Kassandra Learn: What is Quantitative Easing? (Part 1)
In a nutshell…
Quantitative easing is an economic tool governments use to increase the supply of money in the face of economic crises (such as the 2008 banking crisis and the 2021 COVID-19 crisis).
Quantitative easing makes more money available to banks and ultimately the larger economy through a variety of lending measures. Any industry or entity can be bailed out and assisted, such as the economic relief to small businesses and during the pandemic to help out renters, so quantitative easing in and of itself is not a necessarily a bad thing in the short term.
However, access to “cheap money” has typically benefited bad actors (people and institutions who find it cheaper to borrow money than to pay it off) who cause or contributed to economic problems. Examples include the big bank bailouts following the 2008 financial crisis.
This behaviour can create a vicious economic cycle where major currencies lose value and economies don’t improve, with the only winners being big banks and investment firms that can buy up debt with a ready supply of easy money.
The ultimate direct consequences for normal people in such cases can be:
- inflation (from printing more money and devaluing existing money)
- stagnation (if unemployment stays high and the economy doesn’t recover despite pumping more money in)
What is Quantitative Easing?
You may have heard the term in the news, especially in relation to the 2008 financial crisis or as a result of unstable financial markets in the wake of the coronavirus crisis in 2020 and 2021. Or you could have seen the term in other Kassandra Learn articles. But what is quantitative easing? How does it work? And why is it important for crypto investors and traders?
We’ve talked about how governments and central banks work together to set the monetary policy for countries, controlling the money supply through the rate at which money is printed and setting the rate of interest for loan repayments. Quantitative easing is another monetary tool used to increase the supply of money with the aim of making more money available for lenders and investors (i.e. big banks and investment firms) as a way of “jump-starting” the overall economy for everyone.
Quantitative easing = more money, cheaper debt
Quantitative easing is another monetary tool that adds more money to the economy.
What makes quantitative easing unusual is that it requires a country or government to buy up the rights to collect long-term loans (debt) and government bonds, a sign of trust in the state of the government’s ability to repay its own loans (these are called a “security”).
By buying these securities from big banks and investment firms, governments add more money to the economy. For banks, this means that rather than money in the form of assets that they expect to collect over time, they now have money ready to spend and lend (otherwise known as “liquidity”, or liquid assets which simply means something like cash that people can trade and spend quickly and easily).
Sounds complicated, but more money and cheap lending should benefit everyone if the economy grows, right?
Problems with quantitative easing and printing more money
In essence, quantitative easing makes currency available in a way that is not determined by the value of economic outputs but by the need of economic actors. This contributes to growing inflation because there is just more money in the money supply without any associated increase in value or output of goods and services to necessitate the creation of that money.
There is now more money available but not because an economy is growing and creating the things people need. As we’ve seen, if we increase the supply of a currency but don’t increase production or the assets backing a currency then the value of the currency will go down, creating inflation.
This means for quantitative easing to be successful, it strongly depends on who gets this “free” money and what they do with it. Investing in labor or the means of production, for example, can be a good investment. Investing in a failed business without making changes to why it failed in the first place, is not.
The problem is that the debt that central banks are buying up is the same unpaid debt that got the lenders like big banks and investment firms in trouble in the first place. Some can see this can be seen as just a bail out for their bad bets and bad practices, like a casino that rewards you for losing… but only if you’re already rich.
Even worse, what if the economy doesn’t recover despite making more money available? What if the banks and firms hoard that new cash because they’re worried about lending? Or people don’t recover their confidence in a broken market and don’t want to lend? What if production doesn’t grow fast enough companies downsize and cut jobs to save money in the short term?
Then the economy stagnates while inflation increases, and a country faces a rare and difficult problem of combined stagnation and inflation (stagflation). This makes the money in your pocket have less value and prevents people from finding more work or promotions to increase their income, trapping people in a vicious cycle of loss and more debt as they try to hold on to their standard of living.
How can crypto make a difference?
People put their trust in banks and governments to take decisions in their best interest as a country. But this invests a lot of responsibility into one central decision-making authority. These decisions, as we have just illustrated, can go wrong very easily. Time and time again, poor monetary policy has induced national and even global recessions.
Money is given away without good oversight or accountability. The people at the top seem to ask people working on Main Street to put their hands in their pockets time and time again to bail out gamblers on Wall Street. Basically, when banks and economists mess up, you pay the price.
Big banks and governments have come together to create what has been referred to as “a central decision-making authority for recessions”. So is there a way to save effectively and avoid the problems associated with this centralization of trust and responsibility into a single entity that seems to let down ordinary people time and time again?
Crypto currency, decentralized and “trustless” and often immune to the issues that affect the value of fiat currency, can offer a solution for individual savers who want to escape the boom and bust (and bust and bust) of centralized economies like the US financial system.
Crypto currency can therefore offer the following solutions:
- by holding value better than fiat currency and being globally and instantly transferable between anybody.
- in terms of saving and investment.
- for most cryptocurrency and tokens, Quantitative Easing is simply not possible: the currency is generated by a documented algorithm so large amounts of currency can not be immediately created.
We will explore these and other ways in which crypto is uniquely equipped to escape the trap of quantitative-easing induced inflation in Part 2 of this series.