Since the global economic crisis of 2008, the Federal Reserve, the US central bank, has printed more than $2 trillion and continues to do so. As a result, the size of its balance sheet has more than tripled and now it holds more than $3 trillion and still growing, while the markets continue to rally.
A Forbes article noted that “by the end of June, the Federal Reserve will have purchased $600bn (£363bn) of longer-term Treasuries, with the US government effectively buying its own debt from funds created ex nihilo. That’s on top of the original $1,750bn (£1,048bn) QE scheme, launched in late 2008”.
What is the reason behind this paper money printing spree? What is its impact to ordinary citizens and the economy?
To better understand this, we must first know what “quantitative easing” is. Federal officials used the term Quantitative Easing to describe this money creating activities. (Since the economic crisis, there have been two rounds of Quantitative Easing: QE1 and QE2.) The money printed for this purpose was used to push up the stock market. We all know that higher stock prices mean more wealth for people; therefore more money to spend for richer people.
This spending supports the economy, creates jobs and generates tax revenues that help reduce the government’s budget deficit.
Some say the Fed did it to prevent the global credit bubble from imploding and collapsing into a New Great Depression but others say this action has made two crucial contributions to the economy.
- It allowed the government to finance the trillions of dollars of budget deficits at very low interest rates. The Federal Reserve did it by creating money and used it to buy government bonds and other debt instruments from the market. The people who sold the bonds would then have cash and some of the cash were invested in new Treasury bonds that the government sells to finance its deficit. In that way, government kept the economy from collapsing. By directly buying government bonds and injecting cash into the market using the money used by people to buy government bonds, it became easier for government to spend more than it took in as tax revenues.
- The new money pushed up the price of bonds which caused the yields (the interest rates the bonds pay) to fall. The creation of paper money therefore pushed interest rates lower that resulted in the lowering of mortgage costs, car loans and other consumer credit.
However, these money printing activities have its negative consequences.
As we all know, printing more money creates inflation and there are three categories of inflation: CPI ex-food & energy, asset price inflation and commodity price inflation.
- Consumer Price Inflation (excluding food and energy) or core CPI as it is often called. This measures the price increases for the things consumers buy such as clothing, electrical goods and cars; but it excludes the price of food and energy because these are considered to be too volatile. Globalization has resulted in the collapse in the cost of hiring workers in the manufacturing industry.
- Asset price inflation, or, inflation in the price of stocks and bonds – This has been successfully addressed by the Quantitative Easing
- Commodity price inflation – Too much money creation has pushed up oil prices and cause the surge in food prices which could result to civil wars and destabilization in some countries
The worst potential consequence of this would be hyperinflation which could end up in tragedy. The great American economist, Irving Fisher (1867 – 1947) put it this way, “Irredeemable paper money has almost invariably proved a curse to the country employing it.”
Time will tell if it eventually proves to be a curse for the United States and the rest of the developed countries such as Germany, England and Japan.