Beginners Education: What is Money Printing
I have been asked by one Member "What is Money Printing". I'm no economist, but this is my understanding – it's a complex topic and I am happy to be corrected by any budding economists as long as you can put it in language the other Members will understand.
The Fed has a “Desk” which lends and borrows money every day to institutions that want to park cash (mostly overnight) or want cash for their business. They do this through repurchase deals or “repo” deals. Only qualifying institutions (banks, mutual funds…) can use the “Desk”.
A repo deal is the normal deal, this is a normal part of the functioning of the financial system. This is when an institution that has lots of cash through its business, cash it is earning no money on, offers it to the Fed (mostly overnight) and at the same time promises to repurchase/repossess the cash the next day (usually). This is a “repurchase deal”. A repo deal. The lending institution will be paid an interest rate by the Fed (the overnight rate) for leaving the cash overnight. This is how the Fed set rates by manipulating the overnight rate it is prepared to pay and in so doing they encourage or discourage institutions to give them cash or borrow cash. It’s how they control the liquidity of the financial system. Raise rates and everyone lends to them (gives them cash) and in so doing they tighten the supply of cash in the ‘economy’ (in the hands of lending institutions) and so "tighten" the economy. Through this mechanism, when rates go up the economy tightens.
A reverse repo is the other way around. This is the key to money printing. This is where the institution wants cash and they lend the Desk (the Fed) assets (financial assets they happen to hold/own). Treasury Bonds mostly, Mortgage-Backed Securities, other qualifying collateral assets. They lend these assets to the Fed and the Fed gives them cash. The institution promises to repurchase those assets at some point in the future at a price and the difference between the price at the beginning and the price at the end implies an interest rate on the cash. In some countries of course this interest rate has gone negative so the Central Bank are effectively paying their financial institutions to borrow the cash (in return for the bonds or mortgage-backed securities or the other acceptable collateral) in the hope they will put it to work in the economy and in so doing 'stimulate' the economy.
So money printing is when the Fed simply creates cash (on a computer) and offers to buy lots of assets and hand out the cash to financial institutions. This is done through these reverse repo agreements to qualifying institutions (banks, mutual funds…) who offer the Fed bonds and mortgage-backed securities they own as collateral for the cash the Fed gives them.
Definition (hopefully you can understand this now) – "A reverse repo is a short-term agreement to purchase securities in order to sell them back at a slightly higher price. Repos and reverse repos are used for short-term borrowing and lending, often overnight. Central banks use reverse repos to add money to the money supply via open market operations."
So effectively the Fed is printing money and buying bonds off financial institutions and those financial institutions then go and use the cash for their business (stimulating the economy) or, as now, when there is so much cash around, they “park it” in financial markets and in so doing support the financial markets (and make a fortune by effectively investing cheap cash in racing asset markets). Hence the Goldman Sachs price has doubled since this latest round of money printing began:
And Morgan Stanely is up 270%.
The more money printing and bond-buying the Fed does the more they support the financial system that feeds the economy and the more they support the financial markets which is where the money gets parked. Tapering is simply the Fed telling the markets that they are not going to offer to buy as many bonds and mortgage-backed securities each month so they will be printing (creating) less money.
Through this money creation process, the Fed is obviously doing what is called “Building their balance sheet” by printing (creating) money (which becomes theirs) and offering that 'cash' for bonds and other assets.
Here is a chart from the FOMC’s website. The scale on the right is in millions of millions so the current size of the Fed balance sheet is $8,342,598,000,000 or US$8.3 trillion. You can see that the balance sheet first started to move after the global financial crisis in 2008 and was just beginning to taper in 2019 when the pandemic struck and it accelerated again. During the financial crisis and the subsequent recession total assets increased from $870 billion in August 2007 to $4.5 trillion in early 2015. Then, reflecting the FOMC’s balance sheet 'normalisation program' that took place between October 2017 and August 2019, total assets declined to under $3.8 trillion. Beginning in September 2019 total assets as you can see, started to increase again. The pandemic has doubled the Federal reserve’s asset base or as they call it “balance sheet”. They have printed that much money.
This is not without a price. As they effectively becoming richer by printing cash for themselves and no-one else, they do so at the expense of everyone else’s dollars. So they are devaluing the US dollar, so the US dollar goes down. Which is why this has happened, since the pandemic and the start of money printing, the US dollar immediately took a dive (whilst the financial markets and the S&P 500 has flown).
The recent pick up in the US dollar is obviously reflecting the idea that the Fed’s money-printing might have peaked.
Note: This money printing and the fall in the US dollar as a consequence is one of the main drivers of the A$ – that and the iron ore price. Whilst the US dollar has dropped and the iron ore price has risen the A$ has done this. And as the money-printing seems to be peaking and as the iron ore price falls, the A$ is now falling.
I hope that helps explain this whole money printing episode although I am not an economist so please correct me if wrong (in layman’s language).
Tapering does not stop the Fed from injecting cash into banks and the banks putting that into the financial markets, it just slows it. JPMorgan writes about cash continuing to build up in the financial system well into next year despite tapering. Tapering may mean the peak level of monthly bond-buying (and mortgage-backed securities buying) but the bond-buying still continues and the banks (through what are called reverse repo deals with the Fed) will continue to lend bonds to the Fed and the banks will still have to find a home for the cash they receive. There is more than a trillion in excess cash already parked in ever more risky asset classes including equities and corporate bonds and it will continue to grow albeit at a slower rate. The reverse repurchase agreements with the Fed will continue and that “vast pool of liquidity” will continue to be invested in markets, will continue to send bond yields lower, and will continue to support equities over Treasuries (no yield) even if tapering arrives and if bond purchases do trend lower in the next 6 to 8 months. In other words, tapering is just a slowing of money in the system, the money is still arriving and finding a home in asset classes.