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QE, MMT, And Inflation/Deflation

May 06, 2020 10:12 AM ETBND, EEM, EFA, GLD, IWM, QQQ, SPY, TLT378 Comments


  • An overview of how QE works and whether that money makes it to the public or not, and under what conditions.
  • A look at the underlying deflationary trends that are in place, as well as the inflationary responses from fiscal and monetary authorities.
  • Some catalysts to look for as it pertains to the disinflation-to-inflation trend change.
  • Looking for a helping hand in the market? Members of Stock Waves get exclusive ideas and guidance to navigate any climate. Get started today »

Quantitative easing (QE) occurs when central banks, such as the U.S. Federal Reserve, create new money to buy government bonds or other securities.

Some people fear that it will cause high inflation or even hyper-inflation and that it is essentially money-printing, while others suggest that it has no impact on inflation because the money that is newly-created or "printed" gets locked away in bank reserves rather than ever making it to Main Street (a term for the broad public), or that the printed money is otherwise offset by deflationary forces of debt and demographics.

Based on history and math, the inflationary side of the argument is eventually correct, but with a lot of nuance along the way.

I've received tons of emails and comments in the past few months from people that want research on this topic, to provide a model to think about the deflationary forces of debt and the inflationary forces of unprecedented fiscal and monetary response policies.

One thing I've noticed is that the inflation/deflation debate tends to concentrate into the extremes of crippling deflation or hyper-inflation. What about moderate or high inflation as a possible outcome in the years ahead? And how about some actual numbers to see how we get to different possible outcomes, rather than just claims of deflation forever, or hyper-inflation just around the corner?

This article discusses quantitative easing "QE", Modern Monetary Theory "MMT", and inflation/deflation, and how they link together.

The first part provides several examples of government financing, to walk through differences in money flow in a QE or non-QE environment, to tease out what the impacts are and show how some of that QE money does make it to Main Street (not just locked in reserves), despite some claims to the contrary.

The second part dives into numbers about

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This article was written by

Lyn Alden Schwartzer profile picture

Lyn Alden has a background in engineering and engineering management, and since 2016 has provided research with a systems engineering focus into macroeconomics, energy markets, stock opportunities, and digital assets.

She serves as the fundamental analysis contributor to the investing group Stock Waves, which seeks to find market opportunities where the fundamentals and technicals align. Features of the service: daily technical analysis, multiple videos weekly with chart analysis, fundamental analysis, 2 deep dives on specific stocks monthly, and a vibrant chatroom for discussion. Learn More.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (378)

US Investor profile picture
Phenomenal job. One of the best articles I’ve read in a long time.
This is an amazing article and Lyn is to be much commended. Since the virus struck, I've had plenty of time to try to figure out what is going on in the economy, with the massive increase in the national debt, interest rates apparently stuck at zero (or worse) for the foreseeable future, and a stock market apparently disconnected from the real economy. What does our economic future hold, and how do we invest in it? In the course of my studies I kept reading conclusory statements such as "the US will have to inflate itself out of the debt", but I couldn't find any article that explained what that meant. Until this article, which is indeed the "gold standard" of what clear writing should be. Thanks for all your efforts writing this incredibly educational piece (including the entertaining mild sarcasm therein). I will return to my private island now and feed the tigers.
willsmit1 profile picture
Hi Lyn,
I thought this was a very good article, in fact I consider it the gold standard of articles on MMT. It was impressive that the originator of MMT came looking for you here to see for himself what you were up to, it's proof positive that your views are an authority on Wall Street now. I feel that you are among the best (maybe THE best) at what you do. Wouldn't be a surprise to hear that you've taken up some huge position in the USA. Whatever, hold out for the best dollars, I only hope that if you become say Secretary of the Treasury it will not be under some left wing government! Anyway it would be fun know that I discovered you online before you became the Treasury Secretary!. All the best,
Heartily concur. 😊
Salmo trutta profile picture
She's the most literate.
So does new money created via QE replace money that was available through credit? I.e as credit markets tighten, that shortfall is compensated for by the Fed?
Thank you for a very educational treatise.

