Today’s drama stars Mr. Banker and Mr. Fed, and our hero Quantitative Easing. It’s a production you won’t want to miss, because you’re one of the cast! Will our hero be able to save the masses from economic calamity? Or will the hero turn out to be a zero? Join the cast of millions as our hero burns through Billions in cash like he created it out of thin air! A must-see drama! Gripping! Thrilling! Suspenseful!
You’re going to hear much about Quantitative Easing in the coming weeks, as the Fed desperately tries to manipulate the economy to move again. Much will be written for and against it, but what is it, and why is the Fed pursuing the strategy?
If you subscribe to the idea government stimulus provides the way out of economic depression, you must find a way to inject more “stimulus” into the economy. However, almost everyone agrees another $800 Billion stimulus isn’t going to happen (the first stimulus didn’t work out so well), so how to use “stimulus” to spend another $800 Billion or so without calling it stimulus?
Enter Quantitative Easing, stage left (cue the spooky music).
It works like this. Suppose Mr. Banker holds $10 Billion in bonds or other assets. Nobody wants to buy them right now, so the Mr. Banker just sits on them, tying up resources. The Fed comes along and says, hey, we’ll buy them for more than the market will pay right now, and Mr. Banker says “sweet!”, and takes the Fed’s cash in exchange for the assets Mr. Banker couldn’t sell anyway. The theory says when Mr. Banker suddenly has his pockets stuffed with fresh dollars from Mr. Fed, he’ll loan them to business, and presto! Instant recovery.
Lather, rinse, repeat (with many banks) and suddenly you’ve “stimulated” the economy with another Trillion dollars or so … all without calling it stimulus!
Here’s where the fun starts (or the tragedy begins) — where does Mr. Fed get the money to pay Mr. Banker? Mr. Fed creates it out of thin air. That’s right, crank up the printing press Ma, we need another $800 Billion!
If you wondered this will cause inflation, ding ding ding! Winner! Exactly. At some point the economy figures out many more dollars exist out there, and prices rise accordingly to the supply of money. Of course, the Fed (and politicians) hope they (before hyperinflation sets in) can suck out that money before anything bad happens, like, you know, certain economic destruction.
And that, ladies and gentlemen, is how Quantitative Easing works. If it sounds scary and risky, you don’t need to adjust the colors on your TV, because it is scary and risky.
Conveniently, the Fed will begin this plan just after the election.