Quantitative easing – the $5trn gamble

Janet Yellen: gamble might have paid off

In April 2009, the world’s most powerful people were in a tight spot. Shey met in London to come up with a plan. You see, the world economy was not meant to have blown up the previous September. And the lawyers, central planners, politicians and central bankers of the G20 needed to be seen to have things under control.

They were backed into a corner, so they decided the only way out was to print loads of money. These guys were willing to ‘roll the dice’ – they decided to print the money and pray to God that inflation wouldn’t rip the world economy apart.

Almost five years later, they’re still at it. The major central banks have printed $5trn and counting. And it looks like their gamble might have paid off.

A little bit of poison does you good

Inflation is the key variable when it comes to macroeconomics. It determines how much stuff your investments will buy you, and it’s the number the central bankers base their monetary policy on.

In fact, in the USA, policy makers are now concerned that inflation is too low, having settled at around the 1% mark.

What’s wrong with low inflation, you may well ask?

Well, for Janet Yellen, the newly appointed chair of the Fed, this figure has considerable implications.

You see, Janet Yellen was instrumental in adopting the Fed’s 2% inflation target. It is officially an aim of the Fed to target and maintain 2% inflation. Though runaway inflation isn’t the goal, it seems that a little bit of poison does you good.

If you ask me, all this is really about eroding the value of debt. But they make some other spurious arguments about how it helps the employment market.

Anyways, despite the heroic efforts of money-printing central bankers, inflation has stayed low. And that’s a very interesting turn of events.

You see, over recent months, the US jobless figures have been improving. The economy seems to be ticking up. Now, normally one would expect inflation to pick up too. But it hasn’t happened, and it’s left many policy makers “baffled”.

Well, perhaps, they shouldn’t be so taken aback. After all, energy prices have been falling because of the shale gas revolution. The dollar has been pretty stable, and as we see in the UK, consumer prices are subject to massive discounting.

Shale’s a big part of the story. The internet is another. The internet is thrusting competition into just about every aspect of the consumer market. As the headlines about an awful Christmas season for retailers suggest, there’s a lot of downward pressure on prices.

In fact, inflation is falling in much of the Western world. Last week, the European Central Bank reported core inflation is down to 0.7%. Even here in the UK, inflation has gradually come down to 2.1%. Crumbs, we’re almost on target.

My timing was off

I have to confess, I hadn’t expected things to turn out so well. Yes, it’s probably true that the reported figures are manipulated to some degree. Whether the statisticians are improving statistical technique, or just changing what they want the stats to show, is a moot point.

The crucial point is this: in the good old days, before these bold central bank experiments, it was taken as a given that dovish policy (low rates and a growing money supply) would always lead to inflation. If you like, inflation kept central banks on the straight and narrow.

But if, in the light of falling inflation, the bankers now feel emboldened to continue, or improve upon this ultra-dovish policy, then surely they will do so.

Many readers have been surprised by a relatively benign outlook on the economy; indeed, on the markets themselves.

But if you really want to know why I’m so convinced that the status quo will follow through in the coming year (if not further out than that – but we’ll get to that nearer the time), then it all comes down to inflation.

Yellen, and her ilk want to gee up inflation. That means looser policy, not tighter. Yes, I know that the Fed is talking about tapering. But in the scheme of things, this taper is just a tiny tightening. There’s room for the fed to loosen off in other places. And indeed, they have been keen to get across the message that rates are staying low – and for a long time.

As for Europe, well, despite near on depression in many of the southern states, the stock markets have continued to improve. And why not? With no inflation, money supply propped and interest rates stuck to the floor, exactly where is one supposed to put all this cash?

Of course, there will come a day when inflation does begin to take off. I suspect that when it does, it’ll baffle the boffins at the central banks to an even greater extent that today’s subdued figures do.

The truth of it is, nobody has a clue why inflation behaves like it does. Though they threw plenty of time, effort and money at the problem, communism never really got to the bottom of how an economy works. Why? Because you cannot plan economies. You cannot possibly know how they react to events. Inflation will spill out onto the streets one day.

The only thing is, I don’t think it’ll be this year. On the contrary, this year the central banks will continue to fight perceived deflation.