Question: Since the US population has increased (~doubled) since WWII, shouldn't the amount of money in the system have increased at least proportionally? Perhaps measures such as $M2/person and GDP/person and $Fed-liability/person would be appropriate to describe the current economic state.

The amount of gold has been pretty static (relative to population growth), but money creation via QE has not.
Dollars extant must be hugely multiplied, way beyond population. And there is more gold, how much, I wonder? If you are serious, you might provide some numbers.
Lyn Alden Schwartzer profile picture
M2 grew much faster than population, and has accelerated over the past decade.

I track a gold-vs-m2-per-capita chart regularly. Here's an article on it:
Lake OZ boater profile picture
M2 cannot be looked at in a vacuum. We also have to look at money velocity. It is declining, and that's why we don't see much effect on the inflation rate.


The "real" interest rates drive gold prices. See Gibson's Paradox.
Honus profile picture
Fantastic work as always Lyn. The subscription to your service is some of the easiest and most fruitful money we spend all year.
Bhughes7918 profile picture
this bank is rock solid!

Comments400 | Following
Author’s reply » Fauquier Bankshares' regulatory capital ratios continue to be deemed "Well Capitalized," the highest category assigned by the Federal Deposit Insurance Corporation (FDIC). At September 30, 2008, the Company's leverage ratio was 9.38%, compared with 9.35% one year earlier, and its total risk-based capital ratio was 13.13% compared with 12.71% at the same respective dates.
"With our level of capital strength, we can continue to extend credit and execute our growth strategies, including the building of new branch locations," said Randy Ferrell, Fauquier President and CEO. "While we are seeing some increase in our non-performing loans, it has been commensurate with the current economic conditions and continues to compare favorably with our bank peers. Our conservative principles have kept us away from the sub-prime mortgage and other high-risk lending activities that are making headlines recently."
Fauquier reported the following performance strength indicators for the quarter ended September 30, 2008:
-- Net interest income before the loan loss provision for the third quarter of 2008 increased by 5.2% compared with the same quarter in 2007.
-- Net interest margin of 4.10% was slightly higher in the third quarter versus the same period in 2007.
-- Total deposits grew $17.4 million or 4.5% from June 30, 2008.
-- Charge-offs, net of recoveries, for the third quarter of 2008 was $66,000 compared with $114,000 for the same quarter in 2007.
Ferrell said, "The primary mission of The Fauquier Bank is to provide our community with the financial products and services that they need during both good times and difficult times. We continue to make loans available to our community as we have done during our 106 year history, and our management and Board are confident that we can continue to do so without requiring government support.
Bhughes7918 profile picture
Insiders buying small bank stocks like crazy the past 2 months the most in years over 100 of these banks are buying shares in force.
We hedged a few of the big banks like WFC again at the open today but covered at the close with the huge sell-off.
Today we added heavy FBSS at $12.75 , cheap, smart old bankers, nice yield 4%+, good markets, good asset quality. Trades plenty some days. Over 110,000 shares left on their buyback, they should buy it soon. They own most of their locations as well, maybe some hidden value there also.
NWIN added a few shares under $30. Insiders have also been buying, many of them.
FFIC all in Friday under $10 add heavy, cheap. We sold this one today for a nice flip today.
Insiders are also buying at GCBC and CHMG as well as at least 50 other banks this past month the most in a long -time, we, however, would stay cautious on most.
The market moves to fast today for most small bank traders but the reward is there if you have the money and time.
We also sold 10% of OPY today to get it off margin, after the huge run the past 4 days.
Most cash left is used for hedges, trading and going long names like NWIN and FBSS when we see size to buy, right now we can on both but that may change anyday, like it did on OPY.
TMP we may get back in under $55.
Crazy market stay nimble and safe.
This is the trading market of a lifetime for banks like these with the best risk- reward in a
If anyone can please clarify, I would appreciate it. I am following an intriguing analyst that talks about how QE is deflationary, which seems empirically to be the case. Money "recycled" by getting investors to buy US treasuries and thus have the government utilize it in a more ubiquitous way (not sat on and saved by that particular investor) should increase the money supply, at least a little bit. International investors buying treasuries should do it a little bit more (USD that wasn't in the US for a while, now is). But shouldn't the FED creating digital money and buying treasuries as the lender of last resort increase the money supply? This as opposed to just the monetary base, when they buy up all the bad debt which doesn't reach the supply, just increases the monetary base thus no inflation. Or is it that the other deflationary forces "beat out" all the other types of government spending (to old people via SS with low velocity, medicare or centralized DoD spending)? I ask because it just doesn't seem to be the case that inflation has kicked, and the CPI even went down last week. I see why QE is deflationary for multiple reasons given the mechanism, but I don't see why increasing debt by the government, especially with the Fed as lender of last resort, doesn't seem to --- it should go pretty directly into the "real economy." Thanks.
Lawrence J. Kramer profile picture
"But shouldn't the FED creating digital money and buying treasuries as the lender of last resort increase the money supply?"

