What is "Quantitative Easing" Anyway?

by Xin Lu on 13 August 2010 11 comments

Recently, the news is abuzz with the term "quantitative easing." What is it anyway and how does it affect you?

Quantitative easing is the act of central banks injecting the economy with cash in every conceivable way. In response to the financial collapse and the ensuing recession, central banks around the world used every tool at their disposal to increase the money supply. The US Federal Reserve has been extremely proactive in coming up with innovative solutions to increase the amount of capital available to banks, increase the money supply, and prevent deflation. These "creative" solutions fall under the umbrella term "quantitative easing," although the US Federal Reserve has attempted to distinguish its strategy by phrasing it as "credit easing."

Basically, quantitative easing is a monetary policy where central banks "print" money and introduce this newly created wealth into the money supply by purchasing securities on the open market. The banks from which these securities are purchased then have additional capital beyond their reserve requirements that they can loan, invest, or horde for themselves. Quantitative easing is usually employed when the federal funds rate is at or near 0% because there is no possible way to lower this rate.This results in the Federal Reserve expanding its balance sheet. In the past couple years, quantitative easing has often been in the news as the Federal Reserve agreed to buy billions of dollars worth of government bonds, mortgage bonds, and other securities.

The intended short-term result of quantitative easing is to increase the money supply and stimulate the economy. By purchasing government bonds on the open-market, the Federal Reserve can lower interest yields, which in turn lowers the interest on new debt, potentially encouraging companies and individuals to consume more credit and increase spending.

Conversely, quantitative easing lowers the deposit rate, or the rate banks pay depositors. A lower deposit rate reduces the benefits of holding savings, and encourages depositors to consume their deposits or seek other investments. The end result of quantitative easing is intended to benefit  consumers. Decreased borrowing costs and an expanded money supply is supposed to increase demand and consumption. Once demand starts increasing, confidence should return to businesses and hiring will resume.

Modern economic theory argues that deflation is one of the worst possible economic outcomes and quantitative easing is supposed to prevent that. The idea being that if deflation takes hold and prices continue to fall, consumers will delay purchases, assuming that prices will be cheaper in the future. Delaying purchases decreases demand and leads the economy on a downward spiral. Furthermore, quantitative easing reduces the pressure on banks by increasing their available capital and increasing demand for loans.

The biggest risks associated with quantitative easing can occur when the folks in charge introduce too much cash with their policies and hyperinflation results. If there is a great increase in the money supply, then real goods, commodities, and services can drastically increase in price while savings and the value of the dollar are destroyed. Creditors will lose real return on their investments and the effect on the country's credit could be disastrous. These problems can be exacerbated by politicians who see government debt being purchased and use the opportunity to increase government spending without increasing taxes.

The bottom line is that quantitative easing can be a double-edged sword. In the case of Japan, quantitative easing did not work and deflation ensued for years.  This could also happen in the United States. What do you think? Should central banks around the world continue their policy of quantitative easing to battle deflation and spur borrowing? Have you taken advantage of the lower interest rates?

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Guest's picture
Ken

I’m mainly concerned about the Fed buying toxic assets-mortgages from those seeking to dump them on the American taxpayer, again. I know the Fed has sent billions to states already to keep them from defaulting, California being the biggest recipient so far. I also know they have purchased a worthless shopping mall in Oklahoma, and I want to know what other worthless assets they have purchased with the American Taxpayers’ money.

If the Fed is going to Peg their Balance Sheet to $2.054T, we need to add this debt to the national debt which is at $13.2T right now. According to http://tiny.cc/e5lac, the BEA.gov site shows our GDP at $14.597T, which means we are above 100% debt-to-GDP if you add $13.2T and $2.054T.

We need to stop this BS and take our medicine to get better. Pain now or pain later, the pain later is going to be much worse.

Guest's picture
Guest

The only people whom deflation is bad for are banks and housing speculators.

Deflation of house prices makes them affordable for us younger generations, or any of us outside the corporate C-suite.

"QE" is more orwellian coverup of what the banksters are really up to.

A) helping politicians kick painful decisions down the road, so they will be even more painful
B) theft of everyone's savings but making them all diluted (printing more money makes existing money worth less)

Instead of a fancy word, why not be forthright? The big banks are creating a bigger mess of currency to prop themselves up and delay the "day of reckoning."

