QE cannibalizing bank lending
Thanks for great content on the site. I've been thinking about this for a while, and I believe the trouble in loan growth will continue to persist. When the Fed creates deposits in the system via QE bypassing banks, it is cannibalizing the demand for money by individuals and businesses, which is usually fulfilled by bank loans at a higher cost. In effect, the Fed is lending to businesses and individuals at below “market” ie below what a normal bank would charge to provide a loan/deposit. And because of the deposit creation by the Fed, they do not need loans as their demand for money is satiated (this is the substitution/cannibalization).
Imagine a business getting deposits via a loan from a bank (costly), vs the Treasury selling to the Fed for reserves in TGA, which it then spends into the banking system for free to supply that same business with deposits. The bank which would have held a loan with that customer is now holding reserves from QE, while the business is agnostic and sees the same deposits in its account. As the demand for money across the economy is satiated by QE, loan growth will continue to be tepid, and loans will only go to those that the Treasury does not spend on or access, and who cannot access the secondary source like the capital markets or private credit funds, who are forced to access bank lending. Thus traditional bank lending faces headwinds from both QE and capital markets (direct lending, etc).
What do you think of this logic?
I agree with this view, except I would focus more on the Treasury rather than the Fed. It is the Treasury that is allocating bank deposits. That would occur even if there were no QE. With QE the bank deposits would ultimately be sourced from the Fed, without QE it would've been sourced from whoever bought the Treasury securities.
In the past year Treasury has made $800b in PPP loans to businesses, so that is a lot of new cash. I have to think that would've effected demand for bank loans.
I see, however, doesn't QE enable the more issuance of Treasuries without raising the rates? As in, the Fed replaces the natural demand from investors and thus allows its balance sheet worth of money it be incrementally generated and spent?
Yes QE is a tool intended to influence rates. But it is ultimately an exchange of one form of money for another.
Thanks Joseph: I mocked up the below example which I found helpful for me to understand your explanations:
|Real Economy (Inflation-causing)|
|Step 1:||Treasury borrows; Fed buys||$0||$100||$100||$100||$0||$100||$100||$100||$0||$100|
|Treasury spends out of TGA,|
|Creates deposits in Corp's Bank|
|Step 2:||Treasury borrows $100 more||$100||$200||$100||$0||$100||$0||$0||$0||$100||$100|
|Secondary borrowing from Corp|
|Step 3:||Treasury spends $100 from TGA||$0||$200||$100||$100||$0||$100||$100||$100||$100||$200|
|Gives to Corp|
|Step 4:||Fed does QE||$0||$200||$200||$200||$0||$200||$200||$200||$0||$200|
|Buys $100 Tsys from Corp|
I agree that it is the Treasury's decision to borrow and spend that create incremental assets in the real economy. It can recycle the same existing deposits as long as the economy has the appetite for the Treasuries, i.e assuming Treasury can sell. If it can, then the Treasury's allocation decision is indeed key as to who they spend on, but the Fed plays an important secondary role via QE in ensuring demand for Treasuries. Without the Fed, the Treasury could not allocate or function effectively, because there is indeed some natural saturation of Treasury demand from investors willing to provide deposits, and so the Fed steps in as buyer of last resort. In a sense, the Fed guarantees the moneyness / safe asset status of Treasuries with its buying.
Point 2 is that this assumes that deposit money and Treasuries are perfectly substitutable, but a Treasury is more institutional money vs deposits are retail and institutional money (per one of your articles), and so the QE transforms more assets to be eligible for inflation in the real economy (although it cannot ultimately control if those institutional investors really spend it into the real economy, or if it continues to be held in institutional cash pools).