How does the fed add liquidity to the economy?

you're assuming an increase in money supply increases stock market liquidity which is incorrect. in regards to your topic title, fed adding liquidity just means increasing money supply... done through debt monetization

 

If they are buying government bonds, how is it NOT lending money to the government? US treasuries are debts issues by them. Or are they not?

 

They are not borrowing money from the government they are purchasing assets from banks holding the assets on their balance sheet and giving money for the assets they bought from the bank. The bank the assets were bought from now have the money the central bank paid to buy the assets the central bank now holds on its balance sheet. There has been an increase in liquidity because the bank now has liquid cash assets to invest or lend out. The central bank now holds the illiquid assets it bought from the central bank. The central bank now owns illiquid assets in exchange for liquid cash that commercial banks can lend out, which increases the active money supply that enables a greater number of transactions to be made. That is generally how Open Market Operations work Got it?

 

By suppressing interest rates on savings people are forced to speculate and buy stocks.

Hedge funds can borrow even more to pump up TSLA stock up to 1000 P/E because comm banks have excessive liquidity.

 

Thanks you that makes sense! However, what's there to prevent the banks from using these liquid assets to buy illiquid assets again? What if they buy more treasury bonds?

Also if that is the case, why does the fed only buy treasuries? Banks hold many non-liquid assets.

 

What I don't get is, are you saying banks act as a middle man for US Treasuries? If the fed is buying them from banks to give them cash, than they are not getting it from the government directly.

 

There is a whole industry of banks borrowing money from other banks because they can lend it out at a higher interest rate than they borrowed it at to make money from the difference. The central bank is also involved in this process but usually acts as lender of last resort to the commercial banks when they need money and can't borrow it from anywhere else. There is money to be made from buying cheap loans then lending it out at a higher price.

There is money to be made by the central bank buying up the assets the banks have then selling them at a later date when the assets' values have appreciated. There is a short term version of this in the repo market, which lends money over days. This is something the banks and central banks use a lot to make money on assets and cash reserves they have on their balance sheet.

Since the financial crisis the central banks have had to buy up a lot of other securities that they would not have normally purchased, you can read about this at the link below.

https://www.investopedia.com/articles/economics/10/understanding-the-fed-balance-sheet.asp

 

That's pretty scary since this was almost 12 years ago... They're still buying up assets from 2008??

 

I feel compelled to warn you, that "Morganist" , although he promotes himself as an economist, had previously almost no correct understanding of central bank operations in either the U.K. or the U.S.. Perhaps he has learned something in the interim. He gave you a link to Mises.org that has badly out of date information.

Confusion often arises because it is natural for people to equate their personal finances with government finances. And it seems we are going to be stuck with this forever, because getting people to believe that the government should operate just like they have to when it comes to money is politically very useful. It's an easy way to convince people that there is no way we can afford to pay for expansion of head start, or for prisons or the post office, so we should privatize head start, our prisons, and our post office, so they can stop being a drain on the American taxpayer and start making a profit "just like any other business." In reality, personal and federal finances for a government that issues its own sovereign currency have practically nothing in common.

The finances of any government that issues its own currency -- something you, I , and state governments can't do -- is very different then our personal finances. Most people think that when the government wants to spend more than its revenue it must borrow the difference. And the steady stream of bond issuance by the Treasury certainly reinforces that view! In an era of fiat currencies, however, governments "money finance" their spending, i.e., they "print" as much as they need. Treasury Bonds serve an entirely different purpose than raising money to spend.

Don't let all the misinformation traders post on this site confuse you. The Fed and Treasury are one coordinated operation. This can be seen by examining the consolidated books. The Fed has been given, via statutory law, a certain amount of independence, but in the end it has no choice other than to coordinate closely with the Treasury, and vice versa. The fed does not determine fiscal policy; it just reacts to it.

"If they buy US treasuries, it means they're just lending the government money. " ​

That is what most of us think because that's what appears to going on. But appearances are deceiving in this instance. Remember the Fed and Treasury are both government agencies and really one coordinated operation . The government does not need to sell treasuries to be able to spend, and it doesn't need to borrow. Treasuries are a tool of the central bank used to regulate the amount of outside money in the economy.

In a normal economy, it is credit that plays the major roll in determining the money supply and not fed-treasury operations. The latter, typically, have only a secondary effect on the money supply. That effect is mainly through the way fed open market bond transactions affect the wholesale price that banks have to pay for the money they lend. The fed tries to influence credit by changing the price banks have to pay for money (the fed funds rate), but as this tool is normally applied in small incremental changes it normally affects credit demand only very weakly.

Everyone intuitively suspects there must be some practical limit in how much money a government can spend. Well, there is of course. Ultimately the limit is imposed by productivity, the demand for government bonds and how much inflation a society is willing to put up with. Money is only as good as the value of the goods and services it can be exchanged for. If there is no demand for government bonds, the government will have to operate its outside money supply operation with one hand tied behind its back. It will be left with taxation as the sole means of removing excess money from the economy. And if the government spends too much relative to its productivity and leaves too much money in circulation, inflation will soon follow.

Zimbabwe is a perfect example of what happens if productivity plummets. There was practically nothing that anyone wanted to buy with Zimbabwe currency, and therefore no one wanted to buy Zimbabwe bonds. The government than printed to pay its creditors, but the money was virtually useless. Hyperinflation set in, and Zimbabwe money became worthless.

Speaking of productivity, what will be the effect of productivity becoming increasingly decoupled from human labor is a supremely interesting question to debate, but one for another thread and another day. In addressing the problems that might arise from this decoupling, it would seem the equities market might have a major role to play. If it does, however, great social upheaval might occur if participation in the market is not virtually universal and if stock holders rights are not protected by government.