Where does the Federal Reserve find the money for QE3 and the purchase of mortgage back securities (MBS) and why is hyperinflation not occurring?
Have you ever given thought to where the $40 Billion to $80 Billion a month comes from to pay for the Fed’s purchase of securities? Obviously we don’t have the cash on hand, so are they selling other securities to raise the cash needed for these monthly purchases?
The answer is simple. The money is literally being created out of thin air.
The Fed is simply crediting the amounts due to Fannie Mae, Freddie Mac, and the other GSEs and in return the Fed becomes owner of the mortgage back securities.
QE3 does have some positive points as it has provided liquidity to the mortgage market, but at this point, it really does need to be wound down. MBS should be purchased by the private and institutional sector, not by the Fed or the Federal government – especially with money that is essentially printed.
Sales of MBS in the non-agency jumbo sector have already been a success. The market is ready to purchase these securitized assets and the Fed should really begin to step aside, or at the minimum offer for sale some of the allocations it already holds.
So far inflation has not been a threat, but for reasons artificial. The Fed has accomplished this by paying interest on “Excess Reserves” that banks hold. This essentially pulls liquidity out of the market and counterbalances the artificial injection into the monetary supply from the Fed’s purchase of MBS using “newly created” money. Banks are more compelled to simply hold the money on their balance sheets as excess reserves rather than lend. The bank gets a guaranteed return on their deposited assets / reserves and Fed keeps the extra money off the street.
To a certain degree however we are creating a house of cards. As the economy improves and interest rates rise, the Fed will be forced to pay higher and higher rates to keep these excess reserves on balance sheets and out of the M2 money supply. Currently interest is being paid to member banks at just 0.25%, as this rate of return is generally better than what a bank would obtain by over night interbank lending to another bank – thus the money stay locked up.
So as the Fed spends more “printed money,” more money is locked up in these excess reserves. At some point however, it will be more advantageous for banks to lend the money and thus achieve a better return – at this point the amount of M2 and M1 will explode, perhaps triple. Is hyperinflation in our future?
Lastly, to illustrate the dramatic rise. From 1960 to 2007, the most held as excess reserves was $1.5B. In 2008, when the Fed started paying interest on these excess reserves the number climbed to $10B at the end of August 2008, $880B by January 2009, and finally, by October 2013, today. That numbers stands at $2.3 Trillion.
Houston, I think we’ve got a problem..