Why QE2 Failed: The Money All Went Offshore

On June 30, QE2 ended with a whimper. The Fed’s second round of “quantitative easing” involved $600 billion created with a computer keystroke for the purchase of long-term government bonds. But the government never actually got the money, which went straight into the reserve accounts of banks, where it still sits today. Worse, it went into the reserve accounts of FOREIGN banks, on which the Federal Reserve is now paying 0.25% interest.

Before QE2 there was QE1, in which the Fed bought $1.25 trillion in mortgage-backed securities from the banks. This money too remains in bank reserve accounts collecting interest and dust. The Fed reports that the accumulated excess reserves of depository institutions now total nearly $1.6 trillion.

Interestingly, $1.6 trillion is also the size of the federal deficit – a deficit so large that some members of Congress are threatening to force a default on the national debt if it isn’t corrected soon.

So here we have the anomalous situation of a $1.6 trillion hole in the federal budget, and $1.6 trillion created by the Fed that is now sitting idle in bank reserve accounts. If the intent of “quantitative easing” was to stimulate the economy, it might have worked better if the money earmarked for the purchase of Treasuries had been delivered directly to the Treasury. That was actually how it was done before 1935, when the law was changed to require private bond dealers to be cut into the deal.

The one thing QE2 did for the taxpayers was to reduce the interest tab on the federal debt. The long-term bonds the Fed bought on the open market are now effectively interest-free to the government, since the Fed rebates its profits to the Treasury after deducting its costs.

But QE2 has not helped the anemic local credit market, on which smaller businesses rely; and it is these businesses that are largely responsible for creating new jobs. In a June 30 article in the Wall Street Journal titled “Smaller Businesses Seeking Loans Still Come Up Empty,” Emily Maltby reported that business owners rank access to capital as the most important issue facing them today; and only 17% of smaller businesses said they were able to land needed bank financing.

How QE2 Wound Up in Foreign Banks

Before the Banking Act of 1935, the government was able to borrow directly from its own central bank. Other countries followed that policy as well, including Canada, Australia, and New Zealand; and they prospered as a result. After 1935, however, if the U.S. central bank wanted to buy government securities, it had to purchase them from private banks on the “open market.” Former Fed Chairman Marinner Eccles wrote in support of an act to remove that requirement that it was intended to keep politicians from spending too much. But all the law succeeded in doing was to give the bond-dealer banks a cut as middlemen.

Worse, it caused the Fed to lose control of where the money went. Rather than buying more bonds from the Treasury, the banks that got the cash could just sit on it or use it for their own purposes; and that is apparently what is happening today.

In carrying out its QE2 purchases, the Fed had to follow standard operating procedure for “open market operations”: it took secret bids from the 20 “primary dealers” authorized to sell securities to the Fed and accepted the best offers. The problem was that 12 of these dealers – or over half — are U.S.-based branches of foreign banks (including BNP Paribas, Barclays, Credit Suisse, Deutsche Bank, HSBC, UBS and others); and they evidently won the bids.

The fact that foreign banks got the money was established in a June 12 post on Zero Hedge by Tyler Durden (a pseudonym), who compared two charts: the total cash holdings of foreign-related banks in the U.S., using weekly Federal Reserve data; and the total reserve balances held at Federal Reserve banks, from the Fed’s statement ending the week of June 1. The charts showed that after November 3, 2010, when QE2 operations began, total bank reserves increased by $610 billion. Foreign bank cash reserves increased in lock step, by $630 billion — or more than the entire QE2.

In a June 27 blog, John Mason, Professor of Finance at Penn State University and a former senior economist at the Federal Reserve, wrote:

In essence, it appears as if much of the monetary stimulus generated by the Federal Reserve System went into the Eurodollar market. This is all part of the “Carry Trade” as foreign branches of an American bank could borrow dollars from the “home” bank creating a Eurodollar deposit. . . .

Cash assets at the smaller [U.S.] banks remained relatively flat . . . . Thus, the reserves the Fed was pumping into the banking system were not going into the smaller banks. . . .[B]usiness loans continue to “tank” at the smaller banking institutions. . . .

