- Quantitative Easing and Bitcoin
The European Central Bank has recently announced a 1.1 trillion Euro sovereign bond purchasing program. This action in broadly referred to as Quantitative Easing. It is a monetary policy brought into existence by the Bank of Japan on March 19th, 2001. The first concept to understand in relation to Quantitative Easing is that no expert or policy-maker truly knows how this monetary experiment ends because it is a historically unprecedented action. A 15 year existence is a negligible amount of time in the history of human commerce. With that in mind, while Quantitative Easing may end up working as planned, I argue that it will end it ruin.
Quantitative Easing in Practice
Following the global financial crisis in 2008, The United States, The United Kingdom, and the Eurozone decided to implement Japan’s Quantitative Easing policy. Before Quantitative Easing was put into action, the short-term interest rates for these Western countries had been decreased to near 0%. With interest rates near 0%, financial institutions with access to lines of credit have access to free money. It is interesting to consider that financial institutions have access to nearly free credit but federal student loans have a 4.66% interest rate as of July 1st, 2014. Central banks traditionally influence the economy through manipulation of interest rates. With interest rates near 0% in these developed economies, central banks faced a problem. Those in charge of monetary policy were out of tools to improve the economy. This desperation opened the door to a new, controversial monetary policy known as Quantitative Easing.
I will explain the Quantitative Easing enacted by the United States, though it differs slightly from the QE recently proposed by the ECB. The Federal Reserve, the institution acting as a central bank for the United States, buys mortgage securities and treasury instruments from the banks and brokers of Wall Street. This lowers yields for “safer” investments and offers liquidity. In the simplest sense it is the creation of artificial demand for markets. By lowering yields on safer investments it forces investors to turn to other assets with comparatively higher yields such as stocks, corporate bonds, and commodities. As a result, the artificial demand created by the central bank seeps into all financial markets through transitivity. It is no coincidence that the financial markets have been setting records and preforming so well when compared to the “main street” economy of the United States. There are several issues with this monetary policy. First of all, the financial instruments listed above are dominated by the upper class. According to CNBC, “the top 5 percent own 60 percent of the nation’s individually held financial assets. They own 82 percent of the individually held stocks and more than 90 percent of the individually held bonds.”2 Pundits often refer to stock market success as a sign of economic recovery when that is clearly not the case for middle and lower class Americans. The Guardian had this to say about QE in the United Kingdom, “The Bank of England calculated that the value of shares and bonds had risen by 26% – or £600bn – as a result of the policy, equivalent to £10,000 for each household in the UK. It added, however, that 40% of the gains went to the richest 5% of households.”
While the rich have access to sophisticated financial instruments, the middle and lower classes often have their savings in a bank account that is only accumulating interest. Another issue with loose monetary policy is the reduction in interest rates on bank accounts. There is so much cheap credit available that interest rates in Europe are negative in some places. Put another way, citizens would be paying to have their money stored in a bank because the bank has no use for it. Interest rates are the banks method of incentivizing deposits so the bank can use deposits to issue loans. German citizens are especially worried about the latest announcement from the ECB due to the countries reliance on interest from bank accounts and as a result of the hyperinflation that occurred in the last century. According to The Guardian, “Alienated by the commentators’ rhetoric, many German citizens now blame the ECB for microscopic interest rates on their savings. Because many Germans rely on their savings to look after them in old age, they now see their pension plans under threat.” The Swiss recently uncoupled their currency, the Franc, from the Euro due to concerns of upcoming devaluation. Following the uncoupling, the Swiss Franc jumped nearly 25% in value relative to the Euro, an indication of the relative weakness of the Euro.
There is an argument to be made for competitive currency devaluation, which some believe is the current global climate. Devaluation of currency is beneficial for a countries exports. If the majority of countries are devaluing their currency then the competitive advantage for exports is lost.
