come from the interest. That applies to the Fed unless they paid less than the face value which is a particular situation that is not being discussed here.

                  > Dennis

                  If the Fed said “don’t bother giving us the principal back” that would not be same as the Fed/Treasury buying back its own debt. You are forgetting the third party in the debt spending process. ie the Treasury has spent the money in the economy, and if they did not pay the principle back it would inflate the money supply as orphaned currency without a bond to give it value.

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                  Posted by Dinero
                  Answered on 04/07/2017 7:29 AM
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                    When you take out a loan, new money is created. For every dollar of money in the economy there is a dollar of debt. It there is $100 in your bank account, some else must be $100 in debt. Across the entire economy there will be as much money as debt. If we want more money in the economy, we have to go further into debt. With every new loan comes a new debt. When you pay off your debts, the money that leaves your bank account doesn’t go anywhere else – it just disappears. This is because loan repayments are just the opposite process to money creation: banks create money when they make new loans, and effectively ‘destroy’ money when they repay loans. And you personally can only pay off your debts using money that was created when someone else went into debt.

                    Banks are not really creating money from thin air; they cannot simply manufacture their own assets — whether from thin air or otherwise. What they manufacture are liabilities; that is, debts. Banks obtain assets from external sources, mainly by trading debts for debts.

                    Let’s say I go to a bank and borrow $100,000. The banker makes me sign a promise note to pay back the amount with interest. Then he lends me the $100,000 by marking up my bank account. Loans create deposits. The banker actually created $100,000 of new money in the form of credit in the form of bookkeeper money, which is just as good as coins and paper money.

                    The banker is not afraid to do this. My checks to payees will give them the right to draw money from the bank. But the banker knows very well that 90% of these checks will simply have the effect of decreasing the money in my account, and of increasing it in other people’s accounts.

                    How much debt can a bank create? Lending is capital, not reserve constrained. In other words, banks may lend up to a multiple of their paid in capital, which is risk-adjusted based on the quality of the capital. Reserve requirements to not constrain lending. The reserve requirement may be met after the loan is made. The credit creation process is the leveraging of high powered (state) money (“reserves). The reserve accounts that commercial banks keep with the central bank are credited in HPM (reserves).

                    It is a myth that the monetary base drives the money supply; the reverse is true. The money supply (as credit) drives the monetary base. The reserves at any point in time will be determined by the loans that the banks make independent of their reserve positions.

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                    Posted by John M. Wilkins
                    Answered on 04/07/2017 12:45 PM
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                      Lending is not limited to a multiple of paid in capital. It is endogenous to the accounting of the net value of the assets against the liabilities .

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                      Posted by Dinero
                      Answered on 04/07/2017 4:30 PM
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                        Dinero “You are forgetting the third party in the debt spending process. ie the Treasury has spent the money in the economy, and if they did not pay the principle back it would inflate the money supply as orphaned currency without a bond to give it value.”

                        I understand that in carrying out QE Uncle Sam’s Treasury issued X-bonds (sold with the Fed’s help) and Uncle Sam spent the money raised into our economy (or bought a bunch of war stuff from Lockheed etc. and blew that up on somebody else’s property). Then the Fed later purchased the same X-bonds back off the market before they matured (called QE). So the bond investors got money for the X-bonds before they matured, and now the Fed has them “on the shelf”.

                        So of the “three” parties, the bond investors are gone, the money is spent, and the Fed holds the X-bonds that the Treasury originally had them print and sell. Now via QE they are with the Fed again. So as long as the Fed holds the bonds Uncle Sam’s “wife” Aunt Reserve (the Fed) has bought back that debt. So that is what I mean by “a buy back” = Fed/Treasury buying back its own debt.

                        So this is where I need to think about this some more: “if they did not pay the principle back it would inflate the money supply as orphaned currency without a bond to give it value.” The bond is accounted for because it is “on the shelf”. But, you say if it’s tossed in the trash as I suggest, then money would become “orphaned” and that would “inflate the money supply”. That part I get. But, even if it were a few $trillion that could not actually impact the “money supply” in any meaningful way.

