Dear John: I am a regular reader of your articles in The Post. In your Nov. 13 article entitled, “Is it possible to kill QE painlessly?” you stated something that I have heard in other forums as well but do not quite understand.
What I am speaking of is the idea that if the Federal Reserve holds the securities on its balance sheet until maturity, this somehow alleviates the difficulty for the Fed in terms of managing the reduction of its balance sheet.
For the moment, let’s focus on Treasuries securities. As you know, when the Fed buys Treasuries, it creates money to execute the actual purchase in the hope that the excess liquidity/reserves will eventually be put to work in the economy in some growth-related fashion.
Conversely, when the Fed sells an asset like a Treasury security, it receives money for the asset, which can simply be “de-created,” i.e., make the money disappear. That’s one of the tools to cool down an overheating economy (we all wish).
So, here is my problem with this idea that if the Fed holds securities until maturity that it will somehow make balance sheet reduction easier.
We are not talking about helicopter money here. In other words, the Fed did not buy these Treasuries under some agreement that the US Treasury does not have to pay the Fed back. Thus, when a Treasury bond matures, the Treasury will need to repay the principal to the Fed.
Since the US Treasury is always running a net deficit, it will have to sell a new bond to replace the money that it will use to repay the Fed.
So, if we follow the process here, the bonds mature, and Treasury sells new bonds and receives money from the banking system, which goes to the Fed. The Fed then “de-creates” the money, if it is actually allowing its balance sheet to reduce. The net result is that money comes out of the banking system, and Treasury’s debt remains the same.
There is no free lunch: Letting securities mature is exactly the same as if the Fed sold the securities prior to maturity. It still takes money out of the system, and I would argue that it may be less manageable because the Fed would not be in control of the rate that money was being removed from the system. That would be governed by maturity dates.
One last point: The repaid principal is not the same as the interest that the Fed receives along the way.
Indeed, the interest is a free lunch and does go back to the Treasury. But repaid principal does not, otherwise it would in fact be helicopter money (which may be the Fed’s next move, God help us).
As for mortgages, the main difference is that principal is being repaid along the way and not just at maturity.
But in this case, money is coming out of the system throughout the process if the Fed is not expanding — or at least maintaining — the balance sheet.
It’s not really any different than actually selling the mortgage bonds, other than the rate that money comes out of the system.
The bottom line is, as the bonds mature, money comes out of the system if the Fed is not at least maintaining the balance sheet. That’s no different than the Fed selling securities.
Am I missing something here? Can you please explain the thinking behind the idea that holding to maturity is some type of free pass?
Looking forward to your feedback. F.T.
Dear F.T.:
I don’t have a quarrel with anything you said. I’ve been writing that the Fed thinks it can get out of its predicament — and its purchases — by letting the bonds and mortgages mature. I didn’t say that I think it can.
As you so concisely stated, the Fed is painted into a corner. It can’t keep buying under quantitative easing and it can’t stop. The “hold to maturity” argument is the same rationalization we hear from desperate people. It’s no different from, “Don’t worry, we’ll figure it out.” Let’s hope they do, or God help us.
Send your questions to Dear John, The NY Post, 1211 Ave. of the Americas, NY, NY 10036, or john.crudele@nypost.com.