And this should be good news for the markets.

Next time, we’ll look at the trading figures I promised you on technology company Iomart.

FREE daily investment email from MoneyWeek
Receive our thought-provoking investment email Money Morning every weekday morning, plus occasional promotions, & become a smarter investor.

Please enter a valid email address

To sign up, enter your email address:

[xyz_lbx_custom_shortcode id=10]

• Stay up to date with MoneyWeek: Follow us on TwitterFacebook and Google+

  • Wotan

    It is very obvious why there is no inflation. The money “printed” via QE does not enter the economic cycle, it stays within the banking system. This means that the banks and their associated parasites enjoy a never-ending supply of cheap money that is invested in the stock and bond markets and other financial instruments. As a result asset and house prices (as well as the prices of luxury items) are driven up by these recipients of cheap money whereas the rest of the population is continuously getting poorer and does not have the purchase power to generate inflationary price increases. Owing to the way cost of living indexes are designed this two-tier system is not reflected in these indexes, which, therefore, convey the impression that there is no inflation. The fact is that there is plenty of inflation in the property and luxury goods markets, but not in the traditional consumer markets, which is due to the fact that QE does not reach these parts of the economy. Any additional stimulus of this nature in order to “create” inflation, consequently, will only exacerbate this anomaly and continue to make the rich richer and the poor poorer. It also means that the so-called recovery is nothing but a Fata Morgana, i.e. something build on an illusion.

  • MGC Andy

    and what of interest rates if the money taps remain on? With interest rates used to curb / control inflation (allegedly) yet stagflation/deflation looking more likely what about the short/medium term impact on interest rates. Moneyweek and various main stream press articles say interest rates set to go up as inflation gets stoked but if things are going the other way what are the chances ? to fix or not to fix ?

  • Ellen12

    I would like to share the following piece from a book I have just read “Code Red” by John Mauldin.

    The formula below is given as the link between money and economic growth

    “Money x Velocity = Price x Real GDP”

    But the Fed doesn’t control the broad money supply because they cannot control velocity.

    “Despite the massive increase in the FEDs balance sheet, lending has not remotely kept pace with the underlying growth in the monetary base. All the money that the Fed has created sits on banks balance sheets as reserves. The vast majority of these funds represent ‘excess reserves’, exceeding the 10 percent reserve requirement (US). Historically, banks never kept excess reserves because they earn no interest on them. However, in the US, the Emergency Economic Stabilization Act, 2008 allowed the Fed to pay interest on excess reserves. So the Fed created money and very little happened with it. It did not circulate … instead, it sat around frozen in excess reserves.”

    “Central banks want to increase lending and increase the velocity of money, but they’re doing all the wrong things to achieve their goals. The approach is driven more by the interests of the powerful financial sector than by reality. Interest rates are one of the key drivers of money velocity. When interest rates are rising, velocity tends to be high: and when interest rates are low, velocity tends to fall. With low rates, lenders have no incentive to lend. Paradoxically, the best policy to forestall falling velocity and the hoarding of cash would be to raise interest rates.”

  • mikeT

    I agree with Wotan. How much of all the new money has reached the real economy? Surely this can be measured by an economist out there with a relevant Money Supply figure. Could one step forward please? It should not be a matter for conjecture.
    If it is the case that the new money has largely remained an accounting entry between the Treasury and Central Bank, it is not surprising that inflation has failed to react – except in asset prices where all the old, existing money, facing a reduced supply of government debt, seems to have gone. Or was the aim of QE to force these investors into the real economy with lending to industry and infrastructure projects? That does not seem to have worked unless our brave economist knows otherwise.

  • Short John Silver

    The Fed’s ‘virtual reality money’ is currently walled up in the banking system and has pumped up the US stockmarket. When the wall collapses (and it undoubtedly will, given the ever-increasing pressure), inflation will flood the economy. The wall is already leaking badly, but dishonest, corrupted inflation indices hide the truth. When the wall finally crumbles under the load, it’ll be too late to hold back the tidal wave. Wage claims will soar and the US stockmarket bubble will burst, taking every market on this planet down with it. The inflation versus wages spiral will spin like a demeted top.