The money supply is an INDICATOR of economic activity, not a cause of it. When people are in a spending mood, they sell assets to increase their cash balances, or they borrow, creating money in the process. Thus, the money supply increases BECAUSE people are spending, not vice versa.

The CARES program is about helicopter money, which the Government is providing by issuing bonds. Even if the Fed did nothing, that spending would be inflationary or not depending on the other forces at work in the economy. If the Fed did not act, however, people would anticipate tax increases to cover the interest, and that would be deflationary. By buying the bonds, the Fed relieves the Treasury of the interest burden, as the interest paid by the Treasury to the Fed is returned to the Treasury as "profit." Consequently, QE does what a tax increase would do, without the deflationary effect.

QE with respect to deficit spending avoids an explicit tax increase, but if the economy is running too hot, QE will increase the implicit tax of inflation. It's as if Congress passed a law imposing a variable income tax that only kicked in when the output gap (actual GDP minus potential GDP) was positive, i.e. when the economy was overheating. So, those who consider inflation a tax can take comfort in knowing that it is quite an elegant tax, one that only applies when it's needed, and only to the extent it is needed.
No comfort here.

"quite an elegant tax" I do not care about elegance. I care about taxation without representation. Revolutions come out of it.

"one that only applies when it's needed" who says when it is needed? And needed by whom?

As a child of the 60 and 70ies in Italy I have experienced first hand the devastating effect of inflation on the middle classes. The Red Brigades, terrorism, kidnappings, widespread misery and the internal splintering of the country came out of it and continued into the disastrous overreaction of the Berlusconi quasi-fascist debacle. It is all in front of us.

I follow the reasoning of Mr. Kramer, but in reality the various QE programs have saved the bacon of the top 10% and pushed more of the middle in the "financial uncertainty" category. 330 million people of which most do not have adequate health insurance (or any at all); half of the kids in school can't pay for school lunches and need weekend food to survive; private and public debt (owed to whom?) which is strangling the younger generations.

If that is what an elegant tax is supposed to do, then it has been spectacularly successful.

All done by a few people in the Fed who are NOT elected by the citizens and are not responsible to ANYBODY. While our elected representatives are great at protecting the interests of the 10%.

I am very skeptical of systems without a built-in regulation mechanism. Nature does not work that way. A parasite ends up dying when all its victims succumb.

The wash/rinse/repeat cycle after 2008 is enfolding before our eyes. The virus has painfully and clearly exposed the weaknesses of our system.

Great opportunity to examine the situation and make profound changes to address the real problems.

I do not see a chance of that happening.

Wash, rinse, repeat.

330 millions deserve much better.
Lawrence J. Kramer profile picture
" I do not care about elegance."

Only because you don't want to understand it. Congress passes spending bills, and Congress authorizes the Fed to do its thing. The inflation tax is a product of our representative democracy. It is announced policy, embraced by Fed chairs BEFORE they are appointed.

"...but in reality the various QE programs have saved the bacon of the top 10% and pushed more of the middle in the 'financial uncertainty' category."

Again, Congress is responsible for the precariat, not the Fed. Congress passed the CRA, and Congress passed the CFMA 2000, and Congress (and Pres. Clinton) created the budget surplus in the 1990's that enabled Wall St. to gin up pretend AAA-rated paper for our trading partners in the absence of Treasury issuance. Congress passed the Bush and Trump tax cuts, too, and the CARES act. QE is just the thunder to their lightning.

