What is Quantitative Easing?
Quantitative easing refers to a set of monetary policies first used by the Bank of Japan in 2001 and continuing until 2006 in order to stimulate the economy when interest rates were already approaching zero. Generally speaking, monetary policy revolves around the manipulation of short-term interest rates to either spur additional borrowing, thereby encouraging growth in the economy, or limit additional borrowing and slowing an economic expansion.
Quantitative easing involves other open market transactions that are designed to inject liquidity into the credit markets. Rather than target a particular short-term interest rate and either injecting or withdrawing liquidity to maintain that rate, quantitative easing targets the current account, allowing it to dramatically increase liquidity without the zero-barrier inherent with interest rates.
Quantitative easing involves the purchase of financial securities including government bonds as well as other asset-backed securities and equities. The Bank of Japan was then able to essentially print money to pay for it all, flooding the economy with liquidity. The financial rescue plan of October 2008 has already begun the same process here. The government is purchasing equity stakes in major banks, supported with a massive monetization which is becoming increasingly likely. Let’s look at the history.
In April 2007, the subprime mortgage crisis began with the revelation that almost 14% of subprime borrowers were already delinquent at that time. This came as a shock to Wall Street and the secondary mortgage market immediately began repricing mortgage-backed securities that included subprime mortgages. Interest rates for subprime mortgages jumped up and lenders re-evaluated the qualification requirements to get them. Before long, most subprime lenders were either bankrupt or had stopped offering subprime mortgages.
This marked the beginning of the credit crisis. As bankruptcies rose and house values drifted sideways or fell, the subprime mortgage problems started overflowing into other types of mortgages. Guidelines were tighted and rates rose for riskier loan types. Of course, these changes pushed more homeowners into foreclosure and that caused further chaos in the financial markets. It became a full-blown downward spiral and the mortgage meltdown began to unfold.
With the appetite for risk in the secondary markets completely dried up, retail lenders were forced to carry toxic assets in their portfolios, restricting their ability to make additional loans. These toxic assets jammed the revolving door of modern retail lending and a number of banks began failing. At first, the failures were restricted to those financial services companies that did not have access to the Federal Reserve Discount Window but the crisis continued to balloon until large banks were pushed to brink as well.
This all represented a systemic failure of the credit markets. Lending came to a complete stop and that affected the entire economy. Our entire economic system requires lubricated credit markets. Without available borrowing, most large companies were suddenly confronted with cash flow problems. In less than two years. the subprime mortgage problems had cascaded into a global financial crisis and is now expected to result in a protracted global recession and a possible collapse of the global monetary system.
Stock markets around the world reacted poorly. Uncertainty led to panic selling and nobody knew where to stop. The initial plunge wiped out over 30% of American stock valuations within two weeks, pushing the major indexes down over 50% from their all-time highs just six months earlier. Traders found support and the markets began a consolidation pattern but as of this writing (11/30/2008), it still appears as though a second down leg is coming.
The governments of major developed nations around the world are taking unprecedented steps to attempt to revive economic order but the only tactics available require massive borrowing and monetary policies that are inflationary beyond any historical equivalent - by orders of magnitude. Because multiple governments are all trying to borrow money at the same time, there is nowhere to turn and the most likely outcome is a massive monetization as governments simply print money to cover the debts.
Without any economic activity to support the increased money supply, the future inflation implications are inevitable. Although the inflation affects may not be apparent immediately, the steps taken today will change the global economic order forever. Best case, the flood of new currency will reduce the standard of living for everyone. Worse case, future economic performance will be insufficient to cover current borrowing, forcing a widespread collapse of the credit system down the road.
There are major issues to be considered here. It is possible the credit-based monetary system will fail at its core, having unimagineable effects on world economies. Significant price hikes for food products already caused havok in the early months of 2008. Food shortages caused some producing countries to begin hording food stocks and retracting from international trade markets. If such reactions continued, panick could spread through the developing world and a global humanitarian crisis could begin.
It’s possible the United States Dollar will experience a massive devaluation. That would cause isolated inflation for American citizens. The interesting thing is that a devaluation can only occur relative to another currency. That would require that other currencies somehow weather the storm. Interestingly, other major world economies appear to have more exposure to the credit problems than the United States and this has been demonstrated by the recent stock market performances. US markets lost about 50% of their value while other markets around the world lost 70% or more.
If all currencies lost value at the same time, the relative exchange rates would remain fairly stable but the cost of living would skyrocket because of inflation. This would lead to the same collapse of trade markets as described above. The only bright spot would be that the incredible mountains of debt would suddenly be worth much less than they are today. As citizens, we would all pay that difference each time we make a purchase.
Indeed, the possible outcomes are daunting. But nobody seems to be considering these consequences. This site will attempt to clarify the systems that play a role in the world economic order and the sequence of events that might cause the dramatic outcomes just described. I will need your help spreading the word. This information needs to get out and your willingness to tell your friends and family will increase the awareness and that will mitigate the end result.