In the last issue of Monetary Mechanics, Issue #6, I covered the structure of the market for US Treasury securities with considerable detail. The diagram below highlights the key components that comprise the US Treasury market, as well as the relationships between them, followed by a brief review, if anyone needs it.
You mention in the post that there are a few “deposit creation” steps that are skipped in the QE examples above. Just to make sure I’m clear, do these refer to the deposits technically created by the sale of UST to the Fed for the PD’s account (whether it’s under a BHC or not)?
If it is solely a PD-Fed trade, deposits will be created for the PD’s account at its bank (whether under a BHC or not). If it is a MMF-PD-Fed trade, then the PD will still be left with “new” deposits, right?
Lastly, to be clear, in a MMF-PD-Fed trade, QE expands MMF bank’s balance sheet, holds PD’s bank balance sheet neutral, and expands Fed balance sheet (last one is obvious).
The "intermediate deposit creation" steps that I skipped involve the transfer of bank deposits back and forth from the MMF to the PD as a result of the repo transaction in all scenarios (they net to 0 so I just skipped) and the creation and destruction of deposits on the balance sheet of the PD's bank in Scenario 4.
Regarding deposit creation on the PD's balance sheet due to sales to the Fed - this depends on the specific legal structure and inter-affiliate accounting practices of the PD (some foreign PDs are housed directly in the commercial bank entity, some are in the same BHC and bank with their affiliate, and some use another specialized custodian bank).
The deposits aren't created as a result of the sale of the UST to the Fed, they're created as a result of the new reserve balances which must be held by the PD's custodian bank. The relationship is something like this:
Reserve Balances: Federal Reserve <---> Custodian Bank
Bank Deposits: Custodian Bank <---> Primary Dealer
Remember, sales to the Fed cannot create deposits directly because no one holds "deposits" with the Fed - thouse would just be reserve balances. Since only commercial banks can hold reserve balances, and the sale of securities to the Fed creates reserve balances (not deposits). The deposits are a secondary effect due to the Fed's inability to directly credit anyone with commercial bank deposits (because the Fed is not a commercial bank).
In all scenarios, the PD and MMF's balance sheet should be neutral at the end of the QE process. Other than the Fed, only the balance sheets of the ultimate seller of the security, and the ultimate seller's bank should be impacted (if the ultimate seller is not bank).
The MMF's only involvement is to provide temporary financing for the PDs inventory through triparty repo. The PD's only involvement is as a conduit to the Fed. Neither are permanently impacted (except in the case that the PD is the ultimate seller of the UST and not taking orders from a client, which is less common).
Also another thing that I forgot to mention is the MMF's bank. The MMF, because it is not a commercial bank, must have a bank with whom it holds deposits. So the deposits transferred from the MMF --> PD should come from the MMF's bank, which therefore should also transfer reserve balances to the PD's custodian bank.
You can probably see why I chose to skip some of these steps. I think the important point to get across is to understand the mechanical nature of of how hierarchy of money functions. Adding in too many concepts at once complicates things and tends to obscure the main point.
Hi,
You mention in the post that there are a few “deposit creation” steps that are skipped in the QE examples above. Just to make sure I’m clear, do these refer to the deposits technically created by the sale of UST to the Fed for the PD’s account (whether it’s under a BHC or not)?
If it is solely a PD-Fed trade, deposits will be created for the PD’s account at its bank (whether under a BHC or not). If it is a MMF-PD-Fed trade, then the PD will still be left with “new” deposits, right?
Lastly, to be clear, in a MMF-PD-Fed trade, QE expands MMF bank’s balance sheet, holds PD’s bank balance sheet neutral, and expands Fed balance sheet (last one is obvious).
The "intermediate deposit creation" steps that I skipped involve the transfer of bank deposits back and forth from the MMF to the PD as a result of the repo transaction in all scenarios (they net to 0 so I just skipped) and the creation and destruction of deposits on the balance sheet of the PD's bank in Scenario 4.
Regarding deposit creation on the PD's balance sheet due to sales to the Fed - this depends on the specific legal structure and inter-affiliate accounting practices of the PD (some foreign PDs are housed directly in the commercial bank entity, some are in the same BHC and bank with their affiliate, and some use another specialized custodian bank).
The deposits aren't created as a result of the sale of the UST to the Fed, they're created as a result of the new reserve balances which must be held by the PD's custodian bank. The relationship is something like this:
Reserve Balances: Federal Reserve <---> Custodian Bank
Bank Deposits: Custodian Bank <---> Primary Dealer
Remember, sales to the Fed cannot create deposits directly because no one holds "deposits" with the Fed - thouse would just be reserve balances. Since only commercial banks can hold reserve balances, and the sale of securities to the Fed creates reserve balances (not deposits). The deposits are a secondary effect due to the Fed's inability to directly credit anyone with commercial bank deposits (because the Fed is not a commercial bank).
In all scenarios, the PD and MMF's balance sheet should be neutral at the end of the QE process. Other than the Fed, only the balance sheets of the ultimate seller of the security, and the ultimate seller's bank should be impacted (if the ultimate seller is not bank).
The MMF's only involvement is to provide temporary financing for the PDs inventory through triparty repo. The PD's only involvement is as a conduit to the Fed. Neither are permanently impacted (except in the case that the PD is the ultimate seller of the UST and not taking orders from a client, which is less common).
Also another thing that I forgot to mention is the MMF's bank. The MMF, because it is not a commercial bank, must have a bank with whom it holds deposits. So the deposits transferred from the MMF --> PD should come from the MMF's bank, which therefore should also transfer reserve balances to the PD's custodian bank.
You can probably see why I chose to skip some of these steps. I think the important point to get across is to understand the mechanical nature of of how hierarchy of money functions. Adding in too many concepts at once complicates things and tends to obscure the main point.