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Is QE Lite worse than version 1.0?

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Capitalist_Man posted on Fri, Aug 13 2010 3:34 PM

Obviously, both are just degrees of terrible, but unless I'm completely off track, QE Lite actually seems worse than the original. Here is my understanding of the Fed's recent announcement. The Fed is taking principal payments received from MBS and agency debt to purchase USTs. That part seems pretty straightforward. Where it seems worse is when I thought in terms of the effects on the Fed's balance sheet.

1) Fed makes original purchase of $300B in MBS. They have a $300B asset (whether they bought it mark to market or myth is somewhat immaterial) and a liability of $300B FRNs.

2) Assuming anyone in the U.S. is still making mortgage payments, Fed receives principal payments from MBS of $300B.  They now have $300B asset of FRNs versus $300B liability of FRNs.

3) $300B FRN asset is used to purchase $300B in USTs. Thus, removing balancing asset for the original $300B FRNs and adding another $300B FRN liability.

I definitely could be missing a step here and feel free to correct me, but it seems as though in this isolated transaction the Fed levered their balance sheet 2 to 1. If this is creating a precedent for similar purchases in the future, the disastrous end result is probably the same but seems to up the ante on boring old QE1 style money printing.

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chloe732 replied on Fri, Aug 13 2010 11:21 PM

Hey, first post.  Welcome!

I think you have some debits and credits mixed up.  The Fed buys $300B in worthless MBS's.  The money supply expands by $300B.  Folks supposedly repay to the Fed $300B in MBS.  The money supply contracts by $300B.  The Fed then buys long term treasuries, the money supply expands by $300B. 

You needed to cancel out the debits and credits in your #2 above.

How I see it, is the Fed is now providing a steady source of liquidity for the treasury market.  This calms the market, knowing a buyer with unlimited "funds" is ready to buy. 

The Fed claims it is merely keeping the money supply constant by buying treasuries to the extent of MBS repayments.  This too calms the market, making it sound like there are no concerns about hyperinflation. 

How can the Fed ever stop this "program"?  It can't.  Not with $1.5 trillion deficits that must be monetized to keep bond yields low (for now).

There is no accountability for the Fed.  It says and does anything it wants to do.  Who's to verify that the Fed is doing the treasury purchases dollar for dollar with the MBS payments?  Even if they were, there are winners (bond market) and losers (citizens, savers, the hidden tax of inflation).

I don't think QE Lite is worse than QE1.  The only difference is that QE Lite is permanent, and will increase in time, to become QE Heavy.

"The market is a process." - Ludwig von Mises, as related by Israel Kirzner.   "Capital formation is a beautiful thing" - Chloe732.

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