    Fed mission accomplished. Ruin the value of currencies and all debt is diminished. The fat can get even fatter. The ill-informed masses will be paying for it.

  • mikeT

    Ellen12 and Short John Silver – of the 5 trillion,how much is “walled up in the banking system” (of huge inflationary potential) and how much is in the form of an accounting entry between Treasury and Central Bank (reversable, so not much inflation threat)? Anyone actually know, please? Bengt?

    • Boris MacDonut

      I guess nearly 80% of it is in ther banks. Bigger stimuli to the economy have come (in the UK) from maturing endowment policies,PPI mis-selling compensation and burgeoning inheritances as the pre war generation reach 80 plus.

  • tot777

    In the US, banks have $2.4tn of reserve balances with the central bank.
    See the chart here:


    So most of the QE money is converted into excess reserves at the FED.
    The reason there has been no inflation is because banks are not fractionally lending on the new money money being created by the FED.
    They are just parking the newly created money at the FED and earning 25bps on it. Not a bad trade if you’re a bank!

    Note that prior to the crisis the interest on excess reserves (IOER) was 0, in order to encourage lending by banks and discourage them parking it at the central bank.
    IOER was changed to +25bps once the excess reserves became large, so that FED could maintain control of monetary policy.
    There is now talk of the FED cutting IOER back to 0 to “loosen” monetary policy.

    If/when domestic banks start lending out these newly created funds, then inflation will let rip.
    It’s a balance sheet recession. Consumers are still repairing their balance sheets, so there is no demand for loans YET.
    Like the turkey on the day before thanksgiving, confidence that inflation is contained will be greatest just before it lets rip. Hold real assets.

  • mikeT

    Thanks Tot777 – what an extraordinary chart. So the banks sold their Treasuries and mortgage-backed to the Fed and deposited the cash with the same Fed for 0.25% and, I assume, bought riskier bonds and equity on the side. Little was lent to the real economy, at these very low interest rates, for long-term investment. So QE has failed and a wall of money is set to be unleashed OR will the Fed just sell back all its bonds? Equity and bond prices will head south but the money – again – will not hit the real economy, so maybe inflation will be contained. Has anyone got a contrary view?

  • tot777

    MikeT, you are welcome.

    This is the graph of the money supply, M2.
    This includes, cash, demand deposits and saving deposits. Note that it has not spiked up since 2008, unlike my first chart of bank reserves. It has increased steadily.

    It’s a similar story for cash in circulation (a subset of M2)

    Another way of viewing it is the money multiplier is decreasing:
    So banks are lending out less and less, per $1 of reserves they have at the FED.

    I believe the FED will never sell its bonds in the open market, or let them run off (which amounts to the same thing). I doubt it will even complete the proposed tapering this year, without backtracking. The central planners simply cannot tolerate falling stock/bond prices anymore. The US economy simply cannot cope with higher rates. Once they openly admit to monetising the debt/deficit, then the inflation cat will be out of the bag.

  • mikeT

    Tot777 – thank you again. Frankly, I think you should write an article, based on this hard data, and submit it to MW. So much of what I read about QE is opinion based on emotion and generalisations, rather than on rational, detailed argument. I agree that the US cannot tolerate higher rates both because the State has to finance its debt and because the broadbased economy is still weak – if you took away the shale gas revolution, what would be left? (You don’t have any data on this, do you??) We Europeans look at gas prices in the US with incredulity; if they existed in the UK (pace fracking, lack of competition etc), the savings in energy costs would almost certainly lead to loads of consumer spending, sustained recovery (as opposed to a manipulated housing boom that drags everything else along) and happy days….

  • tot777

    MikeT, thank you for your kind comments.

    Alas, I don’t know much about shale gas.
    Data on central banks is freely available in the public domain, but you are correct there is much ignorance about QE and our monetary system in general.

    As Ford said,
    “It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

    I think my favourite QE quote was when a US senator asked Bernanke at a hearing if “QE wasn’t just printing money?”, to which he replied, “Not literally.”
    An ingenious response from the Princeton professor!

    ZH has some good analysis on QE/Fed balance sheet.


