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The economic effects of quantitative easing
QE3 ahoy!
Let’s refresh our memory about how QE happens. The Federal Reserve has a special relationship with banks in which the banks buy or sell bonds whenever the Fed demands. This is called the repurchase, or repo system. And the banks are buying and selling all the time. When the banks buy bonds, they pay money to the Fed, and when they sell, the Fed pays money to them. In this way the Fed can send money in and out of the banking system at will, and that can also control the amount of money in the economy.
Imagine a swimming pool with a wall about a quarter of the way down it, acting like a dam. The water in the pool is the cash in the economy. Behind the dam is where the banks are located, so they’re up to their chests in money. In front of the dam is the rest of the economy, where we all paddle about in ankle-deep cash. Cash flows in and out of the banking area as we borrow money and save, and the janitor (the Fed) can control the amount of money in the system by taking a bucketload out when he wants the banks to suck more cash out the economy, and by putting that bucketload back when he wants them to lend more cash out to us.
So far the system is operating with a set amount of cash. The Fed’s bucket work, which is done via the buying and selling of bonds, is called open market operations, and it happens all the time. Quantitative easing is when the Fed adds extra money into the system. It’s a bit like the Fed sticking a hosepipe into the deep end of the pool and turning it on. This is new money, and idea is to almost drown the banks.
Which brings us to the reason for QE. Once the banks are in danger of drowning in money, the hope is that they’ll start to bail furiously to get the levels down -- and they’ll do that by lending the money to us. You see, banks hate cash, because when it’s sitting in a sweaty vault, cash doesn’t make money. It needs to be invested, lent out, to the likes of you and me. The idea is that once the banks are drowning in cash, they’ll turn around and lend it to us, so that we can go out and buy houses and all the stuff that goes in them. The demand for all that stuff will push manufacturers to hire more people, who’ll then be able to qualify for loans, so that they can go out and buy houses and fill hem with stuff, and so on.
In other words, QE is all about forcing the banks hand, pushing them to lend cash that will reinvigorate the economy.
The danger, of course, is that if the banks turn on the pump and start pouring cash into the shallow end of the pool, we could end up being the ones drowning in cash. Which is an analogy for a little problem called inflation.
Paddy Hirsch the author of Man vs Markets, an explainer on the financial markets and the eocnomy. You can buy a copy of the book from your local or online bookstore, or enter to win one for free by submitting a suggestion for an upcoming Whiteboard explainer video.
Seems such a round-about trickle-down way of increasing demand, a way that by design goes through unnecessary middle-men who can take profits along the way, reducing the volume of the trickle, and then have the freedom of deciding where to allow the money to trickle down from them, including to speculators fueling asset bubbles. If the Fed is lender of last resort and wants to stimulate the economy, why not lend directly to borrowers who would use the money to increase demand? Or at least restrict how the banks use QE money?
There is a third factor of water flowing over the dam, retirees. Since the money that flows over the dam as interest has slow or nearly stopped, the retiree draught is going to start showing up as people out live their money. The stock market made sure that you cannot safety invest all of your retirement funds and CD and bonds are paying next to nothing. When inflation takes off and some year it will, these poor people will be broke. The lack of higher interest rates keeps people in a wait and see mode. You raise rates by 1% and those who can spend will for fear of rising rates. Those who do spend, never could.
There is a third factor of water flowing over the dam, retirees. Since the money that flows over the dam as interest has slow or nearly stopped, the retiree draught is going to start showing up as people out live their money. The stock market made sure that you cannot safety invest all of your retirement funds and CD and bonds are paying next to nothing. When inflation takes off and some year it will, these poor people will be broke. The lack of higher interest rates keeps people in a wait and see mode. You raise rates by 1% and those who can spend will for fear of rising rates. Those who do spend, never could.
That is the most ridiculous reasoning for the Fed's actions that I have heard. The Fed's actions are all about fueling the overseas expansion of US corporations while sending money that will be used to replace all the toxic assets all banks still have on their balance sheets. We don't want them to have to write off bad/fraudulent loans so we supply them with free money for a decade so they can make money on the market.
Secondly, corporations need the American economy to remain stagnant as it tries to push all the privatizing and end to social programs that the 'New Economy' requires. People are not going to stand to lose entitlements unless made desperate to survive. High unemployment allows corporations to push worker wages ever lower and end all benefits and it gives leverage in killing unions. So stagnation is critical to their strategy. The buying of bonds simply makes it impossible for people to find a safe place to invest in an attempt to send them back into the stock market. After all a 0% rate keeps saving account rates too low to put money there so now the Fed wants to make bonds less attractive. Remember, Bernanke was part of the Greenspan team that gave all in the pursuit of corporate/financial gains. No one thinks they are working to stimulate job growth.
