Why Unwinding QE Won’t Matter

Ashwin Parameswaran nails it once again. If you want to understand how the modern financial/monetary system actually works, run don’t walk to read this post.

His key insight:

Just as the East India Company could access cash on the back of their government bond holdings in the 18th century, any pension fund, insurer or bank can do the same today.

Let me translate that into my words:

If the CB unwinds QE by trading bonds for “money,” “sopping up” “cash” (those are all “so-called” quotes) from the private sector, the private bond-holders can just use those bonds as collateral to get (new) cash loans. Commercial and shadow banks will create (“counterfeit”) the new money under (explicit or implicit) license from the central bank, and deposit the money into the bondholders’ accounts.

Result: roughly the same amount of “cash” in the system.

In other words:

…the private sector can monetize the deficit as effectively as the central bank can.


…the reversal of QE, if and when it happens, will have no impact on economy-wide access to cash/purchasing power.

Update, 08:30 PST: This also serves to explain why QE may not have had as much effect as one might hope. The Fed gave bondholders cash in return for their bonds, so bondholders ended up with more cash but less collaterizable/monetizable/convertible-to-cash bonds. A wash?

Discuss. (But not until you’ve read Ashwin’s whole piece [at least once].)

Cross-posted at Angry Bear.