  • mikeT

    Tot777 – I’ve read the zerohedge article.am not sure I understood it all but came away with the impression that the biggest danger is the Orange County-style death spiral ie repo assets and invest the cash in more assets, and so on. This problem (!!) is exacerbated by the relatively poor quality of the those assets (because the Fed has bought all the good ones). Is that roughly right (not just for me but the many, I’m sure, who are following this thread)?
    On Bernanke – is there not a grain of truth in what he says? Forgetting all the facts and figures for a sec, the “big” picture is that this money was created electronically, has not entered the real economy; hence, it can be withdrawn electronically with no effect? No money is printed so “this time it is different” (oh dear!)…….

  • tot777

    MikeT, Bernanke’s reply was perfectly correct – he is not physically printing the money, but doing it electronically. Either way, the effect is the same, as most of the money supply is electronic these days. It is a lot easier creating the money than it is withdrawing (uncreating) it. Witness the taper tantrum of the markets in May 2013. That tantrum was over a proposed reduction in the rate of increase of the Fed balance sheet. Imagine what the market will do when the actually start to decrease the Fed balance sheet, if ever.

    The just of the zh article is that that bank balance sheets have to keep growing or our ponzi debt-based money system collapses. As US banks have stopped making loans since the crisis (the normal way to increase their balance sheet), the FED has stepped in and increased its balance sheet to compensate, hence the divergence between US banks assets and liabilities, the difference being capital, or reserves, held at the FED.

    One of the reasons touted for the taper is that the FED is starting to corner the market in US treasuries, which are used as collateral for banks in repos. I think the FED now own close to 1/3 of total US treasury issuance. The US deficit is shrinking, so QE is less for monetising the deficit and more for buying up the existing debt stock, which deprives banks of high-quality collateral that they can leverage off. Yet another unintended consequence of QE that the soviet harvard economists didn’t envisage in 2009.

  • Boris MacDonut

    $5trillion over 4 years in a World economy worth close to $70trillion is not a big deal. But it has helped stave off the deflation that was a clear danger in the early stages of the credit crunch. We in the UK should see 1% inflation very soon now.

  • Tyler Durden

    America’s official debt is $16 trillion+, which is several times the size of its economy. They’re currently expanding that at $1 trillion per year in a desperate attempt to create growth, or something that Paul Krugman believes will magically materialise if only a few more dollars are printed.

    This isn’t a gamble, it’s got a 100% chance of failure.

    • Boris MacDonut

      No Tyler. The US GDP is $16trillion. Their Governemt debt is £17.2 trillion and personal debt is at £16.4 trillion. This is NOT “several” times, but twice the size of their economy.The rate of expansion of their debt is about 3%…..at that rate it will double in 24 years.

  • Tyler Durden

    Oh, and inflation. Well, we currently have deflation in all the things that hurt ordinary people, which is wages, salaries and capital investment, and inflation in……all the things that hurt ordinary people such as food, fuel, rent, houses……..

    The QE money has flowed into expanding the stock market and all those things that hurt ordinary people, but why bother lending to anyone when you can just get free cash from your local, friendly central bank? The top 1% pockets the cash and the rest of the economy suffers.

    It’s ironic that those who think they’re fighting deflation are actually causing it and it will not end well.

  • mikeT

    Boris – is 5 trillion so little when added to QE from the UK, Japan (and potentially, Euroland)? To say nothing of the debt Tyler alludes to….How much do the major economies have to grow and increase tax receipts to actually stop, or even reverse, the debt growth? Any ideas?
    On a more positive QE note, I note that L and G is investing 5 billion into creating new towns (and I know that pension funds have also put money into solar farms). If this means that investors are being forced into spending on the real economy, all well and good!
    Tot777: so banks have stopped lending/renewing loans and hoarded cash to repair balance sheets. Eventually, central banks can withdraw their substitute cash injection by selling bonds, regularly and cautiously, and they have saved the banking system! Banks can now return to lending and the real (deflated) economy gets going. Inflation remains subdued because the consumer is even more deflated and wage increases will take a while to filter through. Meanwhile, bond and stock markets, having suffered something of a shock, start to offer some real returns. All back to normal! Where have I gone wrong?? I am not a soviet harvard economist.

    • tot777

      mikeT, Although you are not a Soviet-Harvard economist, your thoughts are similar to them!

