TechniTrader Article: QE2 and What it Means for the Economy

    AUBURN, WA, October 20, 2010 /24-7PressRelease/ -- I have been asked about QE2 and what it means for the economy, stock market etc. I have also been asked about the fraud charges and foreclosure freezes by Bank of America.

And I have been asked how the heck do we get out of the economic slump and get more jobs.

Since these all relate to long term investing and stability of your pension funds, I am going to discuss these here. You may feel that all you want to read about is what stock to buy for long term but I assure you, if I didn't feel this was worth you learning about I wouldn't bother wasting my time. I feel these topics will help you understand the world of investing we are in right now.

QE2 refers to what economists call Quantitative Easing which is a money flow policy enacted by the Federal Reserve Board of the US or any governing body of the banking system of any country.

The goal of any central bank for any modern democratic style country is to control money supplies to keep inflation tame, but avoid deflation. The ideal money supply provides disinflation: for more on this, study the Lab Class on Inflation, Deflation and Disinflation which covers all of this in great depth.

QE2 is a highly emotional money policy. It is relatively new in that before the 1970's the US was on the gold standard which meant the money supply equaled the amount of gold held in vaults by the US. Since the US went off the gold standard 40+ years ago, it has allowed the US central bank to have more flexibility in periods of economic strife to increase the money supply by "creating money".

Often times the uninformed call this "printing money". The actual printing of money doesn't occur. The paper dollars floating around the system do not increase. It is all done electronically by adding virtual funds to the central bank account. The central bank creates ex nihilo or out of nothing money that it then uses to buy back government bonds, agency debt, corporate debt or bonds, municipal bonds, mortgage backed securities etc from financial institutions.

The central bank can do this because we are no longer on the gold standard. What this does is it increases the money supply by freeing up money for the financial institutions such as banks, savings and loans, etc. The intent is to stimulate financial institutions into lending money to small business, consumers, home buyers etc.

QE2 is also referred to as Monetizing Debt.

Another way to look at QE2 is the expansion of the balance sheet of the central bank. Some view it not as creating money but as increasing the size of the balance sheet through an increase of monetary liabilities and riskier assets. So although the central bank creates ex nihilo it also is gaining assets that it can sell later on through purchasing from financial institutions. At least that is the view of some economists and financial experts.

The risk is extremely high however as this can cause hyperinflation due to the sudden influx of money into the money supply system. A stagnated job market coupled with hyperinflation is what happened in the 1970's. The result was a long period of weak economy, rising government debt, and unhappy citizens.

QE2 as an economic policy:

This is usually done during a time when interest rates have been cut down to near zero or at zero but the money supply remains tight and economic conditions are stagnated with a lack of job growth such as we have right now.

The reason the central bank would consider this is:

1. The perception that if banks had more money available for loans they would loan out the money and get small businesses the cash they need to grow and expand and hire help. And there would be money for startups.
a. The Flaw in this theory is: the central bank can't force financial institutions to loan the additional money available. In the current economic and financial markets environment, most financial institutions can make more from derivatives or other high risk investments.
2. The central bank believes the risk is rather low for hyperinflation as inflation is "tame" right now.
a. The problem with this scenario is that the central bank can't control business or consumers and historically QE2 has been a disaster for Japan, and the European community.
b. The perceived lack of money supply is questionable since financial institutions have funds moving through many exotic financial instruments.

The real crux of the matter, and I am now moving away from fact to my personal opinions which you must take under consideration, is that the central bank is supposed to control money supply NOT try to run the economy per se.

The government, in my humble opinion, is supposed to govern, not control business enterprises. The central bank is supposed to set policies for financial institutions that maintain the flow of funds throughout the system, not attempt to entice financial institutions to change their business plans.

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