Your article correctly points out that Massive Money Printing usually ends in tears for savers. Zimbabwe is a good example. So is Germany. The Japanese people are suffering due to the insane yen-carry trade. Only the big corporations, banks and elite are doing well in Japan.

Central banks SHOULD stop creating more debt. Debt is heroin, and I don't know of any addicts who benefit from more substance.

Guest's picture
kenao

Hey Xin, here's a great response to "QE" -

""Quantitative easing" doesn't solve anything, as all you're doing is debasing the currency, which in turn makes everything more expensive (or depresses wages - same outcome) and that in turn means that purchasing power decreases, which means that forward economic activity decreases as well."

http://market-ticker.org/archives/2575-To-DC-Waking-Up-Yet.html

Cheers,
kenao

Guest's picture

Wow. I put this post in Google Translate for bureaucratic-to-English. It's still churning.

Guest's picture
Guest

It's hard to convey my disgust with 'quantitative easing'. Asset prices need to drop. All this easing does is delay the inevitable drop. Real wages are stagnant. Once interest rates rise, demand will drop and prices will follow. All we are doing is delaying the inevitable and making the problem worse.

Guest's picture
Guest

If the rise in housing costs (and everything associated with it)over the last decade were a "bubble" wouldn't "deflation" be the letting the air out of of the bubble bringing prices back to where they should be? Why is this bad? We can't keep the bubble inflated continuously. We're all out of air.

Guest's picture
Aaron

I have been the the Federal Reserve's mall in Oklahoma. It is a worthless asset, and a pretty good example of the the kind of things that get purchased with the "extra" money created by expanding the money supply.

Guest's picture
Kasasa

Hyperinflation is definitely something the U.S. needs to avoid. We want America to come out of this recession stronger and more resilient than ever, and hyperinflation is definitely something that could destroy that. That, and if the public doesn’t start putting money into local resources instead of national, monopolizing chains. We have to think different to be different!

Guest's picture

Great post -

WVFC had Kathleen Rogers, a previous trader and CNBC employee, explain what Quantitative Easing is and why it is important.
I think it serves as a great supplement to this post:
http://womensvoicesforchange.org/what-is-%E2%80%9Cquantitative-easing%E2...

Guest's picture
Travis

Really? Come on. I haven't heard such an uniformed take on the Fed and money printing like this in a long time, if ever. Wake up! Look at commodity prices. They're up, they're way up and, if the Fed keeps it up, Americans can count on their standard of living plummeting. Corn prices are up 90% in under a year. Silver is up from $4 in 2005--when everybody was busy buying over priced houses--to $30 today. Now look at the chart for America’s Long Dates Treasury Bonds – 20 year bonds – these are plummeting! America’s “safest debt”, 20 year treasuries are being dumped, because huge institutional investors and Governments around the world know, the U.S. Dollar is doomed! What you’re posting here is very narrow, and one sided.

Governments and central banks throughout history have always tried to print away their problems, claiming that deflation is the worst case scenario when, in fact, inflation is far more damaging to the average person--no question. Your savings get wiped out. You're a personal finance site, trying to convey to people the merits of saving money, but you're not accurately presenting the facts about money printing, watering down one’s savings, killing the purchasing power of the dollar. Remember Zimbabwe? This is a prime example in recent history, of a government trying to print away their problems. You actually used the word “wealth” to describe the infusion of dollars be the Fed….I am God Smacked! That’s not wealth, you can’t create wealth out of thin air!

As for Japan, yes, the Fed loves that example. I have lived in Japan, worked there, and I'll tell you their government is bankrupt, like the U.S. government, but the people have a HUGE savings rate. The myth about ‘quantative easing’ (read: government speak to confuse the masses on the truth of their dubious actions) not happening fast enough in Japan is a joke. The Japanese central bank and the Japanese government, like the U.S. counterparts, propped up bankrupt companies like Mitsubishi and hoards of banks. Sound familiar? GM, AIG, Fannie Mae and Freddy Mac? American citizens, hard working people, are going to be the ones to see their standard of living drop. Companies and governments need to go bankrupt if they are incompetent. You or I will! If you are I is incompetent we either get fired or go broke. If you print money to bail out companies and banks you prolong the problems and make them worse. I say you, because America is still a democracy, so it’s really you’re responsibility – As a member of the American press!