      IN THEORY, the private banks will start lending again and IN THEORY the central banks can reduce their balance sheets accordingly without spooking the markets, but this is unchartered territory in the great experiment of current monetary policy and I remain sceptical that it can be done smoothly, if at all. It is much easier to provide stimulus than to withdraw it. I predict an untaper from the FED later this year.

      The problem is that the levels of debt (personal and government) are so high now that taking on new debt is actually detrimental to growth. The system needs to be reset, the real value of the debt reduced, either by default or by inflation – I would bet on the latter. Deflation would knacker the whole system and central banks know this, hence their ZIRP policies. More debt is not the answer, but the answer (a reset) is not politically palatable, so expect more financial repression for many years to slyly inflate the debt away.

      Only when inflation takes off and there is widespread disgust with central banks, similar to what you saw in Germany in 1922 will there be the political appetite to reform the current monetary system. Until then, the unaccountable Soviet-Harvard bean counters will remain masters of the financial universe – lord help us!

    • Boris MacDonut

      $5 trillion is all the QE. Over the course of 7 years it is the equivalent of a man who earns £450 a week winning £300 on the lottery one year.

      • tot777

        Boris, are you implying that QE has benefitted the average working man? A man who earns £450 a week will very likely have seen his real earning power fall, due to QE. Unless is he is stock market investor, of course.
        QE benefits those who receive the money first – the banks.

        If the new created QE funny money was directly converted into tax cuts, that would be a different story..

        • Boris MacDonut

          tot777. No. I am saying that QE is of little consequence in the great scheme of things. Most has been used to shore up Bank balance sheets and guarantee the flow of undeserved bonuses. For the man in the street it is little more than a daft acronym for an unpronoucable bit of econo-babble. It is not big enought o have affected the World economy over the past 6 years beyond avoiding the risk of some deflation.

      • Tyler Durden

        It’s curious how many people have no idea just what a trillion is.

        If I spent a million dollars every days since the time of Jesus I would not have spent a trillion by today. That’s the scale we’re talking about here.

        • Boris MacDonut

          But compared to a World economy worth $65 trillion a year and spread over 7 years that is not a lot of money.

    • Boris MacDonut

      MikeT. That is a difficult question. I would expect major economies to need to grow by about 10% and tax receipts to increase by 12 to 15% to reverse debt growth. The issue though is, I don’t particularly see debt growth as a problem…..not in rich coubtries.
      Brazil has governmetn debt at 63% of GDP, India at 48%.Surely BRICs nations should be near debt free.

    • Boris MacDonut

      Mike. The $5 trillion includes all the QE from the UK and Japan. It covers “all central banks”.

  • Boris MacDonut

    Just to help form a perspective here. $5trillion over 6 years is the same as giving everyone in the World £60 a year.

  • mikeT

    Thank you Boris. Putting these things in perspective is very useful BUT that £60 has not gone to everyone (the real economy) but to the banks, as Tot777 showed. Far from money printing being inflationary, I read somewhere:
    “Please ignore the monetary base, which is not money, and focus on M2 which is money. M2 growth has been falling for two years, from 10% at the beginning of 2012 to 5% today. Money growth declined by 1% over the past three months. The Fed has been steadily tightening, whether it admits it or not. This will have to start showing up in inflation and earnings growth.”
    So bonds have got it largely right – deflation is coming – and equities are wrong!
    Boris, Tot777, even the Soviet-Harvard bean counters (please) – where does this leave us?

MoneyWeek magazine

Latest issue:

Magazine cover
Prime location

The best property buys in the eurozone

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues

Which investment platform?

When it comes to buying shares and funds, there are several investment platforms and brokers to choose from. They all offer various fee structures to suit individual investing habits.
Find out which one is best for you.

22 May 1980: Pac-Man hits the arcades

It didn't take long for Pac-Man, or Puck Man as it was originally called in Japan, to become a worldwide craze after it was released on this day in 1980.

The Kids' Portfolio: the four best funds to buy for your children

Investing for your children's long-term future is an excellent idea. But what should you buy? The Kids' Portfolio is a simple collection of four funds intended to be tucked away for 20 to 40 years.