The Investment Scientist

Archive for June 2020

40397946-close-up-view-of-cash-money-dollars-bills-in-amount.jpg“Since the beginning of March, the Fed’s balance sheet has expanded by just over $3 trillion, with the bulk of it from central bank purchases of Treasuries and agency mortgage-backed securities.” This is a quote from a MarketWatch news piece titled “Fed’s Daly Defends $3 trillion in Asset Purchases …”

After my last newsletter article, you should understand that balance sheet expansion is just an economic jargon of money creation. Today I am going to give you three reasons why the Fed needed to “print” money to prevent a Great Depression scenario.

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Investor-Optimism-Fueling-Corporate-Bond-GainsThree days ago, the Fed announced that they will go directly to the corporate bond market to purchase $250 billion worth of investment-grade corporate bonds. A few of my newsletter readers asked me to comment on this, so here I am.

Basically, the Fed buying $250 billion of any securities can be seen as the Fed creating $250 billion of new money and injecting it into the economy. It really doesn’t matter whether these securities are treasury bonds, munis or corporate bonds. Munis are bonds issued by states.

So how does the Fed create new money?
The classical monetary theory posits that paper money must be backed by something valuable. Since 1974, the US dollar has no longer been backed by gold. For a long time (until 2008) it was backed by US treasuries. The Fed has a balance sheet. Let’s say by 2008, the economy needed $3 trillion to function. The Fed would create $3 trillion out of thin air and use the money to buy $3 trillion worth of treasuries. The Fed balance sheet would look like this : on the assets side, it shows $3 trillion of US treasuries, on the liabilities side, $3 trillion issued. Now the money is no longer considered to be out of thin air, since it is backed by treasuries that carry the explicit guarantee of the US federal government.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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