The Cantillion Effect doesn't say the Fed did anything wrong but that the Fed's actions had a predictable disproportionate benefit to a particular stratum of the economy. It required appropriate fiscal and tax policies to offset the unfairness inherent in the Fed's action. To ignore the unfairness was and remains the public policy malpractice.
When Covid lockdown struck last March, the world economy screeched to a halt, right? What is the Fed supposed to do, when the credit market froze, stock market collapsed and the economic activity pretty much ground to a halt ? Sit on the side lines, saying we don't want to help people with assets(stock/real estate) or the institutions that facilitate the distribution of printed money and let the world plunge into the worst depression in recent history? It is easy for armchair economists like you to criticize the Fed for the emergency measures they had to take to prevent a cataclysmic collapse of world economy. Stimulus checks not helping argument, what is the Fed supposed to do? The congress and the President passed it, as quickly as the process allows. Although this theory sounds reasonable, you have to caveat it with the circumstances which forced the Fed and the federal government to act the way they did. They didn't do it deliberately to hurt the poor and further enrich the rich.
Most of the comments here are misclassifying how the Fed posts QE to its books. When the Fed buys assets, like Treasuries, the offsetting balance sheet entry is “Cash” - currency in circulation. Throughout all of QE the Fed instead posted the offsetting liability to “Reserves”. I was taught in business school that reserves were the free cash distributed across the banking system that resulted from activities of depositors. A bottoms up phenomenon.
We have to look at the other counterparty to the transaction to understand the full impact and strategy of the Fed and its Cantillon effect. The counterparty? Member banks in the Fed. Specifically the Top 20 banks which control the vast majority of deposits. The Fed is not a government agency, but a private venture - a consortium of member banks.
Reserves are assets to member banks. Member banks earn interest on their reserves. Their reserves are assets that cost them ZERO! Every penny of QE fell to the bottom line of member banks as bank equity, not money supply. Banks have been loath to lend this money except to buy Treasuries. This money was their “get out of jail free” card as it boosted their capital to be able to pass any stress test.
The proximity benefit is clear. US banks were recapitalized by QE. No effort. No new shareholders. No public bailouts, but a private sweeping of the problem under the rug. Reserves held by member banks are not inflationary in and of themselves. Banks must make loans using that fresh equity, which in large part did not happen.
It is becoming clear that most banks chose the path of least resistance: buying long-dates Treasuries. So complacent were some that maturity insurance via swaps was not employed, hence the embedded MTM losses.
Equating QE as money creation is not accurate. QE was much more nuanced and targeted, and sadly under the control of banks who cause the 2008/2009 crisis.
Allowing QE assets to roll off the books of the Fed has another impact other than taking liquidity out of circulation. A shrinking reserve posting on the Fed balance sheet also shrinks banks reserves and the associated “free” equity. What other business has the luxury of getting equity investment where one’s equity investor (the Fed) pays the business for the pleasure of investing?
How banks screwed up a free lunch is beyond me, but they did. Lemmings. Does not bode well for the future!
Your take is interesting, but I don't think your line of reasoning holds up in this case. The reason is that QE-style Federal Reserve operations don't "create money" the way most people seem to think it does. Cullen Roche at Pragmatic Capitalism has written entire books on how this works, but explains it very clearly and concisely on his blog too. On the other hand, the stimulus checks, which were funded through government deficits which was immediately purchased by the Federal Reserve, DOES "create money" in the meaningful sense that there is net purchasing power created that did not exist before. Cullen correctly predicted that the multiple rounds of QE would NOT cause inflation, and was proven correct. He also predicted that the stimulus WOULD create inflation, although he also argued that it was still the correct thing to do and worth it. So if the QE-style operations aren't actually "creating money", there isn't anything for the rich to be indirectly benefiting from, at least along your lines of reasoning using the Cantillon Effect. I do actually think QE operations primarily benefit the rich, but through a different and less direct mechanism.
Very insightful commentary. The challenge we have is that they are such few tools to help those at the bottom of the pyramid. The most potent tool, the fed have is quantitative easing which creates assets inflation. The people at the bottom however are also asset poor. Maybe a better way to get cash to those who need it most. A digital currency which we can distribute directly to people based on tax returns etc maybe a good idea. What else ?
Hi Sahil, could you please explain the sentence 'The Federal Reserve's escalating asset purchases have an injection point at the top.' along with an example?
I think you missed the mark here. Proximity certainly matters, that's clear. The comparison to the Covid response methods misses the fact that the FED buying a bond doesn't hand out wealth, it takes a bond out of a rich person's hand and gives them cash instead. A stimulus check is a direct gift, analogous to your island story. So the quick spender was the stimulus check recipient, not the bond seller that simply changed their form of wealth storage. Maybe the rich bought assets more quickly with their transformed wealth medium, but the masses bought goods and drove the inflation.
The Cantillion Effect doesn't say the Fed did anything wrong but that the Fed's actions had a predictable disproportionate benefit to a particular stratum of the economy. It required appropriate fiscal and tax policies to offset the unfairness inherent in the Fed's action. To ignore the unfairness was and remains the public policy malpractice.
