Quantitative Easing is a Meaningless Term
We are heading into an inflationary crisis. Quantitative easing and an irresponsible Federal Reserve are the major culprits. Quantitative easing is an approach where a central bank purchases long-term securities to provide cash to an economy. Economists will use fancy terms to sound smart, but it’s really nothing more complicated than that. However, some backstory is needed.
“Inflation is taxation without representation.”
Milton Friedman
The Federal Reserve Is a Failure
Before the specifics, let’s start with the basics. The Federal Reserve is the U.S.’s central bank. It controls the country’s money supply. However, the Fed itself doesn’t actually print money. It is the Treasury Department’s Bureau of Engraving and Printing that does the dirty work. The Fed “just” decides how much money to print.
Congress created the Federal Reserve in 1913 through the Federal Reserve Act. It may seem odd that it took the U.S. so long to have a central bank. However, it fits nicely with the U.S.’s emphasis on the states.
For those history buffs out there, you’ll remember that Alexander Hamilton tried to create a national bank in the 1790s. Indeed, he did create a bank. It’s called the Bank of the United States and it’s in Philadelphia as a National Historic Landmark. Unfortunately, in 1811, the Democratic-Republican majority in Congress decided against renewing its charter.
The dispute was long-winded, but there were two main reasons for the opposition. First, many (like Thomas Jefferson and James Madison) believed it was unconstitutional. The country was a baby then, and it was unclear whether the Constitution permitted such overreach of the national government. There were state banks, and the thought was that a national bank would centralize power in the federal government.
Moreover, farmers in the South and merchants in the North hated each other back then. The farmers distrusted the merchants and hated the idea of a big, bad central bank. Jefferson and Madison tended to support the farmers.
What Does the Fed Do?
Anyway, the Fed today has two tasks: controlling inflation and unemployment. It has several tools to accomplish these tasks. The three main traditional tools are open market operations, or OMO; the discount rate; and reserve requirements.
OMO is when the Fed buys and sells assets in the market. Generally, this means the Fed will buy/sell short-term U.S. Treasury Bills from/to banks. For example, if the Fed wants to increase the money supply, it would buy T-bills, giving money to banks. These banks can then lend the money to customers where it circulates through the economy.
The discount rate is the interest rate the Fed charges banks to borrow money from it. With a low discount rate, the Fed incentivizes banks to take money from it, which gets that money into the economy.
Finally, reserve requirements are the percent of money banks must hold on them. You store your money in a bank, but the bank is out there lending that money to others. Lending money puts that money in the hands of others who boost the economy. With low reserve requiremets, the Fed can boost liquidity.
The Fed’s Cooler Friend Is Quantitative Easing
Following the Great Recession, the Fed began to find new tools. The less exciting one is related to the discount rate. Instead of charging banks a rate to borrow money from the Fed, the central bank now pays interest on money banks store at the Federal Reserve.
However, the flashier tool is quantitative easing. As I mentioned at the beginning of this article, quantitative easing is buying/selling long-term assets. You may have a question now. Isn’t that the same thing as OMO? The answer is a resounding YES. And that’s the point of this post.
Quantitative easing sounds really cool. When I first heard it, I thought the Fed was performing some really new tricks. But that’s not it at all. In fact, quantitative easing is a reminder of why Jefferson and Madison didn’t want a central bank: give some economists too much power and they get out of control.
Short-Term Vs. Long-Term: Who Cares?
So you may be thinking: if OMO is the same as quantitative easing, then who cares? Well, I care. And you should too. The only reason for OMO is to put liquidity in the economy (in effect lowering/raising interest rates). Don’t let anybody tell you otherwise. It’s not for the Fed to hold assets like a hedge fund. Unfortunately, that’s what the Fed does nowadays.
Take a look at the Fed’s balance sheet. The Fed is now the wealthiest business in America. On May 31, 2021, the Fed had nearly 8 trillion dollars in assets! In early 2008, before the Great Recession, the Fed had 900 billion dollars in assets. By the end of the year, that amount doubled, but it was still a quarter of the current amount!
The Fed is putting money into the economy that we don’t have. The annual inflation rate in April of 2021 was a whopping 4.2%. For the record, the Fed claims its goal is to keep inflation at about 2%. It has become a massive Ponzi scheme. It is carrying expensive long-term assets that cost billions of dollars, pouring money we don’t have into the economy. With OMO, assets are shorter-lived with lower values and smaller effects on the money supply and interest rates.
Quantitative Easing Is Irresponsible
Hopefully, this article has shed light on why quantitative easing is irresponsible. Congress created the Fed as an independent body that can’t be easily manipulated by the rest of the government. However, now we have a rogue Fed that is pouring money into the economy and is threatening mass inflation. Fed, stop it!
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