The Federal Reserve reported a massive $97.7B in net income for the year 2015 thanks primarily to the income the Fed earned on its asset holdings via QE. And while the media will likely report this as a windfall profit the reality is that this is a huge drag on the aggregate economy. You see, the Fed doesn’t retain these profits and spend them back into the real economy like most corporations do. Instead, the US Treasury taxes the Fed (they generously call this “remittance) at a rate of about 90% and uses the funds to pay down the deficit. This is income that the private sector would have otherwise earned. Instead, it’s going to pay down a deficit that some people want you to think we can’t afford (one of the many horrendous myths about QE and the way our monetary system works).
Over the last 7 years I’ve spilled an embarrassing amount of ink on QE. Since I approach everything from an operational perspective and I have a rather good understanding of banking I was able to assess how QE worked at an operational level and make some decent predictions about how it might play out. In short, I said:
- QE was not accurately described as “money printing”, but should be described as asset swaps. This concept was ridiculed at first, but has since become the common description of how QE works.¹
- QE in the USA was not implemented with a transmission mechanism through which it would cause high inflation, rising bond yields or warrant inflation protection of any type.²
- QE could be described as a tax on the private sector since it removes high yielding safe assets from the private sector and swaps them with low yielding less safe assets. In this sense, QE was marginally deflationary as opposed to being inflationary as most people believed.
- QE could potentially destabilize the financial system as it reduces the aggregate credit quality of the outstanding financial assets and also reduces the income that services those financial assets.³
The academic assessments of QE are mixed at best depending on the author and what school of economics most influences their thinking. But the operational facts that I described almost 7 years ago have held up extraordinarily well. I certainly didn’t predict the outcomes with precision, but given the state of things I think it’s safe to say that I was much more right than wrong. Working from an operational understanding of the financial system has proven quite powerful in terms of assessing QE and its efficacy.
¹ – Understanding Quantitative Easing, Roche. C, SSRN
² – QE: The Greatest Monetary Non-Event, Roche. C, SSRN
³ – The Destabilizing Force of Misguided Market Intervention, Roche. C, SSRN
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.