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Question on Debt and QE

Hi Cullen, I recently finished reading your book and it was an eye-opener in many regards.

However, there is one topic about debt that doesn't give me peace and I need a resolution 🙂

As far as I understand, there are two kinds of debt. There is debt granted by banks (loans, overdraft facilities, ...) which create new deposits, and there is debt granted by non-bank institutions (corporate bonds, for example), which don't create new deposits.

My first question is, in the case of government bonds, do they pertain to the first or second category, or to both depending who is acquiring the bond? So basically, does the issuance of government bonds create new deposits or not?

My second question is about QE. I understand that QE is basically an asset swap. However, this asset swap happens with banks but also with non-banks (I don't know in which proportion, but would be nice to know). As fas as I understand, when the central bank swaps assets with a non-bank institution, the central bank retrieves a bond from the economy, but the non-bank institution is receiving a newly created deposit. Now, this by itself doesn't reduce indebtedness, but, since all debts are payable in deposits, I would assume that general indebtedness in the economy should gradually reduce, as more deposits are circulating in the economy, allowing for increased spending and therefore debt repayment. Of course, the big IF here is that these new deposits are actually used for consumption or investment, instead of just being used for asset transactions. Is there any mistake in my logic, that QE with non-banks increases deposits, and an increase amount of deposits should translate in increased economic activity that allows for companies to reduce their indebtedness?

Actually, this made me think of a third question. Going back to the two kinds of debt, I would assume that an excess in debt that doesn't create new deposits can potentially destabilize the economy, if this debt isn't balanced by debt that does create new deposits (so, debt granted by banks), as there would be a scarcity of circulating money in the economy. Thus, debt that creates new deposits is preferable to debt that does not create any new deposits. Again, do you see any flaws in my logic?

Sorry for the lengthy question but I would be very grateful if you could answer.

Merry Christmas!

Hi @danielz

Thanks for the nice comments and for reading my book.

1) T-bonds are good old fashioned bonds. Think of them like a savings account as opposed to a deposit account. They pay you interest and someone is always locked into holding it until it's retired.

2) This question gets more confusing when we add in your question about QE. It's important to note that QE is monetary policy and T-Bond issuance is fiscal policy. These two policies can be implemented entirely in solitude. For instance, QE without new fiscal policy is a clean asset swap. Households get deposits (with banks as intermediaries) and the govt essentially retires a bond from circulation.

You could argue that QE turns the bonds into deposits via monetary policy, but that's really two different and separate operations.

3) This is a really tough question. The thing about bank issued deposits is that they're created in the loan creation process. So, that generally means there's some collateral or expected collateral being made. Most of that collateral is people's houses since most borrowing is housing related and the loans are all collateralized by real resources. This is good. It means that the new money is supported by real resources.

Govt debt creation isn't really collateralized. But that doesn't mean it is necessarily good or bad. For instance, let's say you wanted to start a new world changing company, but a bank won't lend to you, but the govt runs a deficit and someone holding cash buys the bond from the govt and the govt gets the cash to you then you can start your company and the economy should actually benefit from this. There's a big multiplier effect from this.

You could argue that this is what a lot of govt spending is in essence. It's adding liquidity to the economy when it otherwise might not be able to obtain it. Of course, the opposite can happen as well. You might not have excess capacity in the economy and the govt spending just adds to inflation....So, the answer is it depends.

Hope that helps.

Happy new year!

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche