How quantitative easing works — or doesn’t (Part One)
From the wiki we get a definition of Quantitative Easing:
The term quantitative easing (QE) describes a monetary policy used by some central banks to increase the supply of money by increasing the excess reserves of the banking system. This policy is usually invoked when the normal methods to control the money supply have failed, i.e the bank interest rate, discount rate and/or interbank interest rate are either at, or close to, zero.
In this excerpt from the wiki, we see that quantitative easing is a method of flooding the economy with money when other, more traditional, methods have already failed. QE is an acknowledgment that the amount of currency in circulation in the economy is probably still contracting, which implies the economy is contracting as well.
QE is undertaken on the assumption that the amount of economic activity can be increased by increasing the amount of currency in circulation. This is because, in times of economic contraction (i.e., a depression), as the economy contracts, money is withdrawn from circulation in order to satisfy (payoff) debts, and no new opportunities for productive investment exists. As money is withdrawn from circulation, this withdrawal is felt as a shortage of credit like the one we are currently experiencing.
This is the rub, however: for reasons we will explain below, QE cannot increase the amount of currency in circulation by itself.
For now, let’s look at how the policy is implemented:
A central bank implements QE by first crediting its own account with money it creates ex nihilo (“out of nothing”).
From this excerpt it is possible to conclude that QE is only possible in an economy with a debased fiat currency. Why? Because, of course, government cannot simply create more gold or other metal money “out of nothing”. Gold requires rather arduous physical exertion in comparison to merely entering the number 1,000,000,000,000 into a computer terminal.
The money created “out of nothing” can itself only be a fiction. It is a fiction of money, since, unlike metal money, it requires no meaningful exertion of human effort, and, hence, has no value.
Most writers — even those who understand that this currency is not really money — still consider it some sort of token representation of money — akin, in some fashion, to the paper money that circulated in the economy prior to the Great Depression. Because of this mistake, their analysis of the economy must be defective. The paper currency that circulated before the Great Depression was token money precisely because it could be exchanged for gold in some fixed proportion. Gold circulated alongside these tokens in the economy — you could walk into a store and use a gold coin to buy groceries.
In short, token money was converted into fictitious money not because it replaced real money in circulation, but because gold was withdrawn by law from circulation as money. This withdrawal removed the token character of the token.
And, why would gold be removed from circulation? Remember our earlier statement: money is withdrawn from circulation leading to a contraction of credit, because economic activity itself is contracting. When the Great Depression hit, gold was pulled from circulation to satisfy debts, and because the amount of profitable investment outlets for which it could be used suddenly shrank. All over the economy, gold fell out of circulation and into lifeless hoards. At the same time, like a game of musical chairs, when the music stopped, everyone without gold suddenly found themselves in dire need of cold hard cash, yet none could be found.
The implication of the above for QE is obvious. During the Great Depression gold did not disappear; it simply reverted to a dead hoard of metal. On the one hand, there was no shortage of money, but an excess of money. On the other hand, however, this money could not actually circulate in the economy since it could serve no productive purpose as capital — just as there were no shortage of workers, or shortage of factories to turn out product, millions of workers and thousands of factories stood idle because no profitable use for them existed as capital.
It is the same for the Federal Reserve’s QE program. It is not enough simply to create a trillion fictitious dollars, having created this fictitious money “out of nothing”, the Federal Reserve now has to get this new fiction to circulate in the economy. This first step is to hand it out to the agents of the Federal Reserve:
It then purchases financial assets, including government bonds, agency debt, mortgage-backed securities and corporate bonds, from banks and other financial institutions in a process referred to as open market operations.
Did you see what just happened? According to the wiki, the Federal Reserve created fictitious money — something absent any value at all — and then used it to purchase some other things: government bonds, agency debt, mortgage-backed securities. These financial instruments, which are in the possession of banks and other financial institutions, are voluntarily sold to the Federal Reserve for a sum of fictional money having no value at all!
It may appear at first that the Federal Reserve is systematically stripping the banks and financial institutions of their assets in return for worthless dancing electrons, but the situation is just the opposite. This is not robbery, folks. There is no coercion involved in the transaction, yet banks and other financial institutions voluntarily hand over their assets to the Federal Reserve in exchange for a fiction that doesn’t exist until the Federal Reserve creates it. Assuming that the CEOs of these financial institutions are not insane, this transaction amounts to an admission that the bonds, debt paper and securities sold have no value — that the face value of the assets are as fictional as the dancing electrons for which they are being exchanged.
There is, of course, this difference between the two fictional objects: at least so far as toxic mortgage-backed securities are concerned: there is no market for them, while currency is currency and can always be spent — especially when the currency in question are dollars.
Also, it should be acknowledged, since the object of the exercise is alleged to be a lowering of interest rates generally, the Federal Reserve will likely be paying more than the original price of the bonds, agency debt, and mortgage-backed securities. In this way, the Fed can push interest rates down still further. (This is because, the higher the price paid for a bond, or like asset, the lower is the interest rate accruing to it.)
So, according to the wiki, the Federal Reserve implements QE by purchasing certain assets from banks for more than the banks paid for them originally — and, this it does in order to push interest rates as low as it can. Rather than stripping banks of their assets with worthless dancing electrons, the Fed actually absorbs worthless assets from them — assets the banks could not sell since there is no market for them — and hands out more currency than the banks initially paid to purchase the assets.
Since, the Federal Reserve is only an oligarchy of private banks, ruling behind the fig leaf of laws which give them “responsibility” (read: control) of the world reserve currency, it is unimaginable that the situation could be otherwise. This much is revealed in the next silly statement by the wiki:
The purchases, by way of account deposits, give banks the excess reserves required for them to create new money, and thus hopefully induce a stimulation of the economy, by the process of deposit multiplication from increased lending in the fractional reserve banking system.
The authors of the wiki entry invite us to believe that the banking cartel, which already has the legal capacity to create currency out of nothing, now needs currency on hand to create this currency out of nothing! In fact, the actual mechanism of currency creation differs drastically from this scenario: Banks create currency simply by creating a balance in your account whenever you borrow — or in the account of the person from whom you purchase something. They do not need to have any excess reserve in place to create this money, since all of this is done at a computer terminal.
Excess reserves, therefore, do not stimulate lending at all. And, the wiki, in this particular explanation, gets us no closer to understanding how QE actually works.
In part two, we will try to get closer to a real explanation.