The real lending by commercial banks is not taking place in the United States. The lending is taking place off-shore, underwritten by the Federal Reserve System and this is doing little or nothing to help the American economy grow.

Tyler Durden concluded:

. . . [T]he only beneficiary of the reserves generated were US-based branches of foreign banks (which in turn turned around and funnelled the cash back to their domestic branches), a shocking finding which explains . . . why US banks have been unwilling and, far more importantly, unable to lend out these reserves . . . .

. . . [T]he data above proves beyond a reasonable doubt why there has been no excess lending by US banks to US borrowers: none of the cash ever even made it to US banks! . . . This also resolves the mystery of the broken money multiplier and why the velocity of money has imploded.

Well, not exactly. The fact that the QE2 money all wound up in foreign banks is a shocking finding, but it doesn’t seem to be the reason banks aren’t lending. There were already $1 trillion in excess reserves sitting idle in U.S. reserve accounts, not counting the $600 billion from QE2.

According to Scott Fullwiler, Associate Professor of Economics at Wartburg College, the money multiplier model is not just broken but is obsolete. Banks do not lend based on what they have in reserve. They can borrow reserves as needed after making loans. Whether banks will lend depends rather on (a) whether they have creditworthy borrowers, (b) whether they have sufficient capital to satisfy the capital requirement, and (c) the cost of funds – meaning the cost to the bank of borrowing to meet the reserve requirement, either from depositors or from other banks or from the Federal Reserve.

Setting Things Right

Whatever is responsible for causing the local credit crunch, trillions of dollars thrown at Wall Street by Congress and the Fed haven’t fixed the problem. It may be time for local governments to take matters into their own hands. While we wait for federal lawmakers to get it right, local credit markets can be revitalized by establishing state-owned banks, on the model of the Bank of North Dakota (BND). The BND services the liquidity needs of local banks and keeps credit flowing in the state. For more information, see here and here.

Concerning the gaping federal deficit, Congressman Ron Paul has an excellent idea: have the Fed simply write off the federal securities purchased with funds created in its quantitative easing programs. No creditors would be harmed, since the money was generated out of thin air with a computer keystroke in the first place. The government would just be canceling a debt to itself and saving the interest.

As for “quantitative easing,” if the intent is to stimulate the economy, the money needs to go directly into the purchase of goods and services, stimulating “demand.” If it goes onto the balance sheets of banks, it may stop there or go into speculation rather than local lending — as is happening now. Money that goes directly to the government, on the other hand, will be spent on goods and services in the real economy, creating much-needed jobs, generating demand, and rebuilding the tax base. To make sure the money gets there, the 1935 law forbidding the Fed to buy Treasuries directly from the Treasury needs to be repealed.

___________________

Ellen Brown is an attorney and president of the Public Banking Institute, http://PublicBankingInstitute.org. In Web of Debt, her latest of eleven books, she shows how the power to create money has been usurped from the people, and how we can get it back. Her websites are http://webofdebt.com and http://ellenbrown.com.

30 Responses

  1. [...] Why QE2 Failed: The Money All Went Offshore [...]

    • I just discovered your blog after reading article.
      We have to form public information, otherwise ppl or sheeple would be in darkness.
      The thought, that we a governed by computer program is fascinating.

  2. “Interestingly, $1.6 trillion is also the size of the federal deficit – a deficit so large that some members of Congress are threatening to force a default on the national debt if it isn’t corrected soon.”

    Deficit hysteria is a smokescreen for the oligarghs and their mercenaries in media and political sectors to plunder the public resources of working people in Europe and America as they have long done in Africa, Asia and Latin America.

    The majority of newly independent nation-states in what is derisively termed the “third world” started out with full control of their resources, vibrant public sectors (universities, utilities, communications, airlines, manufacturing, hospitals & schools) and the ability to feed themselves.

    In some countries, the leaders were seduced into odious debt to the IMF/World Bank complex and were forced to sell off their public assets to foreign interests, sell their resources for pennies and import food that they were capable of providing for themselves. In other countries, leaders that wouldn’t play ball were simply assassinated and replaced by puppets who were willing to destroy the lives of their fellow citizens for a cut of the action.

