Quantitative easing is a phrase that has been tossed around frequently in the United Kingdom over the past year or so. This vogue has been caused by the fact the Bank of England has been forced to engage in the activity, but nevertheless there does not seem to be a widespread understanding of what the term means. This is a shame, because it is not that difficult a concept to understand, and it illuminates many of our current economic problems.

Quantitative easing is something typically embarked upon by central banks when they feel there is not enough money in the economy: this is what the phrase means, an "easing" of the quantity of money in the economy; to coin another similar phrase, it is a "loose" policy. A lack of money in the economy causes all sorts of problems, but the most apparent one is the difficulty everybody experiences in borrowing money.

This is why the first phase of the global economic crisis was called the "credit crunch": money, or credit, became more difficult for everyone - from banks and companies to individuals - to borrow. This severely restrains economic activity. The first thing central banks do when credit becomes difficult to obtain is that they lower interest rates, which means they will themselves lend money to other banks at very low rates of interest. It is hoped that this will make commercial banks more willing to borrow money, which will in turn increase the amount of money in the economy and make borrowing cheaper for everyone. However, sometimes this is not enough, and credit still remains stubbornly hard to obtain because commercial banks are still unwilling to lend money at reasonable rates. This is when quantitative easing comes in.

Under a programme of quantitative easing, a central bank literally creates money (not by printing it, merely by electronically adding it to its own balance sheet) and then uses it to buy things from other banks. Typically it buys government bonds or various other things with which we need not concern ourselves. By doing this, it adds yet more money to the overall supply of money in the economy, which it is hoped will contribute to making credit more cheaply available. If you imagine quantitative easing as being a process whereby the central bank throws money out the window to the people below to stimulate spending and hence the economy, you won't be far from the truth.

If this doesn't seem logical to you, just consider the simple laws of supply and demand: when something is in short supply, it is very expensive, whereas if something abounds then it is cheap. Money is the same. If the overall money supply is large, then the cost of borrowing will be low, because everyone is trying to lend you money and you can shop around for the best deal. If money can be lent easily, economic activity like starting a business or buying a car becomes easier. Like low interest rates, quantitative easing is supposed to reduce the cost of borrowing and hence stimulate the economy by making banks feel more confident about lending money. However, the risk is that the banks will simply absorb the money themselves rather than increasing lending, as appears to have happened in the United Kingdom.

There are other risks. The opposite of a credit crunch is a credit boom. If quantitative easing is too successful, then it could lead to a massive surge in the availability of money, which will in turn lead everyone to increase their prices because they know their customers have easier access to credit. This causes inflation. Quantitative easing causes inflation not just by increasing the overall amount of money and hence decreasing the value of every unit of that money, but also because it makes credit much more easily available. This can in turn cause your currency to become less valuable on international currency markets, which dissuades people from investing in your economy because they are worried that they will lose money as inflation renders your currency less valuable.

One perceived upside of quantitative easing is that it can be used to lend money to governments who are having difficulty financing their deficits. In Britain, the Bank of England "printed" hundreds of billions of pounds and then used them to buy government bonds - effectively lending the government money. At a time when the government faces the prospect of finding it increasingly difficult to borrow money because investors are worried that the budget deficit is large enough to make it increasingly unlikely they'll ever get their money back, the added advantages of this are clear.

The European Central Bank, responsible for the euro, has just embarked on a programme of quantitative easing to artificially make it easier for countries like Greece to borrow money.1 This might be attractive in the short-term, but it risks allowing governments to postpone the difficult decisions they need to take to reduce their debts to a level where they can borrow money on their own merits. Furthermore, quantitative easing is not sustainable because of the risk of inflation, and hence while it may be necessary or at least beneficial for a while, eventually its beneficiaries have to learn to stand on their own two feet. Otherwise, the negative consequences will quickly outweigh the positive. How countries like Britain manage their "exit strategy" from quantitative easing will determine how soon they can again achieve some measure of sustainable prosperity.

