Quantitative Easing is a term that many Americans might hear bandied about on the late night news, but few understand or appreciate its significance.
In short, Quantative Easing (QE) is monetary creation by the Federal Reserve. In the current economy, investors find it tough to locate a safe place to lend their money with hope of any interest return. Therefore they turn to Uncle Sam and his frequent treasury debt auctions to stash their cash in government treasury bonds.
Of course this starves the private marketplace of lending ability so, with massive government debt sucking up so much private capital, borrowers have trouble finding lenders. Hence the Fed swoops to the rescue, buying up government debt from secondhand owners, thus driving up treasury scarcity and accompanying prices, while sinking interest rates on government debt and making it less attractive to lenders.
However, the Fed does not use tax dollars, nor does it borrow money to purchase these treasuries. Instead, it simply creates the money and injects it into the economy to stimulate private borrowing. As a convenient side effect, one arm of government (the Fed) can freely finance another (Congress’ appropriations) through monetary manipulation.
The Fed’s asset purchases during the first two QE sessions since the recession began have been enormous. During the first round that begun in November 2008 and colloquially called QE1, the Fed bought $1.75 trillion in assets, followed up in November 2010 by QE2, purchasing another $600 billion worth of government debt.
In fiscal 2011 the Fed bought a whopping 77 percent of all debt treasuries issued by the federal government.
Of course this type of monetary injection must have consequences for the economy. After all, the Fed cannot dump trillions of fiat dollars into the economy and see no ripples of inflation or economic distortions, but paradoxically the latest figures from the government’s Consumer Price Index show that inflation averaged around 1.7 percent over the last year.
So where is all of this QE money disappearing into?
Much of it is going overseas, into commodities, and into even more purchases of government treasuries. U.S. dollars are our greatest export to countries like China—who amass them into their central banks’ foreign currency reserves—and Washington’s debt blowout demands ever more domestic capital to be sunken into federal treasuries. Commodities are also rising in part to this artificial flush of liquidity and fear of further devaluation of the dollar.
The viability of these excess monetary outlets all hinge on the assumption that the dollar remains the world’s reserve currency and our government’s bond markets never see the loss of faith that is occurring in many European countries. Unfortunately, both scenarios are currently unsustainable and this cached money eventually will make its way back into the U.S. economy, risking ruinous inflation and economic chaos.
Despite trillions in previous purchases and close to zero percent Fed interest rate, lenders are still hesitant to lend, and the economy continues to grow at an anemic pace. After the dismal job market data released in early September, the Fed began anew the effort to buoy the economy with easy money. In an upping of the ante, QE3 has now commenced with the Fed buying $40 billion of assets a month indefinitely. This monetary distortion will have an impact on every American as financial speculation prompted by easy money builds a mirage of economic growth that will shatter against the slightest economic hiccup or monetary tightening.
Moreover, every QE dollar created will inevitably shrink the purchasing power of each greenback, steadily eroding the assets of the saver and consumer. Inflation is the equal opportunity destroyer of wealth.