What in the world is QE2?

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What In The World Is QE2?

QE1: Is it the big British Passenger Liner or some obscure planet in the Main Belt? Yes, but not economically speaking. The same is true of QE2, to some it may be the name sake of the big ship QE1, but not economically speaking.

Quantitative Easing is a monetary policy or instance of increasing the money supply by pre-determined quantity via open market operations, as an economist would say.

In economic terms this is code for ‘turning on the printing press’ or in extreme circumstances, governments flooding the financial system with money, easing pressure on banks by giving them extra capital.

QE1 came in the form of the Federal Reserve purchasing over $1.25 Trillion in securities from the private sector. It was intended to inject lending dollars into the economy, this into business activity that would create jobs, goods and demand thus energizing the economy as a whole.

But, the dollars never made it to the street, jobs were not created, goods were not made and demand was not stimulated.

The banking system hoarded the money while businesses and consumers deleveraged (paid off debt) rather than borrowing. Many credit this contraction to the uncertainty of government spending, tax policies and commitment to private sector job creation.

When Washington recognized the failure of QE1 they set the stage for QE2.

The objectives appear to be the same as QE1: the Federal Reserve credit will increase. The banking system will lend out the cheap money and the economy will blossom again.

There are several flaws to this scenario:

1. Making cheap credit available does not create demand from the bottom up.

2. Injecting cheap money from the top down only encourages lending institutions to invest it in higher yielding safe securities and profit from the margin.

3. And finally, the cheap money behind the credit has to be created somewhere.

The first two points are self-evident. The third point is where the scenario gets sticky.

The Federal Reserve Bank has to cover these enormous expenditures for which they have not cash. There is not enough international demand for the extraordinary high volume and low securities. These securities are IOUs backed by the credit and good faith of the US Government, so when the Fed steps in to buy them they just print more money that is back by the credit and good faith of the US government.

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