Money printing - Most people have no idea how it works.
The most common way is when the FED steps in as primary buyer of treasuries, aka QE. When this happens, the FED essentially moves those treausiries to its own balance sheet, and replaces them in the economy with newly printed money. But it doesn't work exactly like that. When the FED buys the treasuries, they in effect expand their own balance sheet. This increased balance increases they amount they have to hold in reserve, and also increasing the amount of assets they can loan to banks. But that doesn't happen automatically. Banks have to WANT the loan from the FED. And for the banks to want to expand their own balance sheet, their has to be a demand for loans from banks. That way, the bank can earn more interest on loaning money out to the private sector than it pays to borrow this new money from the FED. If there's no demand for loans, then theres no demand for new printed money from banks, and new assets sit on the FED balance sheet while they dig deeper into their deferred asset "cumulative loss" hole.
But right now, the FED is in a huge hole, the deferred asset hole. They haven't remitted to the treasury since early 2022. And their situation keeps getting worse, because they are paying banks to park their reserves more than it costs banks to borrow from the FED. This net debit either has to be borrowed by the FED, or minted from scratch. But the FED isn't buying assets, its selling them. So the FED is paying interest on reserves through interest earned in the repo market and interest earned from securities it has loaned out. But the hole the FED is in keeps getting bigger, as the FED is paying more interest ultimately than it receives. This is a position it HAS NEVER BEEN IN. This is not a position from which the FED is likely to EXPAND its balance sheet to create new money. And even if it tried, the demand from the private sector isnt there. It would be a noose around the FED's neck.
As mentioned above, the FED allows banks to park their "reserves" at the FED and earn interest on it, currently at the upper end of the Fed funds target rate. This only started in 2008. And right now, it's the PRIMARY income source for banks. Why buy US treasuries, commonly the "safe" investment for reserves, when the FED will pay pretty much the same rate with absolutely zero risk? At the same time, banks have no incentive to lend to the public unless the return is significantly higher than what the FED is paying them, and high enough to justify taking on substantially more risk.
Right now, there is minimal demands for loans from the private sector. Why? Because they are extremely costly. But if the FED drops rates, it really doesn't change much, as the delta of risk between banks loaning to the risky private sector vs loaning to the 100% safe FED will remain as it is today. There will still need to be DEMAND for loans from the private sector, at asset prices that still don't justify the cost of funds. Banks will just keep parking at the FED, only lending to those private sector entities that are willing to pay the huge premium above what the banks can earn from the FED.
Now, if Cruz and Bessent get their way, and we are able to end the FED paying interest to banks on reserves, that can change things. If banks can no longer park reserves at the FED, their choices narrow.
1. They can park them in treasuries - This will net a similar return to them as what the FED paid them, but with a slight increase in risk. This is what Trump and Bessent think they will do.. and its the goal because their entire mission is to have money flow into treasuries which will bring bond yields down and force the FED to cut even more. And with rates going down and treasuries going up, they believe the FED will systematically unwind its balance sheet further and eventually dig out the of the big hole and start remitting to the treasury again.
2. Loan them to the public - There needs to be demand for this. As described above, that's not going to happen. And banks are very risk averse right now. There will still be an interest rate premium to borrow from banks, and that premium might even grow if rates come down, as they would rather just not loan to the private sector and park somewhere safer.
3. They will park the cash in the reverse repo facility - This is essentially the same result as the FED paying interest on reserves. Currently, it pays less interest, as the FED wanted to wind down the liquidity in this facility. But in the absence of holding reserves at the FED, banks will likely choose to accept this slightly lower return as its still considered safer than treasuries, and much safer than loaning to the public.
The goal by Cruz and Bessent is to get bank reserves into treasuries, driving down rates. But if banks dont buy treasuries, we are just in the same place, except with less liquidity available, banks reserves in a more risky place at a time when bank unrealized losses are high and putting the economy in an even more vulnerable place.
