There’s this saying that goes, “Give a man a gun and he can rob a bank. Give a man a bank and he can rob the world.”
Warning: I’m about to talk about economics. Read on at your own risk.
QE defined:
Quantitative Easing is a form of monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending, investment and consumer spending.
What does this look like in simple terms?
Central bank creates money. Yes, just like that – whether physically or electronically, a bank will add a few zero’s to their balance sheet.
They will then use this money to purchase mortgages, bonds and securities from the open market, ie. Banks, through their trading arm.
The result is that yield (interest rates) will decrease and safer investments are removed from the market.
The Banks, now flush with cash are able to lend to businesses and consumers.
Businesses are able to use the money to produce, hire and sell more products and Consumers are able to borrow money at lower interest rates and spend to satisfy their demand.
Why it doesn’t work:
Most people I know don’t feel good going to the bank and asking for a loan in order to go buy let’s say… A fridge.
Economically speaking, QE in theory should work. If you took out a loan to buy a fridge that cost $1000 and the original interest rate on that was 10% a year, that would mean you would pay $100 in interest on that fridge. Once QE kicks in, banks are able to offer you a lower interest rate, say 1%; so now instead of paying $100 a year, you now pay $10. Sounds pretty good right? But this is not really how it works in real life.
It is important to understand the fundamental psychological difference between earning and borrowing.
Imagine this scenario. Joe has been working at his construction company for the past 3 years; he’s diligent, punctual and reliable. He has been earning $10/hr for all of that time.
One day, his boss brings him into the office and says: Joe, you’ve been doing such a great job these past few years I want to double your pay.
What’s the first thing Joe’s going to do? Save and or invest his surplus? No! He’s going to go shopping.
If you want to increase consumer spending, we need to pay our employees more money.
Unfortunately, the reality is that wages have stagnated for the 2-3 decades while productivity and inflation have risen.
The solution:
This practice of expansionary monetary policy leads to low interest rates which in turn has an adverse effect on productivity forcing capital to migrate into foreign and emerging markets in order to realize higher returns.
This creates a savings-investment gap that reduces the capital formation required for the economy to grow which then renders a high fraction of its existing capital stock obsolete.
In a QE environment, while aggregate spending may increase, this behavior does not flow down to the real economy because relative prices (labor vs. capital) work against it. What results is a higher rate of unemployment as capital moves to foreign economies – especially those with lower labor costs. As money moves abroad, outsourcing is encouraged; imported goods and services become more attractive to Western consumers because they are cheaper in comparison to locally produced goods resulting in yet more outflow of capital, outsourcing and unemployment. The vicious cycle exacerbates the disadvantaged position of western economies leading to mounting budget deficits and external debt obligations.
Printing money will not address the fundamental problems underpinning struggling western economies – on the contrary, it has damaging effects in the long-run in terms of capital accumulation, output, employment, innovation and living standards. Growth and job creation needs to become the overwhelming preoccupation of governments and not that of central banks. Short term solutions need to cease and an consideration of long term domestic investments in production, infrastructure, education and healthcare should be examined.