I read that the fed buys bonds from the big banks, say Chase for instance, and pays for them by adding zeroes to the amount of money registered to Chase in the fed's bank.
My q is, didn't Chase have to pay for those bonds at some point in the past? So isnt the fed just re-releasing money that was already in the system at one time?
Governments create bonds, then sell them. The FED monetizes that debt by conducting open market operations, where it buys back those bonds, and credits the banks with reserves, they can use to expand the money supply fractionally.
I *believe* that is how it works. This is an advanced topic, and my strength is not banking.
If you find something evil that wobbles, push it. - Gary North
Chase didn't buy the bonds from the Fed originally. It bought them from the "open market", with money it had earned in exchange for services of some sort. That is circulating money, since the bank earned it.
The Fed, however, buys bonds from the "open market" not with money that it has earned, but with money that it prints, or promises to print. That is counterfeiting, since the Fed did not earn any of that money.
Now imagine that the Fed decides that it really likes you, and opens an account for you at the Fed for 10 trillion Federal Reserve Notes. Is that inflationary? In the narrowest sense, no, but in a long-run sense, it is. At first what you will do is realize that you are rich, but you haven't changed any of your buying behavior yet. You might only withdraw 1 million of the account in your first year, buying a fancy house and a fancy car. Then the year after that you start buying companies, and spend 100 millions. The price of companies is going to go up. The year after that you buy out the gold market, and gold goes up to 10,000 an ounce. As you withdraw from your Fed account to buy assets of all kinds, the prices of these assets increase, and thus inflation becomes an aknowledged reality.
Now the Fed doesn't just give away money. But what it will do is, say, buy all your worthless bonds (assets that have mysteriously become illiquid) for a price that is very generous. Then you feel much richer than you truly are.
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Traditionally, the primary dealers (big banks) have bought the bonds from the U.S treasury at auctions using existing money. The Fed then buys these bonds with newly created money. So the primary dealers did buy the bonds with existing money but sold them for newly created money. They can then use the newly created money to buy more bonds.
In the past couple of years, the Fed has started to lend money to the primary dealers, so the primary dealers can now borrow the money instead of using their own. I don't know whether the Fed creates money in order to lend it to primary dealers.
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