The Flaw Of Quantative Easing

So yesterday the DJI took a 300 point tumble as the European Central Bank instituted Quantitative Easing.  What is that and why is it unhelpful at best.

Quantitative Easing is a monitary policy to create liquidity when interest rates are already at zero.  The Central Bank redeems it’s old bonds at face value and issues new ones reflecting the zero interest environment.

Now there’s already a mechanism to do that called a Bond Market where you can take your paper and sell it to someone else at the current interest rate BUT you have to do so at a discount to face value to reflect the current interest.  A trivial example-

If the interest rate is 10% over 10 years you can buy a bond from the Central Bank for $900 that has a face value of $1000 redeemable in 10 years.  Now during that 10 years you get nothing, at the end you get $1000.

If you need the money now (liquidity), you go to the Bond Market and sell your bond at the going rate which has several complicating factors like the current interest rate and the date the bond comes due but is less than the face value promised if you hold the bond until it is paid (discount).

Quantitative Easing pays you face value now.  Whether this is a good deal for the Central Bank (and it almost never is because that’s not the point) depends on the amount of time between now and when the bond comes due and what interest rates are (if interest rates rise steeply and there is a lot of time between now and when the bonds are due it’s a good deal for the Central Bank).

So what is the point?  Central Bank bonds are mostly held by regular Banks who are required to hold a certain amount of assets in the form of these bonds.  The Banks cash out their Central Bank bonds, buy zero interest Central Bank bonds and pocket the difference.  In other words, just another bailout disguised with accounting tricks.

This is thought by Keynesians who think this new influx of money will be put to productive economic use to be slightly stimulative.  It’s thought by Modern Monitarists to be meaningless and by Austerians a debasement of the currency.

In fact most of the money simply goes into the pockets of Banks, the Billionaires, or gets wiped out in speculative bubbles like… oh, say the Stock Market.

So what we have here is a policy that might make a minimal amount of sense if there were a demand for productive use but will really only be used to make our insolvent Banks seem more solvent when they are in fact bankrupt.

This will become very apparent in Germany and throughout the Euro-Zone after Greece, Spain, Italy, and France repudiate their Euro debts and return to their own devalued (but for who?  Banks and bond holders, that’s who) currency.

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Michael Hudson is a Research Professor of Economics at the University of Missouri, Kansas City.