    Now, those same forces are bent on destroying the public institutions of the US and Europe. We don’t have a deficit problem, we have a plunder problem. The Greeks are resisting plunder. Will the American people also resist plunder?

  3. Regarding the bonds that the Fed bought from the banks; doesn’t that mean that the Fed are now sitting on $1.6 trillion worth of assets?

    Is the intention to sell these bonds back to private banks, as in the UK? Rather than writing them off, wouldn’t it be possible for the Fed to bank against this $1.6 trillion and invest in the real economy? It’s obvious that this printing of money to buy back bonds from the banks has not resulted in hyper-inflation, as some have predicted, therefore, can’t the Fed simply release funds on these assets ny simply banking against them?

    That’s assuming there would be any political will to do so, of course!

  4. I have a few reservation on this article.

    For example

    Ron Pauls suggestion seems pointless as it will not achieve anything. This is because the Fed’s profit is returned to the US treasury. And if the loss (due to this write off) is recognised by the Fed won’t this make matters worse as future profits will disappear (which means the treasury will be worse off).

    And this point

    “As for “quantitative easing,” if the intent is to stimulate the economy, the money needs to go directly into the purchase of goods and services, stimulating “demand.”

    QE2 has been used to indirectly finance the Govt deficit. So it is going almost directly into the purchase of goods and services ie Govt spending.

    I’m not sure what Ellen is recommending here. That Fed credit can be used like notes and coins and commercial bank credit in the real economy. If so I do not agree.

    And why is overseas banks owning US bonds or Fed Credit such a big issue. Surely if the US runs a trade deficit this will occur. They will either own bonds or Fed credit. Or something to back the good or services sold to the US.

    And in the current climate I think this is very justified

    “it was intended to keep politicians from spending too much”

  5. “It’s obvious that this printing of money to buy back bonds from the banks has not resulted in hyper-inflation”

    Central bank credit is not printing of money. Money in the real economy includes
    Notes and coins and
    COMMERCIAL bank credit

    Central bank credit can not be spent in the economy. It is an asset used by commercial banks to settle with one another. So all QE does is replace one liquid asset (Fed credit) with another one (Treasury Bonds).

    So of course it will not cause inflation. Govt deficits might but from a taxpayer point of view it is better to fund this indirectly with Fed credit than from non Govt owned commercial banks or the market.

    And if these bonds are sold back to the market. Two problems with this. One it will increase interest on Govt debt when it is already too high (as the interest payable will not be returned as Fed profits are). Secondly it just reverses the QE and does not make the commercial banks any stronger (as they would lose one liquid asset and just replace with another).

    Govt deficits have to be financed somehow. There is no way to prevent an assets being generated. Either notes and coins, Govt bonds or Fed credit. Because the suppliers of good or services will want something in exchange for these goods or services.

    • I was referring to the hysteria in some quarters that QE could cause hyper-inflation…something that obviously didn’t happen. QE was meant to recapitalise the banks in order for them to lend. There’s a sort of irony about the government creating money form thin air, interest free in order to get banks to lend to consumers and business at interest, don’t you think?

      As Ellen explains though, this largely hasn’t happened. The banks have largely invested in derivatives and such. Why wait a year or more for an investment to mature when you can get the same return in a couple of weeks?

      QE should be directly invested into the real economy rather than trying to get banks to lend.

      What my main point was, and I am unsure if it can actually be done, is instead of writing off the bomds purchased with QE and getting rid of a lot of government debt (not a bad idea, by the way) if the US Treasury is sitting on top of $1.6 trillion worth of assets, can they not simply bank against these assets and release money for gobernment investment that way?

      It’s about as likely as the Pope taking part in an Orange Order march, but would this be at all feasible?

      Incidently, government deficits do not necessarily cause high inflation. Countries like Germany, Japan and, yes, the US, ran huge deficits that only caused nominal inflation. In the UK, we ran national debts of 250% and 150% respectively (NOT during wartime) without inflation getting out of control. Curiously, the only time it did was when the national debt was cut to around 54% in the mid ’70s when it spiralled to over 15%

      • That should have been 105%, not 150%, sorry for the typo!

      • “QE was meant to recapitalise the banks in order for them to lend.”

