Economics, Library

How it Works: Quantitative Easing

“Printing” More Money

It’s proven less straightforward in the Information Era for governments to apply traditional methods of raising quick funds, whether through lobbying bribes or increased taxation. A powerful industrial complex also lobbies heavily to prevent any loss in budgets that could affect product demand, such as military expenditures or pharmaceuticals. Add the hodgepodge of legal constructs, media sensationalism, and bipartisan dodgeball, and there’s enough inefficiency in government spending to trap budgets into public debates for eternity.

In response, political leaders have increasingly leaned on an alternate form of fundraising, one that has far greater [short-term] accessibility, albeit longer-term risks. Formally known as Quantitative Easing (QE), this type of policy “increases the money supply by purchasing assets with newly created bank reserves in order to provide banks with more liquidity.”

Quantitative Easing is Toothpaste Money: easy to squeeze out of the tube, and hard to put back.

This is sometimes referred to as “printing more money,” or expanding the money supply overall so there are more dollars (or whichever currency unit) in circulation. This tends to be used to fund bailouts, military efforts, and other “emergencies” that require quick access to money without levying new taxes.

I once heard a term for this phenomenon: Toothpaste Money. Like Toothpaste, QE money is easy to squeeze out of the tube, and almost impossible to put back.

How it Works

This next paragraph may get a bit technical, but stay with me: for QE to work, central banks (in U.S.A, the Federal Reserve) will purchase new assets such as government bonds and mortgage-backed securities. These serve as “assets” and allow the bank to “print” more money using those bonds as collateral. Basically, the Federal Reserve gives ‘toothpaste’ money to banks, so they pass it along throughout the economy to the public through accessible lending.

Increasing the supply of money also lowers the cost and value of money, causing inflation. If the cost of money is less, then banks can “buy” more money and lend with easier terms. QE is used to stimulate economic activity, in the hopes that more available currency from banks will stimulate consumers to borrow, buy, invest, and spend. It “borrows against the future,” assuming that long-term economic growth will compensate for the “loan” towards a short term agenda. But things don’t always go according to plan. Central banks cannot force the banks to increase lending, or force borrowers to take loans or invest. If the money injected into the banks doesn’t flow through the markets adequately, the currency is inflated without the positive counterweight of increased activity.

The intention of providing funds to banks is so they can pass on that money to the public and stimulate economic activity.

QE in action

The domino effect tends to be quite problematic. For example, QE balanced the deficit spending of the War(s) on Terror in the Middle East after 2001. The extra toothpaste money was passed along to the public with easy-access lending (mortgages) stuffed into the real estate market, land being considered the “safest” of assets. But this wasn’t a clean process, and easy lending caused speculation, which allowed prices to surge into a Speculative Bubble, which is a spike in asset values fueled by irrational speculative activity, like a gold rush or beanie babies. For example, houses worth $100,000 were getting priced at $300,000, because mortgages were so easy to get. When the market “realizes” the valuation is off-balance, it “corrects,” and the loss in value is absorbed by the homeowner and sometimes by the banking institution’s insurance plan. Over time, the market caught up to the ‘real’ value of the money and the Bubble popped, leading to the Housing Market Crash and recession of 2008.

As the economic system contracted, QE came to the “rescue” in the Banking Bailout, during which the money supply was increased by $4 trillion, with the goal that the banks would lend and invest those new reserves to bring growth and recovery. An unexpected outcome happened when the banks (and many corporations) wouldn’t pass the money forward. Companies and banks were holding onto their money in reserve because they were trying to leverage against government taxes and regulation. Like Costco toilet paper at the start of the Coronavirus Pandemic, the toothpaste money was being hoarded. At one point, the U.S. banks were hoarding $2.7 trillion in excess reserves. (There’s another story to be told about where much of this money ended up. It’s mainly about Unicorns and Technicolor bubbles.)

Intended as a vehicle for economic stimulation, Quantitative Easing often ends up a proxy for Deficit Spending.

Inflated currency without circulation is QE gone wrong, known as stagflation. If consumer confidence and investor confidence are both low, people start hoarding money, and the economy contracts again, but this time with devalued currency. Throughout the 2010s, the QE Toothpaste money from the Bailout was being hoarded in corporate reserves. QE Money that’s just sitting there, not going anywhere, can become toxic and festers in the economic system over time.

Kicking the Can Down the Road

While the excuse for QE is economic stimulation, it usually is used as a form of political deficit spending, so political leaders can buy expensive policies without the public realizing they’re paying for it. Re-election, private interests, and ego can influence stakeholders to enact this policy when the bureaucracy of taking action gets too complicated or time-consuming. The economic consequences are delayed, so it buys goodwill and capital in the short-term. After having already spent the money on whatever initiative, the aftereffects can be attributed to the next elected leader, and the public’s share of money is devalued under a different administration. No politician wants to be the one in charge (or to blame) for an economic collapse, so QE has become a go-to method of “kicking the can down the road.”

“Inflation is the one form of taxation that can be imposed without legislation. It is also a form of taxation that is particularly seductive. In its early stages, people find it rather attractive, because the first effects of inflation are expansionary and pleasant. It’s like the first drink you take. It’s only the next morning that you have a hangover..”

Milton Friedman, 1974

In summary, the Federal Reserve buys debt with unpacked printed dollars. The banks sell that debt back to the Fed to unload the money and lower interest rates to motivate more borrowing. Then, the Fed sells bonds back to the banks, and has to raise interest rates because they’ve taken on debt. They often end up having to buy back their own bonds. QE is something of a circle jerk, with various denials and valuation illusions, undertaken in order to justify initiatives that cannot be afforded with existing funds.

In Context
The Federal Reserve announced a $700+ billion QE program on March 15th, 2020, to backstop the U.S. economy against the coronavirus. This follows an earlier pledge by the Fed to fund up $1.5 trillion to the overnight bank repo market and bond purchases to fight the economic slowdown. The subsequent activities will “print” trillions more dollars in treasury bonds. It is estimated that approximately $6 trillion of “toothpaste money” will be added to circulation during this first of multiple QE stimulus packages 2020.


About Chris O'Colla

Chris O’Colla is an economics enthusiast and generally swell dude (self-assessed). Chris studied various things at universities and acquired his MBA at great expense (debt). Realizing that that fatalist attitudes and poor decision-making in regards to money often stem from a lack of economic understanding, Chris decided to share his learnings, opinions and experiences in the hopes of educating people about the logistics of the Money Economy. Chris enjoys herbal teas and winged armchairs, usually alongside literature by economists Milton Friedman, Friedrich Hayek, and John Kenneth Galbraith.

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