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Quantitative Easing, Links and a Primer



April 09, 2012 – Comments (0)

Excellent summary of the most relevant points regarding QE. I have also written several post that discuss the realities of QE, OMO and US Government bonds in more detail as well:

-- What would happen if the US Federal Government stopped issuing bonds?,
-- Margin Debt, the Stock Market, and QE,
-- One of the smartest comments I have read yet regarding Quantitative Easing,
-- Follow Up: QE is not Inflationary, Thoughts on Risk Asset Instability,


9 April 2012 by Cullen Roche

There’s still a lot of confusion over QE and its actual economic impact despite some pretty clear-cut evidence about what the policy does.  A brief recap might help.

Just to be clear – QE in the USA does not work by “funding” the spending of the US government.  I know this is a rather unorthodox perspective, but the government doesn’t need to buy its own bonds in order to print money that it can print at will.  Remember, bond auctions are not funding operations.  They are reserve drains.    You might see here if this is already confusing you.

The keys to understanding QE is in the following points:

-- Because the USA is sovereign in the US Dollar, there is no such thing as “funding” the spending of the government.  Therefore, there is no such thing as the Federal Reserve being able to “fund” the US Treasury.  See this article for more.
-- QE in Europe can actually “work” because it is essentially a form of fiscal policy that actually helps to fund the countries in Europe (or at least help them avoid losing funding).  This would be like the Federal Reserve buying municipal bonds from states in distress who can’t find Federal funding (this would essentially be a form of fiscal policy and would be “money printing”).
-- QE in the form of buying back government debt is not “money printing” or “monetizing the debt”.  It is a swap or a change in the composition of private sector financial assets.  No net new financial assets are being added.  The private sector gets reserves, the Fed takes the bonds.  The net loss is in the difference in interest income.  But the private sector is not left with “more money”.
-- Banks never lend reserves so more reserves don’t mean more lending.  Loans create deposits.  The money multiplier is a myth.  This is why QE1 and QE2 did not cause a surge in loans or inflation.
-- The wealth effect in equities is a myth.  The flaw in QE is that it reduces the number of specific securities so it can force investors out of one asset and into another.  This can drive up prices, but does not necessarily drive up the fundamentals.  It’s not unlike a stock buyback and its immediate effects which drive up price, but have no impact on the underlying corporation.
-- The portfolio rebalancing effect of QE can cause substantial disequilibrium in the economy.  We saw this in QE2 when I repeatedly predicted that QE was causing an imbalance in bond and commodity prices.  And when the air came out of that 2010 nearly turned into a nightmare….

If you still have questions on QE I would consult this more detailed primer.

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