By: John Tamney
March, 10, 2014
The Federal Reserve’s seemingly endless program of quantitative easing (QE) begun under Ben Bernanke, and continuing at a slightly slower pace under Janet Yellen, has some of the punditry and much of the electorate up in arms. With good reason.
Implicit in quantitative easing is the horribly obtuse notion that central banks can produce real economic growth through their monetary machinations. If only life were so simple.
Back in the world of the reasonable, the sole purpose of money is as a stable measure of value that facilitates the exchange of goods and investment. Quantitative easing, by its very name, involves the corruption of money’s sole purpose as a stable medium of exchange.
In that case it must be stressed that QE has in no way boosted growth. The latter results from investment in new and existing commercial concepts, and for destabilizing the value of money, QE works against the very investment that would drive economic growth.
Worse, the imposition of QE can only take place when the White House and Treasury support such a move, the latter support speaks to a desire on the part of the White House and Treasury to devalue the unit of account (the dollar), and as investors are buying future dollar income streams when they invest, QE acts as an investment deterrent.
Looked at in terms of financial markets, QE similarly has not been good for stocks. Indeed, stocks have been rallying ever since word emerged from the Fed two years ago about an eventual end to the program, and as markets always price in the future, it’s apparent that investors would logically prefer an end to what which logically does not, and cannot, work.
Taking this further, implicit in the suggestion that QE has been good for stocks is the view that the creation of liquidity in search of yield will force buyers into the stock market. That’s fine, but for an investor to buy, another investor must be willing to sell. The better question to ask vis-à-vis QE is just how much healthier the stock markets would be absent this investment-sapping ball-and-chain conceived by the ever-fraudulent economics profession.
Another persistent view about QE that’s popular even inside the crowd that is properly skeptical of it is the notion that QE amounts to “money printing.” It does not. To be clear, the Federal Reserve has not been printing money. It hasn’t needed to, and that’s where the horrors of the Fed’s machinations become most apparent.
To see why, we have to address the Fed’s policy of paying interest on bank reserves. At present the Fed is paying banks 25 basis points for their “excess” reserves.
To the Monetarist School thinkers among us, they see IOR as the mechanism whereby the Fed keeps money tight, and in their perfect world the Fed would not be paying banks for access to their funds. They’re right that the Fed should not be competing for excess reserves, but they’re wrong about the impact of doing so.
The willingness of banks to lend money to the Fed for 25 basis points firstly speaks to the low cost of overnight credit that banks charge each other. At present banks borrow from each other on an overnight basis for roughly 15 basis points. This makes lending to the Fed relatively attractive. Still, this does not constitute “tight money.” It doesn’t simply because if the Fed ever succeeds in tightening beyond what the markets want, other sources of dollar credit here and around the world will make up for any dollar shortage.
Considering banks themselves, they never realistically have “excess” funds. Instead, banks long on cash are constantly lending to banks in need of short-term cash (the “repo” market); the lending taking place in return for the borrower showing quality collateral that merits the overnight loan. In this case, rather than lend their excess to each other at 15 basis points, the banks are lending it to the Fed at a higher rate of 25 basis points.
Still, it must be stressed yet again that this in no way signals “tight money.” What it in fact tells us is that banks don’t see quality lending opportunities, and it also signals that demand for credit is very low. This is basic economics. Banks would much rather lend at higher rates of interest to all manner of borrowers in order to earn more than 25 basis points on their excess reserves, but with demand for credit once again low, banks are lending to the Fed.
The lesson here is that despite what is broadly presumed by economists and the punditry, the Fed can’t force money into the economy, nor can it increase “money supply.” Money supply is demand determined, and with the economy still relatively weak, there’s very little demand for the dollar credit that’s been expanded by Fed purchases of bank assets.
What about the supposed “money printing” by the Fed? There’s once again no such thing occurring. Instead, the Fed is able to engage in its program of quantitative easing thanks to its 25 basis point payments for bank reserves. With the funds borrowed from banks, the Fed has the means to purchase all manner of Treasuries and mortgage bonds.