Quantitative Easing

QE_seatrials QE3

Probably by now, the term Quantitative Easing (QE) is familiar to most people, having been widely publicized in the media. It is the “tool” employed by a central bank to revive the economy, by printing money.The aim is to get money flowing and thereby get the economy going. QE also keeps interest rates low as banks are flooded with money to be loaned out.

If you think about it, isn’t it scary to have such huge sums of money (to the tune of hundreds of billion dollars/euro) created out of thin air? In fact, it is scary to have any amount of money created out of thin air at all, which is what our fiat currency economic system does. Here’s how i would reason about how it works (by the way, i’m no economist, so everything i say is just my own logical thinking and i can be wrong): Population growth means more resources are needed to meet the needs of every individual. There is a price tag on every resource, thus as resources are consumed, the money supply has to keep up such that every one has the money they need to purchase the resources they need. As long as the two move in tandem, the economy would remain healthy (as in everyone can live happily). Unfortunately, this equilibrium is quite fragile.

The most basic resources everyone needs are very aptly summarized in the Chinese phrase 衣食住行, meaning clothing, food, shelter and transport. Among these, the biggest ticket item is obviously, shelter. Even with free market at work, It is not always possible to ensure that the demand and supply of houses are balanced. When demand outstrips supply, prices move up. Given that houses cost a lot to begin with, the price increase is naturally also a lot in absolute terms. The fractional reserve banking system allows for such big price increases, whereby credit is created out of nothing, to pay for the house. This is how the money supply increases tremendously and how it becomes disproportionate when compared to the resources consumed. Under free market forces, the divergence is then mitigated by price increases across the board. This is called inflation.

Such a fiat currency system breaks down when people are unable to pay back the loan they took up (say they lost their job). In technical terms, this is called a default. If the banks who loaned out the money are unable to cover the bad debt, they may themselves default on the loans they took up from the central bank. When this happens, money is basically destroyed. This has happened with the Bear Stearns and Lehman Brothers incidents, which resulted in a worldwide economic recession and triggered unprecedented quick fix measures such as QE to be implemented by central banks. In a sense, QE does solve the problem by “replacing” the “lost” money. However, it’s not right to just write off bad debt. In essence, what it does is to force the people who make an honest living to pay off the debt problem created by the careless speculators, fraudsters and schemers on a very very grand scale. As we can see, the fiat currency system doesn’t work well. In fact, no system can work, because the heart of the problem lies in human greed and self-indulgence.

As at the time of this writing, we are hearing news of the possibility of QE3 as the debate over the debt ceiling rages on. Allowing the debt problem to roll-over and to continue to snow ball is seen as the way out, and the support cited for such a “solution” is simply that the problem is too big to be solved any other way. Gone are the days when people work hard to pay off their debts first before going on to spend what they have in excess. Instead, consumerism is the mandate now – spend your way out of economic problems.

By the way, taking a voyage on the other, probably lesser known, QE3 (the ship) may be a good way to spend your money.

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