The main reason that monetary inflation (creating new money out of
nothing) is an economic problem isn’t the effect it has on the economy-wide
purchasing power of money. The general decline in money purchasing-power is
very much a secondary negative. The primary negative revolves around the fact
that new money does not get evenly spread throughout the economy. Instead, it
gets injected at specific points, causing some people (the early recipients
of the new money) to benefit at the expense of others and causing some prices
to rise relative to others. One consequence is an undeserved transfer of
wealth to the early recipients of the new money and another consequence is
the falsification of price signals. I’ve discussed both of these consequences
in detail in the past, but I have never homed-in on the question: Who gets
the new money first?
The answer to the above question will depend on whether the new money is
created by the private banks or the central bank, and in the case where the
private banks are doing the bulk of the money-pumping it will vary from one
cycle to the next. A comprehensive answer to the question would therefore
require a lot more words than I want to use in this blog post, so rather than
trying to cover all the possibilities I am narrowing-down the question to:
Who gets the new money first when the Fed implements QE (Quantitative
Easing)?
By the way, if you think that the Fed’s QE adds to bank reserves and
doesn’t add to the total quantity of money available to be spent within the
economy then you do not understand the mechanics of the QE process. An
explanation of how the Fed’s QE creates money can be found HERE.
Since about 60% of the assets monetised in the Fed’s various QE programs
were US government debt securities it could superficially appear that the
government was the first receiver of most of the new money created by the
Fed, but this was not actually the case. The government benefited from the
Fed’s QE programs to the extent that these programs lowered the cost of
debt*, but it’s unlikely that QE resulted in the government borrowing more
than it would otherwise have borrowed. In other words, the amount of money
borrowed by the government probably wouldn’t have been materially less if QE
had never happened. It’s therefore more correct to view the government as an
indirect beneficiary of the Fed’s QE rather than as an early receiver of the
new money.
It helps to answer the question “who got the new money first in the Fed’s
QE programs?” by re-wording it thusly: As a result of the Fed’s QE, who
initially found themselves with a lot more money than would otherwise have
been the case?
The answer is the group called “bond speculators”. This group comprises
institutions and individuals, including banks, hedge funds and mutual funds,
who invest in and trade large dollar-amounts of debt securities.
To explain, the government issued about $2.5T of debt that was purchased
by the Fed with newly-created dollars. If not for the Fed, the issuing of
this debt would have necessitated the transfer of $2.5T of money from “bond
speculators” to the government. It is therefore fair to say that the Fed’s
monetisation of Treasury debt left “bond speculators” with $2.5T of extra
money. This money was naturally ‘invested’ in other financial assets, giving
the prices of those assets a boost.
Under its QE programs the Fed also monetised (purchased with newly-created
dollars) about $1.7T of mortgage-backed securities (MBSs). In this case the
fact that “bond speculators” ended up with a lot of extra money is obvious,
since the Fed replaced existing MBSs owned by “bond speculators” with cash
created out of nothing.
In total, “bond speculators” found themselves with about 4.2 trillion
additional dollars** courtesy of the Fed’s QE programs. The average
productive salary-earner found himself with a negative real return on savings
and negative real earnings growth courtesy of the same programs. And yet,
Bernanke and Yellen appear to genuinely believe that the Fed’s actions were
righteous.
*The Fed’s debt monetisation not only lowered the interest rate on all
new debt issued by the government, for the $2.5T of Treasury securities
bought by the Fed the interest rate was effectively reduced to zero. This is
because interest paid on government debt held by the Fed gets returned to the
government.
**Just to be clear, the Fed’s QE didn’t directly create
$4.2T of additional wealth for “bond speculators”, since the Fed replaced
bonds with money. Bond speculators would initially have more money and less
assets as the result a Fed asset monetisation, but the new money was a
proverbial ‘hot potato’ and was quickly used to bid-up the prices of other
bonds and financial assets.
