Understanding Quantitative Easing or Q.E.

Understanding Quantitative Easing or Q.E.

by | Jul 31, 2020 | Federal Reserve

What was your inspiration for writing your white paper, “Are We In Another Financial Bubble? ” 

The most dominant financial story after the financial crisis has been the Federal Reserve and their unconventional monetary stimulus, Quantitative Easing or QE.

There was a letter written to the Wall Street Journal by 24 prominent economists, writers, and hedge fund managers warning about QE and inflation (11/15/2010).

One interesting thing about my research was that the people who thought QE would cause inflation were wrong for the same reason. They believed in the so-called money multiplier that the reserves created by the Fed through QE would be multiplied into loans; however, that is not how modern banking works.

Do you believe our economy is in another financial bubble? If so, what will be the force that causes it to burst?

I think our current financial and banking system encourages bubbles. If you look at CAPE, Q Ratio, or market cap/GDP, even with the coronavirus and this incredibly high unemployment rate, they are all flashing that the stock market is at very high levels.

Do you believe that quantitative easing or QE does more damage than good for the economy?

Some say QE is just a swap or that commercial banks are just exchanging one government asset government bonds for another central bank reserves.

Maybe at the start, but the program has morphed. Now, the Federal Reserve is buying mortgage-backed bonds, government bonds, and in response to the pandemic, corporate bonds from pension funds, mutual funds, hedge funds, etc. The seller receives a bank deposit and the liability of the commercial bank offset by reserves provided by the central bank.

After the onset of the virus, the Federal Reserve’s balance sheet went from $4.2 trillion to around $7 trillion. During that time, the money supply went from approximately $15.5 trillion to around $18.5 trillion. So, about $3 trillion in new bank deposits was created in four months.

Do you think that paying executives in stock is beneficial for the economy?

I think the idea of paying executives in stock came from academia. Align the interest of the executives and shareholders. But it, too, has morphed into something that is unhealthy. Companies now spend a large percentage of their cash buying existing financial assets. Executives have an enormous conflict of interest because their pay packages are consistent with short-term stock performance, not long-term performance. If a company buys back its stock, the benefits are immediate, but if a company invests in its plant and equipment, the benefits, if there are any, will be seen years later when the current executives will be gone.

What needs to be done to prevent yet another bubble from occurring and being burst?

We should change the way new money is created or regulate how new money gets introduced into our economy. New money is money that is introduced into the marketplace without reducing someone’s bank account. It creates purchasing power, and our economy is impacted by where it goes. It went to housing in the last cycle, with disastrous results; today, it is going to financial assets like stocks and high-yield bonds. Commercial banks used to create most new money through lending, and because they create it out of thin air, they like to lend against collateral. That way, if the loan goes bad, the bank has an asset to sell. Today, more and more money is added to the economy by the central bank (the Federal Reserve) through QE when they buy assets from nonbanks.

How will the information contained in this white paper benefit your clients?

I wrote it for a wider audience than just my clients. I think people who read it will better understand how our financial system now works and how we went from a banking collapse to the stock market tripling while wages stagnate. Moreover, they will see how the economy lurches from one bubble to the next.

Read: Are We in Another Financial Bubble?

These are the opinions of financial advisor Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.

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