If you watch the news at all, I’m sure by now you’ve heard the term quantitative easing. Yet most Americans have no idea what it is, and even fewer understand what it means for them and their family’s finances. We’ll do our best to make this boring subject both interesting and easy to understand, so you know what it means when it comes to your money.
Quantitative Easing (QE) is essentially a government stimulus program in which the Federal Reserve (the bank that controls the nation’s monetary supply) buys up $85 billion dollars each month in various financial assets. Since the Federal Reserve is the entity that creates money, they do this by essentially declaring such money into existence. Poof! Eighty-five billion dollars a month, thank you very much, have a nice day. It’s sort of like going to the mall with $1.00 in your checking account. But as soon as you got there, you decided to write in $85,000,000,000.00 as the balance, and this money magically appeared, because you possess the magic pen. Then you proceeded to spend that $85 billion buying up things from all the different stores. It creates a nice windfall for the mall. This is essentially what the Fed is doing. It’s creating money to buy stuff, which boosts the economy. There was the OE1 program, then QE2, and now it appears QE into the foreseeable future. This means a couple of key things for both your own finances and the state of the economy.
1. Creating free money undermines your own earnings
Let me ask you this: How many of you and your neighbor’s salaries would be wiped out by a charge of $85 billion? That’s how much the Federal Reserve has been cheapening the money in your own pocket on a monthly basis. The only reason you haven’t felt the full effects of it yet is because currency values are set by the marketplace. As of right now, with Europe in a mess, other nations faltering, and the unappealing prospect of parking your money in communist China, America appears to the cleanest dirty shirt at the moment. This has been keeping our currency stable and disguising the impact of the Fed’s money binge. But there is no such thing as free money, and a cost for all this stimulus will come eventually.
2. What Quantitative Easing says about the U.S. economy
Perhaps the more important issue is what this monthly IV injection into the nation’s Gross Domestic Product (GDP) says about the overall health of the American economy. You probably remember that $780 billion bailout package that Congress fought so bitterly about when the financial crisis first started. Yet as this fierce debate went on, behind the scenes the Federal Reserve was providing the banks with a bailout of many trillions of dollars. (The TARP, or Troubled Asset Relief Program, was installed to essentially buy up all these worthless loans and mortgages, putting the loss on the Federal Reserve and thus saving the banks.) The QE programs in the years since have continued this stimulus in a different way.
On an annual basis, Quantitative Easing equals $1.02 trillion dollars, or about 7% of the nation’s total economic output. Here’s where thing get really scary. During this time out economy has managed to eek out only a 1-2% growth rate each year. This means that absent this artificial stimulus, our actual growth (or lack thereof) may have been as bad as negative 5 or negative 6 percent . . . depression era numbers. It’s impossible to draw a direct correlation between QE and growth rates, but it’s certain that such a large influx of cash has not been insignificant.
A telling indicator of how dependent the markets have become on this money is that whenever the Fed even hints at the possibility that it might start scaling QE back the stock market tanks and the DOW drops 200 point or more. Keep in mind that this is not talk of eliminating the program, merely mentioning that it might be scaled back, perhaps to $80 billion a month instead of $85 billion.
The normal reaction to this news is to get angry and blame the Big Bad Fed for screwing over the American people. But it’s important to remember that the Fed Created TARP so that you still had bank accounts and credit cards to use. Had they not, money would have frozen up, banks would have become insolvent, and we’d have seen a depression worse than the on in 1930’s – a Mad Mac-type collapse of all monetary institutions. They continue this QE stimulus program not because they want to, but in the hopes that it will keep the economy intact until it can stand on its own feet again. This, of course, assumes that our problems are temporary as opposed to structural, and that boom times are just around the corner. Returning to a high rate of growth would save the Fed from its gamble, allowing it to back out and unwind this stimulus without destabilizing the economy.
On the other hand, if boom times are not just around the next corner, then the easy money policies of the Fed are just postponing the inevitable and creating another massive bubble that is destined to pop. When it does, it will do so in a most painful way for the American people.
We are all affected because our money is worth less than it used to be due to these QE artificial injections. The tiny little raises most Americans have received in recent years can not begin to keep up. People on fixed income, like retirees, will continue to find that their savings don’t go as far.
Terms like “quantitative easing” were intentionally designed to confuse people so that the average American would have no idea what was going on. Hopefully, now you have a better understanding of what this program is and what it could mean for you and your family.