The political branches could have forbidden off-shoring of critical medical industries or sharing intellectual property with our enemies. The politicians, and, especially, consumers, preferred cheap Chinese goods to a more secure existence. You can't blame the Fed for that.

As Paul Volcker showed, the Fed is in the business of cleaning up the political branches' mistakes. Enough Fed governors are appointed by ELECTED politicians to make them answerable for results. If you don't like the results, vote for different politicians. Or become one yourself.
The article is likely the best forward looking macro view of what lies ahead not just in USA, but worldwide, as suddenly, the underlying problems facing the world are in many ways, it would seem, similar to those in USA: a dearth of jobs, sinking personal consumption, and to me the most poignant of them all, increasing widespread fear of the unknown, across all age groups.

For most of us, we are just unsure what to do to prepare ourselves for the terrible outlook ahead.
Thank you very much! I'd bet a lot of "financial heavy decisioner" and some central governor too, haven't clear ideas as you have. I'm following you.
Lyn definitely deserves to be a Federal Reserve Member or some
important post with Treasury. Wonder if there is a way to communicate
this to the government.
Very complex topics and although I can't say I followed everything 100% you did a very good job of explaining things and making it as easy to understand as possible.
Simply amazing!!!!!
Salmo trutta profile picture
@Lyn Alden Schwartzer re: “When banks ran out of cash to buy more Treasuries, the Federal Reserve printed up some digital cash and took their place as the primary accumulator of Treasuries” or “tangible example of the difference between borrowing from real lenders, and creating dollars to fund borrowing when real lenders are unavailable.”

Never are the commercial banks intermediaries in the savings-investment process. The Treasury hit the wall (September 2019 repo rate spike) when the level on the 10-Year Treasury Constant Maturity Rate (DGS10) @1.90% on 8/1/19 fell continuously below the level of the remuneration rate @2.10% (the FED’s credit control device). The FED should have drastically lowered the remuneration rate much earlier.
Salmo, couldn’t PDs (Primary Dealers), only being subsidiaries of depository institutions and as such cannot create money, have such a high inventory of Treasuries for which they borrowed (probably using repo), that their ability to borrow more to buy Treasuries be impaired?

I think this is what Ms. Schwartzer meant by ‘when banks ran out of cash…’
Salmo trutta profile picture
@CassDR re: "ran out of cash"

The degree of policy restraint and policy mix-up centers around the level of the remuneration rate vis-à-vis principally the short-end segment of the yield curve; wholesale and retail money market funding, in the borrow-short to lend-longer, liquidity risk and maturity transformation. The money market is differentiated by its position, basis the Daily Treasury Yield Curve’s umbrella (i.e., short-term borrowing and lending with original maturities from one year or less).

Lowering the remuneration rate on interbank demand deposits stimulates the flow of saving to the nonbanks (like lowering Regulation Q ceilings two times did in 1966 for just the commercial banks during the very first "credit crunch"). It increases the supply of loanable funds but not the supply of money. Contrariwise, a higher policy rate induces nonbank disintermediation (an outflow of funds or negative cash flow). This reduces the supply of loan funds. This was the case in Sept. 2019.

Think of it this way. The validity of the money multiplier as a predictive device was previously predicted on the assumption that the commercial banks will immediately expand credit and the money supply (invest in some type of earning asset), if they are supplied with additional excess reserves.

The inconsequential volume of excess reserves held by the member commercial banks during 1942 and Sept. 2008 provides documentary proof that they undoubtedly did.

In other words, without the alternative of remunerating excess reserve balances, it's virtually impossible for the CBs to engage in any type of activity (like buying governments) involving its own non-bank customers without changing the money stock.

After the introduction of the payment of interest on IBDDs, the DFIs obtained higher rates of return by accepting a riskless, policy floating/chasing (when the Fed raised rates), remuneration rate. The remuneration rate “inverted” the short-end segment of the wholesale funding yield curve (destroying money velocity).
Valued Rug profile picture
@Lyn Alden Schwartzer Could you answer my question below? Namely:

Does QE ultimately mean more money going to the rich, and if so, do you believe the current rally in stock prices is directly attributable to this fact?