The Carry Trade
Arguably the biggest long-term issue from the expansion of the money supply is the massive carry trade occurring with cheap money issued from Western Central banks. A carry trade is the act of borrowing or selling a financial instrument with a low interest rate, then using to purchase a financial instrument with a yield higher than the borrowing rate. This generally occurs on a global scale because interest rates generally fluctuate by country. While interest rates in the Western world are 0.5% or lower, much of the rest of the world has much higher interest rates. For instance, in Russia, interest rates are near 17% and India’s interest rates are near 7%. It is difficult to determine exactly how much money is tied up from the carry trade but it is estimated to be trillions of dollars.
Where is the “Trevor Altpeter” Bailout?
According to The New York Times, “Purchases were halted on October 29, 2014 after accumulating $4.5 trillion in assets.”5 According to the U.S Census Bureau, on that same date, October 29th, 2014, there was a total of 319,720,341 American citizens. If the Federal Reserve sent every American citizen a check instead of making 4.5 trillion in asset purchases, the Federal Reserve would have sent every American citizen a check for $14,074.80 dollars. $18,278.96 if the bailout was offered to citizens over the age of 18. If the true goal of this monetary policy is to increase aggregate demand in the domestic economy, I argue that granting every American a “personal bailout” of $14,074.80 would be a more efficient and effective strategy than the course of action taken by the Fed. If the hypothetical stimulus I described occurred, immediate inflation would occur, as the injection of $14,074.80 to every American would increase competition for existing finite commodities. The unfortunate truth is that this price inflation will happen regardless, it is simply a matter of who is acquiring the freshly printed currency. With QE occurring on a global scale, it is logical that financial markets continue to grow in nominal terms but what real value is being created? A nominal price increase creates taxable gains but if these gains are the result of inflation, the real value of price increases in assets may be overstated, and the correction when credit becomes more expensive could be severe.
Short-Term Deflation, Long-Term Pain
Despite adding trillions of dollars of freshly printed currency to the economy, the United States and other Western economies are facing the possibility of short-term deflation. How is this possible? Due to the US dollar being the world reserve currency and a historically strong store of value, there is massive global demand for the US dollar outside of the United States. Financial instruments in the United States are considered a flight to safety during times of global economic uncertainty. It is difficult for the United States to generate consistent short-term price inflation while having such low interest rates relative to the rest of the globe because the excess money supply is absorbed internationally through the multi-trillion dollar carry trade.
When interest rates rise and yields from the carry trade diminish, foreign investors will be forced to deleverage from US denominated debt. This will result in the repatriation of trillions of US dollars in a short period of time. With a finite amount of goods, a sharp increase in the available supply of dollars will certainly lead to massive price inflation. Looking at the Federal Reserve Economic Data statistic above, the currency in circulation issued by the United States more than doubled since 2000. At some point this will be realized in the domestic economy resulting in inflation. With all of this in mind, it becomes clear that the stimulus program conducted by the Fed was a wealth redistribution program masquerading as economic salvation. Quantitative Easing is the issuance of currency to shift value to the upper class.
So how can a citizen hope to preserve value if inflation is to occur? Stocks, commodities and other assets are likely to increase in price since there are a finite number of assets. Economists often refer to the horrors of deflation or low inflation. Inflation vs. Deflation is a debate of its own, but I believe the debate will soon become antiquated due to market forces. Bitcoin, precious metals and future digital currencies offer an exit strategy from the continually expanding fiat money supply. Bitcoin has a predetermined number of units that will ever be created. The market may be volatile in the short term, but the development of risk and pricing instruments in the cryptocurrency space is the first step to creating a more usable digital currency. If Bitcoin is able to sustain use over a long enough period of time it will have a chance to become the most notable reliably deflationary currency unit since gold. The argument of inflationary vs. deflationary currency is not one to waste our time on. Let those in favor of an inflationary currency continue to use the inflationary currency of their choice. It is an illogical economic decision for the consumer and the market will correct the outlook given a more profitable alternative. This should not be a debate of whether inflation or deflation is better or worse on a macroeconomic scale, the realistic debate is the argument for the choice that offers the best long term value proposition for the consumer.
Chart from the Federal Reserve Economic Data (FRED)