        Was it? QE does not / should not recapitalise banks. It can either
        1 Improve a banks ST liquidity. By say issuing Fed credit for LT debt or
        2 Reduce Govt debt by exchanging Fed credit for Govt bonds

        In theory neither of these steps should improve the banks capital. (I think there is a major misunderstanding regarding what QE is and does)

        “QE should be directly invested into the real economy rather than trying to get banks to lend.”

        In fact it is if Govt bonds are exchanged for Fed credit. QE in effect uses Fed credit to fund Govt spending. This requires two steps

        1 Raise money from the market. As Fed credit can not be spend in the real economy
        2 Replace Govt bonds with Fed credit

        One way to recapitalise banks is to run Govt deficits. This creates a new assets (Govt bonds / Fed credit / notes and coins) to fund this expenditure. QE does or at least should not do this.

        Ellen’s articles are usually brilliant (as is her book). But she seems very confused with this article as I have noted above. (Unless someone can explain where my points are not correct.)

        • “Was it? QE does not / should not recapitalise banks”

          Of course it does! What do you think the government was doing it for in the first place? For the good of their health? This from the Bank of England:

          “In addition, banks will find themselves holding more reserves. That might
          lead them to boost their lending to consumers and businesses. So, once
          again, borrowing increases and so does spending. That said, if banks are

          concerned about their financial health, they may prefer to hold the extra
          reserves without expanding lending. For this reason, the Bank of England is
          buying most of the assets from the wider economy rather than the

          banks.”
          What happened in both the US and the UK was unprecedented. Money simply created by both governments on computer keyboards rather tha borrowing was used to buy bonds and securities back from the banks in order to get them to lend. Of course, all that has happened is that they either just sat on this money or spent it on derivatives and such in the finiancial markets looking for a fast buck. Asset prices were also pushed up. The hope was that the wealth would “trickle down” and get the economy moving. Of course, what was really needed was bottom up fiscal stimulus of the real economy, creating jobs and getting the economy moving that way so consumers would have the money to buy goods and services and pay down their debts. Corporations are sitting on mountains of cash, refusing to invest because there is bo demand. There is no demand because their is so much debt and there is so many out of work. Get the money into the real economy, get money circulating and you’re halfway there. Whether directly or indirectly, QE would be mych better servd gettibgthe real economy working.

          • The Fed does not just give credit to the banks without receiving something in return. They need something in exchange for this asset. (It is not just a free gift)

            Like this

            http://webofdebt.wordpress.com/2010/12/18/central-banking-101-what-the-fed-can-do-as-%E2%80%9Clender-of-last-resort%E2%80%9D/#more-985

            “What will they buy? They are limited to only federally insured paper, which includes Treasuries and mortgage-backed securities insured by Fannie Mae and Freddie Mac. But they are also allowed to buy short-term municipal bonds, and given the difficulties faced by state and local governments, this may well be the route they choose, at least for some of the quantitative easing. ”

            So from the commercial banks point of view they receive an asset (Fed credit) but must also record an equal liability. The banks capital position does not change.

            So I can not see how banks are so much better off. All QE does is reduces the interest burden on the taxpayer or provides liquidity for commercial banks (by converting LT debt into Fed credit).

            Trading banks make their profit from net interest less expenses less bad debt write off etc. But not from free gifts from the central banks.

  6. Seems reserves are being hoarded in order to offset the horrendous derivatives overhang that, like a black hole, threatens to suck the global economy into oblivion.

    Take the average criminal bank’s balance sheet, stuffed to the gills with PIIG bonds, CDS’s, tranches of worthless real estate, and other dodgy derivative assets, all worth pennnies to the dollar. How to cover this cesspool? Hoard the QE! And start buying gold, as much as ca be grubbed up, but on the sly…

    That is not only where the money went, but where it was intended to go. No mistake in any of this, all according to plan.

  7. Morgan Stanley is building at least 10 high rise buildings in Cebu, Philippines and all over asia. The Tiger will grow stronger in the next 20 years while we suffer.

  8. “Seems reserves are being hoarded in order to offset the horrendous derivatives overhang that, like a black hole, threatens to suck the global economy into oblivion.”

