What is QE / Tapering?

To make traditional cash, you feed paper and ink into a printing press, and money comes out the other side. To make money used to buy securities for quantitative easing, you feed electrons into a computer, and suddenly the amounts in bank account balances jump up. Welcome to Atlantis Report. Quantitative easing means that the government effectively "printed money" and used it to buy back government securities - in other words repaid government debt. The bondholders that sold their securities received the money, but the US government (and therefore US taxpayers) received the benefit of QE. The danger of QE is that it fuels inflation. To everyone's surprise, this does not appear to be happening despite the Federal Reserve has created $4.5 Trillion to repay government debt. Quantitative Easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money. Quantitative easing occurs when a central bank purchases government securities (e.g., Treasury bonds in the U.S.) or other securities off the open market. It does this to lower interest rates and increases the money supply. It differs from simple open-market operations in its scale. An expansionary monetary policy involves the central bank buying a steady amount of government securities in order to increase bank reserves. Quantitative easing consists of purchasing a lot more for the sake of accomplishing a heftier goal: lowering interest rates and increasing the money supply. It doesn't involve printing more money. In the U.S., the Treasury prints money while the Fed (the actual central bank) performs the monetary policy described above. QE involves the creation, by a central bank, of settlement balances or reserves to purchase assets in a secondary market, typically for government treasuries. The central bank gains an asset equal to the value of the treasuries they buy, and liability of equivalent value, in the form of settlement balances. In layman’s terms, central banks create money to buy assets, with the intention of raising the price (lowering the rate of return) on that asset class. So Where did all the money created by QE eventually end up? It gets sucked back into the Federal Reserve Bank—whoosh!—and annulled. Let me explain. There are two types of money: Central Bank money (“reserves”) and money for the rest of us. Central Bank money can only be used by banks, governments, and some government-linked institutions. It is kept in accounts at the Central Bank, where it is called reserves. Money for the rest of us is private money, created by ordinary banks. Money that comes from the Central Bank, but which everyone uses, is notes and coins. The primary function of reserves is for banks to make payments to each other that reflect transactions between the rest of us. It looks as though private money moves from one account to another. But it doesn’t. The bank of person A reduces the amount in A’s account, which is really just a record of what the bank owes A. A’s bank sends an equivalent amount of reserves to the bank of person B. B’s bank now owes more money to B and increases the value of his or her deposit with private funds. Reserves enter the banking system when the government spends money: on public service wages, or say cruise missiles. Reserves from the government’s account at the Central Bank are sent to the ordinary bank used by the individual or company being paid. That bank increases the deposit in the accounts of the public servant or cruise missile supplier. The government can only get reserves back by selling a Treasury bond to investors. The bond sale is paid for (“settled”) using reserves from the banks that have the deposit accounts of those investors. Quantitative easing floods the financial system with money, making borrowing cheaper. Central Banks created trillions of dollars’ worth of reserves to buy back government bonds from investors, via the banks. This gave the banks vast amounts of reserves. So the banks gave the sellers of bonds vast amounts of new private money. That private money could be spent in the economy. When the economy recovered, the Fed stopped buying Treasury bonds. When the government-owned bonds matured, the government repaid the Fed. It handed reserves back, which the Fed destroyed. Reserves also leave the banking system when the government sells new Treasury bonds to private investors, or when it collects taxes. A tax payment involves reserves being transferred from an ordinary bank to a government account at the Central Bank. An equivalent amount of private money in the taxpayer’s bank account disappears. So, fear not, that money that was invented is regularly un-invented. It is un-invented when the Fed destroys repaid bonds, when new bonds are sold to private people, and when tax is paid. At the moment, reserves are shrinking, because quantitative easing is being reversed. This may be good or bad. We are finding out. A large portion of the new bank reserves created by QE ended up in the form of excess reserves, which are held in Federal Reserve Bank accounts to earn Interest on Excess Balances at a rate of 0.25%. The new reserves are part of the U.S. monetary base (M0 measure), as they can be lent out and create more bank reserves under Fractional-reserve banking and the money multiplier effect. This is happening as well . There are several factors behind why banks choose to park large amounts of excess reserves at the FED and not to lend them out Post-2008 bank regulations increased the cost of bank lending operations by raising capital requirement and demanded stronger compliance Some measures of credit lending standard (to individual borrowers) remain tight Economic growth is still uneven (some sectors of our economy remain weak), and loan demand has not been as strong as in previous recoveries It is "risk-free" to park money at the FED under financial repression The money found itself mainly in the accounts of the too big to fail banks. These in turn not only have used the money to invest and improve their profits (especially in the derivatives market through fractional reserve banking) but, because of the zero interest rate policy (ZIRP) have loaned the money out to corporations who themselves reinvest it to buy back their shares and stimulate the stock market artificially. Obviously, this kind of manipulation (based on Keynesian theory) also feeds the wealthy top 1% and does little to improve the general economy and middle and lower classes. It is a failed attempt by the Fed to keep the economy going. Instead of allowing the market to work things out as it should have in a reasonable way (a form of laissez-faire perhaps) it artificially (relying on academic economic theory) interfered with the economy and in fact, has made things worse. Better in 2008 to have let the big banks fail and reset the economy as painful as it might have been than to allow the economy to get even worse. Most of the banks throughout the US were in good shape and would not have suffered. Money printing never heats up the entire economy uniformly. Depending on many parameters (which are beyond the control of the Fed), it always flows to some places more than the others. By area, I do not just mean geographic location, but more importantly, I mean asset class. In fact, this mismatch of flow is one of the reasons money printing inevitably results in bubbles and then the inevitable busts prompting more money printing. As for the Federal Reserve QE since the great recession, most of it is still in the Fed itself, held in the bank balance sheets. The rest percolated to the economy via bank lending or public spending of the Federal government, boosting up asset prices. A lot of it also ended up outside the US because of the persistent trade deficit the US maintains. Again, a big part of overseas dollars got recycled to the US via the treasury bills, which is considered a safe haven. The QE money has gone to two places. Firstly it has gone into the stock and bond markets where it has very much caused inflation in stocks and bonds. Prices are much higher than they would have been without it. Secondly, it has gone into debt repayment. We hear a lot about money creation, but we rarely hear about money destruction. Nevertheless, money destruction is happening on an enormous scale at the moment because every time a bank loan is repaid, in whole or in part, the principal part of the repayment is destroyed. This is only true of bank loans, not loans between people. And it happens because of the way banks handle the loan process. Between these two, the QE money is entirely used up. This is why QE has not caused inflation. The stupendous amount of debt repayment in today's world dwarfs the merely vast QE money creation.












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