Sunday, 12 December 2010

QE does not equal printing money.

QE is often equated with printing money. This is nonsense.

Let’s start with the QEing of government bonds near maturity. These bonds are widely regarded as, and accepted as a very near equivalent of cash in the world’s financial centres. Thus QEing these bonds is about as earth shatteringly irrelevant as swapping $10 bills for $20 bills. Giving someone two $10 bills in exchange for a $20 bill does not constitute “printing money” and nor does QEing short term government bonds.

As to QEing longer term government bonds or private sector bonds, things are a little more complicated. Let’s start by defining the word money and the phrase “print money”.

There are numerous definitions of the word money, but one definition is “a very liquid asset”: that is, an asset which is readily accepted as a means to pay for less liquid assets like cars, houses, and so on.

As to the phrase “print money”, this is normally understood to mean the creation and distribution of MORE money with no corresponding reduction in the amount of assets which are “near money”. To illustrate (and to use the above example of QEing short term government bonds) creating $X out of thin air and using the $X to buy and tear up $X worth of short term government bonds certainly NOT the same as creating $X out of thin air and distributing the $X to the population (e.g. via a tax reducution or a helidrop).

In the latter case (e.g. a tax reduction), private sector assets RISE by $X. In contrast, in the former case (QEing) the value of private sector assets remain constant, or very nearly CONSTANT. That is a BIG DIFFERENCE! And since the “QE equals money printing” brigade cannot see the difference, the conclusion is that they can’t see an awful lot.

Printing versus printing and distributing.

I said above that money printing equals the creation AND distribution of more money. It could be argued that the distribution element is not a necessary part of the definition. For example, if I print a million tonnes of £20 notes and stash them down a disused coal mine and don’t tell anyone what I’ve done, that is still “money printing” isn’t it? Perhaps it is. But the above senseless “stashing” operation will have no effect whatever on demand, inflation or anything else (apart from temporarily increasing the demand for paper and ink).

QEing private sector bonds.

QEing private sector bonds and longer term government bonds is a little different from QEing short term government bonds, which as noted above is little different to swapping $20 bills for $10 bills.

Assuming a fair price is paid for “long term / private” bonds, then no money printing takes place in the sense that the value of private sector assets remains the same. On the other hand, the liquidity of a portion of those assets certainly IS improved: in the extreme case, hard to dispose of bonds are turned into cash, which is a very definite improvement in liquidity.

The EXTENT of money creation here is hard to estimate. It is certainly nonsense to claim that QEing $Y worth of these bonds equals the printing and distribution of $Y worth of new money. But SOME money HAS been created in that extra liquidity has been created. I’ll leave it to others to quantify this!

1 comment:

  1. Arguably no new money of any relevance has been created unless some of it flows into additional transactions.

    You can create $1 trillion and if it all sits in a bank reserve account somewhere, then it is irrelevant economically (as we've seen with QE in general).

    The only money that matters is that which is moving (and in the US/UK that means money that causes a transaction and some of it is likely destroyed by taxation).


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