    Agree in part. These reserves are likely being hoarded (as you call it) out of necessity. Commercial banks need more capital now to support lending. These capital to lending ratios have now been tightened. Fed credit (and Govt bonds) form part of the banks capital.

    So after the rapid expansion of commercial bank credit when the fractional banking rules were removed. Banks are now building up their capital to support their previous lending. Nothing wrong with this and necessary to try and put banks back on a sound footing.

    The problem was the money supply expansion in the past. The issue now is how best to rectify the mess banks got themselves in after the fractional restrictions were removed or ignored.

  9. Is this hoarding of QEII a direct result of Basil III risk based banking reserve requirements, the pending default of the PIIGS bond issues held by the banks, and the CDS and other such derivatives in play?

    If providing liquidity and the associated money velocity into the economy is the goal, why does the government even need to create bonds that are than only captured and hoarded by the banking system? Granted, the government is getting dollars in that exchange to fund operations. The government could stop borrowing those dollars, create it’s own and spend those directly into the economy as Pennsylvania did in colonial times under Ben Franklin’s direction. There would be no problem with the government debt ceiling were that the case. There is no more moral hazard with that arrangement than there is with the current arrangement. There is no interest burden to be extracted from the populace in the form of income taxes either.

    Plus, if the government were really that interested in having liquidity provided to small business, they would change the banking reserve requirements to include such loans as reserve requirements.

    It’s almost like the globalist bankers have ultimate control of the global human consumption and natural resource burn rate with the present restraints evident.

    • Yes, control and plunder are the ultimate objectives.

  10. “Congressman Ron Paul has an excellent idea: have the Fed simply write off the federal securities purchased with funds created in its quantitative easing programs. No creditors would be harmed, since the money was generated out of thin air with a computer keystroke in the first place. The government would just be canceling a debt to itself and saving the interest.”

    The government can’t simply “have the Fed” do what it wants, not without voiding it’s fundamental independence. Not that I’m against properly nationalizing it, but I am against wishy-washy muddling on.

    I may be wrong, but my best guess is that the FED now returns its profits to the government “voluntarily” (at law). Or is there a statute I missed somewhere?

    Given this payback of FED profits annually, there’s no prompt gain from Ron Paul’s suggestion, and I fail to fathom it’s logical basis. True, it would avoid having that much debt to roll over again, when the treasuries mature, but that’s not for several years.

    My deficit proposal — to make Social Security payments with new issues of U.S. notes, de facto converting the trust’s treasuries directly into money — requires merely that Congress authorize the “printing”. It does not impose any decision or restructuring on the FED, nor does it impose inflation. It could be logical for the FED to draw down its balance sheet in parallel, but that decision would remain the FED’s bailliwick.

  11. i believe things can be fixed if we really wanted to

  12. [...] Why QE2 Failed: The Money All Went Offshore [...]

  13. [...] any case, as noted in an earlier article, the excess reserves from the QE2 funds have accumulated in foreign rather than domestic banks. [...]

  14. [...] any case, as noted in an earlier article, the excess reserves from the QE2 funds have accumulated in foreign rather than domestic banks. [...]

  15. [...] any case, as noted in an earlier article, the excess reserves from the QE2 funds have accumulated in foreign rather than domestic banks. [...]

  16. [...] any case, as noted in an earlier article, the excess reserves from the QE2 funds have accumulated in foreign rather than domestic [...]

  17. [...] any case, as noted in an earlier article, the excess reserves from the QE2 funds have accumulated in foreign rather than domestic [...]

  18. [...] Tina B. suggeted this by Ellen Brown: Why QE2 Failed: The Money All Went Offshore [...]

  19. [...] [...]

  20. [...] any case, as noted in an earlier article, the excess reserves from the QE2 funds have accumulated in foreign rather than domestic banks. [...]

  21. [...] any case, as noted in an earlier article, the excess reserves from the QE2 funds have accumulated in foreign rather than domestic banks.  [...]

  22. [...] any case, as noted in an earlier article, the excess reserves from the QE2 funds have accumulated in foreign rather than domestic banks. [...]

  23. [...] any case, as noted in an earlier article, the excess reserves from the QE2 funds have accumulated in foreign rather than domestic banks. [...]

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