Q2E1 - Qualitative Easing

“Qualitative easing.” WTF does that mean. To me it sounds like sizing pants at 6:00pm Thanksgiving Day. OK, so my waist size says 42. But that's not normally what it is. This was an UNUSUALLY large meal. I don't eat like that every day.

Yes, that's true. But you're treating the future as if it's just a flat line from the past. And while it's probably true for Thanksgiving-sized meals, it's not the case for the economy.

Zoom out. Our money is issued by the Federal Reserve Bank. That bank has two missions. One is to encourage employment in the U.S., and the other is to keep inflation low. Great! I can get behind those ideas. But what happens when the two priorities conflict with one another. Well, we know what happens in the business world. One position must be resigned or at least made less important. The Federal Reserve board must then make one a priority and pay less attention to the other. They have been doing that for 6 years now - making employment their main priority will far less concern for inflation.

Quantitative easing began in 2008, was restarted in 2010, and then put into cruise control in 2012. If 1% of Americans know what quantitative easing means, then I will buy you pizza (NO! I did not dump toxic chemicals in your neighborhood!). Think briefly of the Fed as the world's largest bank. It has assets just like any other, and in 6 years, the fed has tripled it's holdings of U.S. Treasury Bonds. Where did the Fed get the money to buy those bonds? Well, they printed it. They created new dollars and then gave the U.S. government those new dollars in exchange for long term bonds.

I don't know the Fed's total holdings. I've never even thought about it. I doubt .1% of Americans have. It's just the national bank. But if you have American dollars in your wallet, checking account, or life savings, you own stock in the Fed. The reputation of the U.S. dollar dictates your purchasing power.

We want to think of our money as a rock. Prudential. Fidelity. Even the insurance industry recognizes the branding there: stable. This is why the Fed has a mandate about inflation. If inflation were at a crazy rate, like 20%, you would see prices jumping every other month. Businesses would be racing ahead of one another to charge each other more, and eventually the entire system of exchanging paper for goods would halt. No one would trust the prices they set today would be worth something tomorrow, and nothing would get done (or eaten, for that matter...). And no one would save ANY money. So 20% is bad. How bad is 10%? Well, probably about half as bad as 20%. idk. At a certain point, you've slowed inflation to a point where people just don't freak out about it. They just understand that as time passes things will cost more. We just shrug our shoulders and say “It is what it is.”

The U.S. having an amount of inflation that gives stability to the economy is no accident. It is carefully controlled by the Federal Reserve. They have come to the agreement that the inflation target year to year is 2.5%. Why that amount? Well, people don't freak out when inflation is at that rate. And yes, they came up with something more verbose which you can read here.
But apparently, a half of a point higher is appropriate now where it was not two years ago. The Wall Street Journal notices the inconsistency of the Fed's action - read about it.

But the fed also has a mandate to advocate for jobs in the United States. There used to not be published targets about this particular aspect of its mandate, but when the stock market went in the shitter in 2008, unemployment jumped drastically. Politicians then demanded action from the Fed. The Fed, knowing the only action that it could take would conflict with its other mandate, set a benchmark on unemployment at 6.5%. Arbitrary? Maybe. Compared to what was considered “full” employment before, 2 more people out of every 100 would not have a job. This likely just means longer unemployment lines, more public assistance, and less mobility for the lower class. But this is a big deal if any of those conditions affects you or those around you. Also, those 2 people out of every 100 still have to eat. They just might be getting their food from their family, friends, or from public assistance.

Should the dollar itself should be staked on employment? The economy moves in cycles, always has, always will. Even the Bible discusses economic cycles. Seven years of plenty, seven years of famine. The Fed has attempted to smooth the rough edges of those cycles. They control inflation by raising interest rates, and they TRY to impact employment by lowering them. Then they lowered them to de facto below zero. Interbank interest right now is lower than inflation. Therefore, loaning money to another bank loses money for the original bank.

The economically transitional period we are currently in has little to do with interest rates. Technology has finally hit professions and “inside” jobs, and productivity has soared with time and cost cutting computer applications. We as a society should be proud – we have created a system where not everybody has to be working for us to make enough food and goods for everyone to live. We still have very high per capita income, and as far as basic needs go, we are a net exporter to the world.

Ok, so what happens when the 6.5% target is reached. If the Fed had signed a contract for this, it would mean they would instantly cease quantitative easing and raise the interbank borrowing rate, which would filter down into every consumer interest rate on the market. It would be an electric shock to the economy – we would be stunned, disoriented, confused, and we would lose track of the next small period of time. Along with the uncertainty a new Fed chair brings, the market is concerned about the timing of the withdrawal of quantitative easing. This week's increase on capital requirements for large banks represents what I believe to be the first step of the Federal Reserve ending quantitative easing. They are requiring higher capital reserves in large banks so that those banks can weather the storm the Fed knows will hit soon. They know the American economy can't take another body blow like 2008 again, but they also know that continuing down the path they are on will lead to massive inflation. Tapering began in late 2013, coinciding with the strength and distraction of the Christmas shopping season. I imagine that Bernanke knew his term was almost up and the first two months would not be a big deal and the big players would wait to make moves until Yellen took office. And he wisely started a major policy shift while he still held office in order to soften the blow that change would eventually bring

It's very funny to change the Q in QE. Quantitative and qualitative mean opposite things and this marks a large shift in the stated purpose of the initiative. Basically they are saying we officially will meet our goal but will continue pumping money into the banking system because we know that if we stop, things will grind to a halt. I'm running on here, more of the “why” next week.