See www.opendemocracy.net/...
The quick answer is that large entities (corporations, let's say) benefit, as they always do when ever expanding central governments make policies, for obvious reasons. They also have many more avenues available for them to lever, and not being individuals, they can be somewhat protected (bailouts, bankruptcies) at least in a more cushioned way if bad things have to occur. Financialization of the economy always does this, which is why you're asking the question. The only way the common or middle of the road guy can claim benefit is if his investments hold serve given a propped up market. But that will soon go away as well, when inflation sets in ... then volatility might, etc.
Lyn Alden Schwartzer profile picture
As the article describes, QE itself is just a mechanism to create dollars to buy securities. Who it benefits depends on what securities it is used to buy. The QE during the 2008-2014 period mainly benefited people who own assets. QE in 2020 is more widely-spread because it is funding helicopter money as well.
Valued Rug profile picture
@Lyn Alden Schwartzer Thanks for taking the time to reply.

Helicopter payments only allow Main Street folk to tread water though, right? They might be 'benefitting', but it won't feel like it. On the flipside, at least some of this stimulus will show up as a tangible 'bonus' for Wall Street, correct?

Ergo asset prices continue to rise. What am I missing here?
You aren't without a reason my favourite writer in SA.
A combination of knowledge and new understanding with suspence!!
I was anxious to reach the end, like a good book, but I couldn't go there very fast as I had to digest everything first. It took me some time to read it but it was worth it.
For quite sometime I was asking where does this go (FED's QE), is there an end what are the ramifications?
It is the first time I see someone to try and give a quantifiable answer.
Objectively with no ideologies involved.
Pls keep writing with this style (with a lot of explanations on finance terms that many of us are not familiar).
TheLongerView profile picture
Usual excellent quality by Lyn. However, there are several issues that I wish had been explored in more depth, which left me disappointed at the end of the article: 1) This money coming out of thin air has to go someplace. If not Main St, then where? The answer is financial instruments. That is what has been happening and will continue to happen. Junk bonds trading at very low yields and 100 year bonds being issued by Argentina are but a few examples, not to mention the Teslas of the world trading at ridiculous valuations. 2) Eventually creditors are going to wake up and realize that fiat money only works well when there is trust in the issuer. If that trust goes away (Egypt example), then the currency can rapidly lose value. The U.S. dollar's status as the world's reserve currency could be placed in serious jeopardy. Overall, I think we are in for a very bad time due to the current lack of trust in governments around the world. This lack of trust could very easily impact the entire global fiat currency structure, and lead to a run to the exits where hard assets (real estate, precious metals, commodities, etc) are the only thing that people are going to be comfortable using as a store of value. Is the U.S. dollar a good store of value over time? Is a 30 year U.S. Treasury bond paying 3% per year a good store of value? Is an Argentinian 100 year bond at any price? The point being that a global financial crisis could very well be just around the corner if people lose faith in fiat currencies. Psychology is a tricky thing. It can change very quickly. Most financial crises have come upon us by surprise, so while I agree with Lyn that we must build models and do our best to follow the numbers, there is the added element of surprise and sudden lack of faith which can explode very quickly in times of panic. Lyn, I am a math geek like you, but I am also an old guy who has seen the power of psychological panics. We are playing with fire, and run the risk of destroying people's faith in our currency as a reliable store of value. The entire fiat currency model is built on trust. Take that trust away and our entire financial system could collapse.
Have recent events changed any of your thoughts on portfolio positioning?
Lyn Alden Schwartzer profile picture
Overall no, but as the crisis hit I trimmed a few individual stocks and added others.

For example, when Carnival stock fell from $70 to $40 in the 2018-2019 timeframe, I became bullish in late 2019 in the $40's, even considering a potential recession. However, a pandemic and global shutdown of cruises changed the thesis so I had to exit the position.
Thanks, Lyn. Another excellent piece. Great perspective.
This is amazing. I was able to understand up to the part where you predict whether we will have inflation or deflation going forward, and then I got lost in the numbers. Perhaps this is not something that I could read and comprehend in one sitting...I will come back to this again.
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