                        This is because folks do not value our country’s assets even though they can be sold and the proceeds will be denominated in $s. Every building, every plane, every dam could be sold by Uncle Sam for cold hard fiat cash. Does selling an asset, like a USA airport owned by the government, create money, no? If somebody borrows a $billion in funds to make that purchase or issued some bonds to be paid back with interest, does that cause inflation via currency dilution? Does that inflate the money supply? Not in any meaningful amount because the money supply is actually infinite. The co-called money supply is simply a unit of account and is infinite!

                        We only count the amount of fiat currency in circulation. Why — I don’t know? Because the value of all the stuff built or on the ground built by Uncle Sam or Trump s still there and that has a value that could be traded for cash — yet that value is not counted as part of our “money supply”. Our fiat currency has no inherent value because it is simply a unit of account. It’s a way of keeping track of who owes who. Money is debt! Increasing the money supply via deficit spending by Uncle Sam CANNOT create a “National Debt” that we are bound to repay someday. This so-called “National Debt” and your worry about increasing the money supply out of whole cloth comes from a law made up to solve a non-existent problem “National Debt” that does not work anyway (e.g. out of control government spending).

                        What if POTUS Trump started selling dams and buildings owned by Uncle Sam for cold hard borrowed $fiat cash then gave the proceeds to the Fed to buy back the bonds from the market that are the basis of our so-called “National Debt”? Would there be a tremendous increase in the money supply? No, because money is simply a unit of account and now and always will be infinite, and thus can not be diluted.

                        That is my way of thinking about Cullen’s MR. I could be way off.

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                        Posted by Dennis
                        Answered on 04/08/2017 10:20 PM
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                          @ Dennis
                          The process is not the debt bought back and extinguished. The Fed does not extinguish the debt, it exchanges the bonds for Fed reserves, which are in themselves a debt , a debt of the Fed.

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                          Posted by Dinero
                          Answered on 04/09/2017 4:50 PM
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                            I think we’re on the same page. The bonds the Fed bought as per QE did not extinguish Uncle Sam’s debt. They just exchanged fiat currency for the bonds. As Cullen has written many times, it is like taking from the bond holder’s (savings – safe X-bonds) and putting cash in the bond holder’s checking account. No net change.

                            Now after QE we have the Fed with the X-bonds “on the shelf”. So Uncle Sam’s debt is “on the shelf” at the Fed and the X-bond’s interest payment are being paid by Uncle Sam and then returned to Uncle Sam’s treasury. Next, we see that the X-bonds have matured, and the principle is due from Uncle Sam to the Fed. After that payment the moolah is returned to Uncle Sam’s Treasury account by law (thus extinguishing the debt). OR The bond’s are “rolled over” and new bonds are issued by the Treasury/Fed replacing the matured X-bonds (restocking the “shelf”) instead of (1) selling the new bonds at auction, or (2) having the principle being submitted by Uncle Sam to the Fed then returned to the Treasury as per law (thus extinguishing the debt).

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                            Posted by Dennis
                            Answered on 04/09/2017 10:38 PM
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                              The debt is extinguished because no more payments are due on that bond.
                              The Fed does not return that payment of reserves to the Treasury , once it received that payment those reserves ceased to exist.

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                              Posted by Dinero
                              Answered on 04/10/2017 7:52 AM
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                                OK So if the administration wants to reduce /pay down the so-called “National Debt” via remitting the principal when the bonds mature, they just send cash (our tax submissions) to the Fed, and the debt is extinguished. The result is a reduction in the reserves. Is that all that happens, besides me getting pissed? The money will go into the banking system as reserves to extinguish a debt. There is no profit or addition to the Fed “balance sheet”? So unlike the interest payments, the principal they keep. Thanks, Dinero.

                                https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm
                                https://www.federalreserve.gov/aboutthefed/files/combinedfinstmt2016.pdf

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                                Posted by Dennis
                                Answered on 04/11/2017 12:53 AM
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                                  No Problem , Ta.

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                                  Posted by Dinero
                                  Answered on 04/11/2017 8:11 AM
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                                    I’ve written a lot about this. You might google around for my past stuff.

                                    The short answer is that it’s not a big deal. The Fed does not need to unwind the balance sheet. They can just let everything mature and the balance sheet will naturally shrink. Who cares? They might want to unwind it so they can return to “normal” money policy. Whatever the fuck that is.

