Unconventional Monetary Policies – Quantitative Easing:

Exact Science or Desperate Measure?

The following essay is a short inquiry on the quantitative easing policy, its meaning, implications
and effects on financial markets.

Before any further analysis, we should first understand the concept of quantitative easing.
Simply put, quantitative easing, or QE, is when a central bank is “printing” money without
actually printing money. What does this actually mean? Well, living in a developed, high-tech,
high-speed, all computerized world definitely comes with advantages, and creating astonishing
amounts of money by typing down some numbers on an electronic display instead of printing
huge stacks of bills can be counted as one of them.

Firstly adopted in 2009, when the financial crisis was fierce and the attempt of the Central Banks
to boost the economy by cutting down the interest rates didn’t quite put the engine back to work,
at the end of 2013 QE was being used up to a value of $85 billon per month by the Federal
Reserve, money created in order to buy Treasury Bonds or Mortgage-Backed Securities (MBS)
from very large Financial Institutions. The mechanism follows an intuitive pattern, but we shall
also observe an example:

Step 1: A Central Bank wants to buy $10 billion of Treasury Bonds

Step 2: It announces on the market, adding the price range it is willing to pay for the T-Bonds

Step 3: Various banks offer then the specific bonds at certain prices

Step 4: The Central Banks chooses from which it will buy and buys the T-Bonds

Step 5: The Treasury Bonds are now assets on The Central Bank’s financial statement

Therefore, if we take a closer look at a Central Bank’s balance sheet, we should probably
observe huge numbers, maybe trillions, since 2009 until now. And indeed, this is what we see.
 Source: zerohedge.com

The “incredibly small” balance sheet of something around $0.88 trillion for the Federal Reserve
before the struck of the economic crisis in 2008 and the enormous add of approximately $3
trillion until now cannot be unseen. $3 trillion inject in the economy. But where did all that
money go? In the case of the Federal Reserve, $2.3 trillion went in the Fed Excess Reserves,
meaning that the majority of the money created by the Federal Reserve was not made available
for loans. But, the rest of the money, which did not take the form of Excess Reserves, is bidding
up stocks, bonds and real estate – in this case, there are big institutions which are buying vast
quantities of all three asset classes with money “printed” by the Federal Reserve.
Now let’s take a look at this chart, which provides a more expressive point of view in regards
with our discussion. This chart shows the relationship between S&P 500 and Federal Reserve
“Printing”. The image is clear: US stock market will fall if the Federal Reserve would stop
injecting this money in the economy, highlighting the fact that the stock market is hooked on this
artificial stimulus.

Following furthermore the example with the Federal Reserve, it all may seem like a winning
game: the US government enjoys a powerful and strong market for its Debt and very low interest
rates, the banks make huge profits with almost zero risk and great boosts in bond prices, stock
prices and housing prices. But history reminds us that you can only get away with “printing”
money for a while, but when it catches up with you, there is only disaster coming after, like in
the horrible cases of hyperinflation in Germany or Zimbabwe.

All in all, one will never be able to print real prosperity and eliminate poverty. Real prosperity
comes from real people, acting sustainable enough to create real value. QE is therefore an
unusual, never tested before measure taken by the government in an effort to remedy the
economic downward.

References:

1. “Quantitative Easing and Unconventional Monetary Policy – an Introduction”, The

Economic Journal, Volume 122, Issue 564, pages F271–F288, November 2012

2. “What Is Quantitative Easing Explained – Definition, Risks & Effects on the Economy”,
Money Crashers, May 2016

3. The Economist Print Edition - Unpalatable choices, January 4, 2014