Enter China. China technically owns the most U.S. dollars in the world outside of the U.S. The more the Fed prints, the more the Chinese get screwed on their investment in the U.S. Dollar. China is planning and executing their exit from the dollar. They are leaving the dollar, which is the world's reserve currency because it is UNSOUND. Unreliable as money, too high a risk to their prosperity! If the holders of a currency can't be sure of that currency’s future purchasing power, they dump it – straight up. Countries around the world are dumping the dollar - individuals too, including many Americans.

This is maybe the most important problem facing America and it’s unfortunate that it’s being covered in an uninformed and irresponsible way. Americans who have identified this trend (it is not new) and who have moved into sound money like gold and silver have protected their savings. Going forward, those who hold the U.S. dollar will see their savings vanish. That little wheel barrow you have used to symbolize QE means something. It's a reminder that in Germany in the 1920's, before Hitler, the German government tried to print away it's problem--same old story--and people in Germany saw their currency's purchasing power evaporate. Hence, you would bring a wheel barrow of cash to the grocery store and come out with something that fit inside your purse. People burned their paper money, because it was cheaper than using it to buy fire wood. This happens all the time, bankers and governments hide it the same way, all throughout history and, in the end, the people suffer.
If fact a friend commented just yesterday of an American Dollar Investment he had made in 2003 which cost him $7800 Canadian and is now worth…if he is lucky and the company doesn’t go belly up, $5500 Canadian Dollars. So, he’s lost $2300 on the exchange rate over 8 years – because of quantitative easing. So, the world at large has a lot riding on Americans, to wise up, do what’s right.
The proof is in the money. If you want good info about money, look to your fellow Americans who have navigated this mess, seeing it long in advance and making the right moves to protect themselves.
You owe it to yourself to – and I have zero, zilch, absolutely, positively, nada cent of financial interest in saying this- google Porter Stanberry or go to www.endofAmerica2.com or Stansberry Media on Youtube. This man warned investors to avoid the catastrophe in 2008. Unlike most financial pundits, Porter Stansberry knows a lot about accounting and finance and the proof is in his success at foreseeing the consequences of quantitative easing.
Quantative easy is killing your dollar. Other Countries are beginning to refuse the dollar – if you travel to Europe or Asia you see, people around the world know the dollar is doomed. Many currency exchanges in foreign countries refuse to buy your dollar.
People need to know the facts, not another sugar-coated, garbled up mess of half truths and lies. This is me pleading with you to re address this very serious issue facing your nation.

Guest's picture

Wow! I'm really stoked to see the responses to this article - especially Ken's. Q.E. and the state of the American Dollar are of very big concern to me. Anyone I know, who studies economics (outside of political hacks, and new speak pundits, claiming expertise and degrees), those people who really study economic history are concerned that the U.S.D is in deep deep trouble and that when, not if, foreign nations pump it, the cost of living in the U.S. will explode.

I put my bet on rural America thriving! America is the greatest nation in the world for a reason: freedom. The greatest risk to freedom is growth of centralized governments and their oligarch counterparts in finance. What they are doing is disastrous for the average person. But, those who are self reliant, savers outside of the major urban areas, are going to grow very wealthy, I feel. Food! Food, is going to get very expensive because of Q.E., so if you live near food and you have the skills to produce your own - you are going to thrive!

I just watched this video about the impact of China's rapid selling of U.S. dollars and treasuries and their aggressive gold buying. They're buying it by the tonne and they are already the world's number one producer of gold, number two producer of silver and the number one smelter (melting/processing into bars) of both gold and silver, in the world. I honestly believe that one day the Chinese will back their currency with gold - They encourage their citizens on T.V., all the time, to BUY GOLD. They are making a move and the low savings rate in America, the bankruptcy of the U.S. government, make this a real economic problem. They own trillions of dollars and they are selling them. Here's the video.

The problem is, the Fed and their political puppets. America is still a democracy and it’s high time the people reminded these people of that! What’s that saying, “people shouldn’t be afraid of their government, governments should be afraid of their people?”

I like what Thomas Jefferson said, something like, “the only way for evil to thrive is for good men to do nothing.” Quantitative easing enriches a tiny group of super rich, politically connected financiers and it robs you of your savings. That’s evil in my books!