                                    I don’t see the point. And yes, if they did this in a rapid and disorderly fashion then it could cause some problems. But they won’t do that. I might write something about this. There was a lot of confusion about QE when it started and even more when it ended. Almost everything I wrote about QE from the start was dead right, but I don’t think people care about that. People seem to care more about what can go wrong than what is likely to go right….

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                                    Cullen Roche Posted by Cullen Roche
                                    Answered on 04/11/2017 12:09 PM
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                                      Posted by Cowpoke
                                      Answered on 04/11/2017 9:00 PM
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                                        Its about the equilibrium theory. More bank reserves == lower T-Bill rate == more yield seeking behavior. So if you do the reverse as the Fed is now doing, you’ll get higher T-Bill rate and less yield seeking behavior which will allow all assets to stop being chokeholded at the zero lower bound. Note that is inherently bearish for all assets as they are free to discount to provide higher yielding future returns. The real question is if anyone is paying attention yet? Every Fed tightening historically precedes a recession as the overleveraged bottom of the barrel lending idiots blow up… looks like subprime auto and shopping malls/apparel retailers this round.

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                                        Posted by MachineGhost
                                        Answered on 04/11/2017 11:39 PM
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                                          Thank you, Cowpoke, for recalling Cullen 07/29/2014! (http://www.pragcap.com/why-the-fed-doesnt-have-to-unwind-qe/ )

                                          Machine: “Every Fed tightening historically precedes a recession as the overleveraged bottom of the barrel lending idiots blow up… looks like subprime auto and shopping malls/apparel retailers this round.”

                                          So to translate (for me) I understand that Fed tightening causes recession. The folks that invested in debt and those that have lots of assets denominated in fiat currency are all set to gain. Folks that have debts and mortgages to pay must cut back on spending to pay their bills. Since 50% of Americans owe more than they have, they are forced to cut back on their spending and thus we get a recession.

                                          I’m complaining about your characterization alleging that the “bottom of the barrel lending idiots” lose. When the loans default the “idiots” are the ones that confiscate the property. The borrowers are the ones that lose–and never the loan originator.

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                                          Posted by Dennis
                                          Answered on 04/12/2017 3:13 AM
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                                            Well, yes, I suppose it’s a two way street, but labor or borrowers aren’t the ones speculating via net interest margin — the lenders (businesses) are. Essentially, an artificially low FFR, say, below the Modified Taylor Rule, causes malinvestment and lending on subprime projects that would not occur if the FFR was at a more reasonable level for the level of economic activity. So as liquidity dries up, credit standards tighten and leveraged borrowers (lenders) can no longer roll over their outstanding loans to get the cash flow they need to pay their outstanding liabilities, they’re effectively all tapped out and it becomes a game of musical chairs for both the borrowers and the lenders (businesses).

                                            Now, I say that isn’t about consumers so much as interrelated businesseses since consumers are largely immune from changes in FFR as they have yearly wage contracts, 15-30+ year fixed mortgage contracts, 5+ year auto loan contracts, etc.. But over time if interest rates are higher when they want to refinance and incomes didn’t rise to compensate, then it would be an additional upstream drag, but it’s not a short-term issue that will pop a lending bubble unless there is a recession. So its a chicken and egg problem. What happens first, the recession or the tighter credit?

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                                            Posted by MachineGhost
                                            Answered on 04/15/2017 12:43 PM
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                                              In fact, I will speculate and daresay say that consumers have never caused a recession. Consumer spending is solidly stable during both expansions and recessions. No, it is the leveraged or overleveraged businesses that go belly up, scare the dickens out of credit counterparties, lays off employees, etc. that starts the dominoes falling. This has to happen because of bad investment decisions, inadequate risk control, outright fraud… all of those things happened during the subprime bubble. The consumer (borrower) was just acting rational in taking advantage of what the system/environment provided to them.

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                                              Posted by MachineGhost
                                              Answered on 04/15/2017 12:47 PM
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                                                P.S. After all, this is why we [still] have a central bank and an elastic money supply. It was Progressive impetus to deal with the negative social costs of blow ups. There’s also strong element of elitism in this dialectic because obviously Top 1%/Ivy League C-suite executives live in a completely deluded and detached reality than the Great Unwashed Consumer that are the source of their corporate profits and outsized incomes and bonuses.

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                                                Posted by MachineGhost
                                                Answered on 04/15/2017 12:55 PM
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