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There's a lot of misconception on how the Fed really works, how QE and money creation works and whether we are or we aren't headed for inflation.
Thread on how the monetary system works:
Thread on how the monetary system works:
So let's get started of with "money printing". According to the Federal Reserve Act, the Fed may not print money.
The Fed cannot directly control the money supply. The Fed can only control the monetary base.
The Fed cannot directly control the money supply. The Fed can only control the monetary base.
So what is the monetary base?
The monetary base is the sum of the money supply in the economy+the commercial bank reserves at the Fed.
This is not the same thing as the money supply.
The monetary base is the sum of the money supply in the economy+the commercial bank reserves at the Fed.
This is not the same thing as the money supply.
QE (Quantitative Easing) is basically an "asset swap". The Fed buys an asset from a bank and in return, adds to it's reserves.
The asset bought is typically treasuries. Quick note- the Fed CANNOT directly buy treasuries from the US Treasury.
The asset bought is typically treasuries. Quick note- the Fed CANNOT directly buy treasuries from the US Treasury.
Banks have a minimum amount of reserves they must keep at the Fed, and meanwhile, they can lend the rest of it out.
(Banks' lending is constrained by the amount of reserves at the Fed).
The requirement in the US is 10%.
(Banks' lending is constrained by the amount of reserves at the Fed).
The requirement in the US is 10%.
When banks lend, "new" money is created. Credit is the only thing that can create "new" money or increase the money supply.
You can look at my pinned tweet for a detailed explanation of credit cycles.
You can look at my pinned tweet for a detailed explanation of credit cycles.
Eventually, most private debt has to be paid back. When the time comes to pay the debt back, demand for dollars to pay the debt goes up.
The Fed is unable to create new money to help this.
This is the heart of @SantiagoAuFund Dollar Milkshake theory.
The Fed is unable to create new money to help this.
This is the heart of @SantiagoAuFund Dollar Milkshake theory.
The creation of new money (and hence inflation) depends solely on the basis of credit extension by the banks.
The Fed can do infinite QE (and increase bank reserves), but if the banks don't lend against this, money is not created.
The Fed can do infinite QE (and increase bank reserves), but if the banks don't lend against this, money is not created.
Let's talk about the Eurodollar market.
The Eurodollar is basically a dollar sitting in a foreign bank account.
Nothing to do with Euros or Europe.
The Eurodollar is basically a dollar sitting in a foreign bank account.
Nothing to do with Euros or Europe.
The market for Eurodollars is larger than the market for dollars, though there is no fixed "correct" estimate. The best estimates tend to be in the several trillions of $.
The Eurodollar is in a sense the world reserve currency.
The Eurodollar is in a sense the world reserve currency.
The issue with this market is that it creates a massive shortage of US Dollars, when debt comes due.
And while we have the Fed for the US debt, we don't have a Fed equivalent for foreign debt.
And while we have the Fed for the US debt, we don't have a Fed equivalent for foreign debt.
I'm not highly educated on the Euro$ market, however @JeffSnider_AIP Eurodollar University is great.
Moving on to another important concept, the Triffin Dilemma.
Moving on to another important concept, the Triffin Dilemma.
This was "discovered" by Robert Triffin, a Belgian economist, where he pointed out that the country who runs the reserve currency has to run a trade deficit to supply everyone with currency.
If the USD strengthens (significantly), getting reserve currency funding gets hard.
If the USD strengthens (significantly), getting reserve currency funding gets hard.
The last concept to touch on is how this fits right in to the George Soros boom/bust process idea.
Soros believed that every trend/boom started with a misconception, which is fairly valued by the fundamentals till a point, after which it is validated only by the reinforcing of price and psychology.
"Price goes up, so I'm gonna buy more"
"Price goes up, so I'm gonna buy more"
And similarly it reverts and becomes self-reinforcing in the opposite direction.
Here's how it applies to the dollar milkshake idea.
Here's how it applies to the dollar milkshake idea.
You've got this misconception that the Fed has the power to create new dollars.
This leads to the dollar going lower (as shown by the DXY).
When this misconception is realized, the trend will reinforce in the opposite direction, and the DXY will go much higher.
This leads to the dollar going lower (as shown by the DXY).
When this misconception is realized, the trend will reinforce in the opposite direction, and the DXY will go much higher.
That's it folks. Hope you enjoyed a dose of monetary economics from a 16 year old.