When Covid lockdown struck last March, the world economy screeched to a halt, right? What is the Fed supposed to do, when the credit market froze, stock market collapsed and the economic activity pretty much ground to a halt ? Sit on the side lines, saying we don't want to help people with assets(stock/real estate) or the institutions that facilitate the distribution of printed money and let the world plunge into the worst depression in recent history? It is easy for armchair economists like you to criticize the Fed for the emergency measures they had to take to prevent a cataclysmic collapse of world economy. Stimulus checks not helping argument, what is the Fed supposed to do? The congress and the President passed it, as quickly as the process allows. Although this theory sounds reasonable, you have to caveat it with the circumstances which forced the Fed and the federal government to act the way they did. They didn't do it deliberately to hurt the poor and further enrich the rich.
Thank you
How would this relate to bitcoin ?
How can we get close to the source 😀?
I think we are all at the
same distance in this one
Most of the comments here are misclassifying how the Fed posts QE to its books. When the Fed buys assets, like Treasuries, the offsetting balance sheet entry is “Cash” - currency in circulation. Throughout all of QE the Fed instead posted the offsetting liability to “Reserves”. I was taught in business school that reserves were the free cash distributed across the banking system that resulted from activities of depositors. A bottoms up phenomenon.
We have to look at the other counterparty to the transaction to understand the full impact and strategy of the Fed and its Cantillon effect. The counterparty? Member banks in the Fed. Specifically the Top 20 banks which control the vast majority of deposits. The Fed is not a government agency, but a private venture - a consortium of member banks.
Reserves are assets to member banks. Member banks earn interest on their reserves. Their reserves are assets that cost them ZERO! Every penny of QE fell to the bottom line of member banks as bank equity, not money supply. Banks have been loath to lend this money except to buy Treasuries. This money was their “get out of jail free” card as it boosted their capital to be able to pass any stress test.
The proximity benefit is clear. US banks were recapitalized by QE. No effort. No new shareholders. No public bailouts, but a private sweeping of the problem under the rug. Reserves held by member banks are not inflationary in and of themselves. Banks must make loans using that fresh equity, which in large part did not happen.
It is becoming clear that most banks chose the path of least resistance: buying long-dates Treasuries. So complacent were some that maturity insurance via swaps was not employed, hence the embedded MTM losses.
Equating QE as money creation is not accurate. QE was much more nuanced and targeted, and sadly under the control of banks who cause the 2008/2009 crisis.
Allowing QE assets to roll off the books of the Fed has another impact other than taking liquidity out of circulation. A shrinking reserve posting on the Fed balance sheet also shrinks banks reserves and the associated “free” equity. What other business has the luxury of getting equity investment where one’s equity investor (the Fed) pays the business for the pleasure of investing?
How banks screwed up a free lunch is beyond me, but they did. Lemmings. Does not bode well for the future!
Counter quetion: How does this conflict with Peter Turchin's Elite Overproduction problem?
Your take is interesting, but I don't think your line of reasoning holds up in this case. The reason is that QE-style Federal Reserve operations don't "create money" the way most people seem to think it does. Cullen Roche at Pragmatic Capitalism has written entire books on how this works, but explains it very clearly and concisely on his blog too. On the other hand, the stimulus checks, which were funded through government deficits which was immediately purchased by the Federal Reserve, DOES "create money" in the meaningful sense that there is net purchasing power created that did not exist before. Cullen correctly predicted that the multiple rounds of QE would NOT cause inflation, and was proven correct. He also predicted that the stimulus WOULD create inflation, although he also argued that it was still the correct thing to do and worth it. So if the QE-style operations aren't actually "creating money", there isn't anything for the rich to be indirectly benefiting from, at least along your lines of reasoning using the Cantillon Effect. I do actually think QE operations primarily benefit the rich, but through a different and less direct mechanism.
Very insightful commentary. The challenge we have is that they are such few tools to help those at the bottom of the pyramid. The most potent tool, the fed have is quantitative easing which creates assets inflation. The people at the bottom however are also asset poor. Maybe a better way to get cash to those who need it most. A digital currency which we can distribute directly to people based on tax returns etc maybe a good idea. What else ?
Hi Sahil, could you please explain the sentence 'The Federal Reserve's escalating asset purchases have an injection point at the top.' along with an example?
Thanks in advance
I think you missed the mark here. Proximity certainly matters, that's clear. The comparison to the Covid response methods misses the fact that the FED buying a bond doesn't hand out wealth, it takes a bond out of a rich person's hand and gives them cash instead. A stimulus check is a direct gift, analogous to your island story. So the quick spender was the stimulus check recipient, not the bond seller that simply changed their form of wealth storage. Maybe the rich bought assets more quickly with their transformed wealth medium, but the masses bought goods and drove the inflation.
Depressing!
At first glance I ask "How do we help the most people elevate their income" but I don't think that's enough.
Would love to hear your thoughts on what YOU think would help solve the growing wealth gap. There may be no right answer, but still interested.
Thanks for the great post! Love your stuff