1. The ECB claims that it is not increasing the overall amount of money because it will sell assets at the same rate it buys them; this is called "sterilization". It is yet to be explained precisely how this will be accomplished, however, leading many to suspect it is pursuing simple and inflationary quantitative easing .

The greatest danger I can see in QE is as Noung has put it: eventually its beneficiaries have to learn to stand on their own two feet. The problem is that QE makes that much more difficult. The use of a crutch is always in danger of atrophying the parts of the body that the crutch helps to support. Within a single human body, this can be acceptable if age or pain or prior damage makes going without the crutch too much of a burden. Individuals eventually die, and the atrophy caused by their crutches never grows into a problem for the human race, the nation, or even the village or family.

A national economy, however, only dies because it fails to maintain the strength that enabled its existence in the first place. I began this writeup because this difference is important to me, and I think it should be important to everyone.

I Google'd quantitative easing crutch to see if others recognize the same thing that I do. Here's one that describes the specific manifestation of atrophy wherein the government eventually becomes the economy, from http://cij.inspiriting.com/?tag=quantitative-easing: In reality, what government interventions did was to put the economy on a crutch. The longer the economy leans on the government crutch, the more dependent it will be on the government. Eventually, the government will become the economy.

Even though it champions QE, I think this one is important because it shows that even its proponents recognize that it is a crutch, from http://www.metro.co.uk/money/807746-200m-quantitative-easing-slowly-taking-effect: Give QE credit: The Bank of England's quantitative easing crutch is helping to put the economy on a sure footing

Here is a comment to an article by Paul Krugman, recent winner of a Nobel prize in economics, that proposes a question that needs to be asked. There is a growing push to Audit the Federal Reserve (see http://www.auditthefed.com) because this question never gets adequately addressed. This is from Rich888 at http://www.metro.co.uk/money/807746-200m-quantitative-easing-slowly-taking-effect: A more interesting question is the ability of the central bank to sell its credit holdings, particularly mortgages. There are few complaints when the Fed subsidizes an industry, but will there be an outcry when that support is removed? Will they be able to withstand the pressure from realtors, homebuilders and mortgage bankers, to say nothing of the big bond funds, to continue to provide the crutch? Only when this question is answered will they have any hope of retaining the perception of “independence” they have guarded so zealously over many decades.

If you followed one of the links to crutch, you'll find my writeup on atrophy, which is one of the important hidden dangers that authorities never seem to address. I did a search on quantitative easing atrophy and found this, from http://www.rense.com/general88/bern.htm: Now Bernanke is expected to carry on where his former boss left off, using all the tools at his disposal to offset the atrophy that's endemic to mature capitalist economies.

What atrophy are they talking about? My understanding of the atrophy is based on legal tender laws. A legal tender law places an unjustified value on a particular good - that it be accepted as payment in lieu of any and all debts. In this case, "mature capitalist economies" means economies that have suffered from such a law for at least a few generations.

Why does this cause atrophy? This causes atrophy because those who wish to obtain capital goods are able to borrow the extra unjustified value without such value ever being produced. This is even more widespread when the good that is made legal tender is the product of a monopoly. In this way, the economy expands unjustifiably, failing to match its growth with the strength it ought to have to justify new investment. Fiat currency costs very little to produce, and legal tender laws vastly increase its value. QE is a mechanism through which fiat currency is made to look less like counterfeit money than illegally printed counterfeit bills. As Nuong points out: If you imagine quantitative easing as being a process whereby the central bank throws money out the window to the people below to stimulate spending and hence the economy, you won't be far from the truth.

I know why counterfeiting is illegal, but how common is that knowledge? I did a search for "counterfeit illegal" and found a reference to a German WWII plan called Operation Bernhard. Here it is, from http://en.wikipedia.org/wiki/Operation_Bernhard: Operation Bernhard was the codename of a secret German plan devised during the Second World War by the RSHA and the SS to destabilise the British economy by flooding the country with forged Bank of England £5, £10, £20, and £50 notes.

It seems to me that this plan is no longer secret and no longer illegal. It has been renamed and the short-term benefits are now being used to hide it. Someday, perhaps, youngsters will get real educations, and such programs will cease to be acceptable.

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