With all the hoopla and media-bonanza around the merits and pitfalls of contemporary monetary economics, it must make you wonder: where is all this going to lead to (and really, where does it come from)? What is real, what is politics, what is prudent, and what might be outright reckless? ‘Quantitative Easing’ is a term that’s been thrown around a lot these days. Most people now know what that refers to – simply printing more money, having more of it to go around in the hope that it’ll land in the right places and spur some economic production. But to many, just the act of pushing buttons to ‘create’ money seems as morally troubling as it is perplexing. I remember when I had held a dollar bill decades ago and wondered how is that it creates its value on a printed piece of paper. Well, that piece of paper is not coming out of ‘thin air’ as sometimes media-savvy charlatan-pundits like to state. The monetary unit derives its value from the economic value of assets, goods and services in the economy. The Treasury or Central Bank of the economy seeks to equate the monies with the economic value in the country, also known as GDP. But, in order to decipher what is happening today and why, we need to step through a time machine and take a little tour of history.
Back in Time
Paper money is worth what it is because you can use it to purchase goods and services that you need and it is accepted for rendering such goods and services. You can even go buy something considered of value long before paper money in its present form was established (not more than 200 years back), such as diamonds or gold. A long time ago, paper money began its evolution as receipts for gold. Before paper money, gold was the most common form of monetary exchange. Since it was too burdensome and insecure to carry gold around for settling transactions the early forms of paper money were devised as receipts drawn on depositories that held gold. Any bearer of the receipt could redeem it for gold. This was ‘The Gold Standard’. Today we have become quite nostalgic of The Gold Standard given economic uncertainty and printing (or ‘easing’) of money to bail ourselves out of our economic woes. But, the Gold Standard was in fact beset with some fundamental problems and had its opponents. Monetary Planning during The Gold Standard was frustrating due to the uncompromising peg to amounts of gold in the vaults. Gold may go up and down per mining and trade-settlements with other countries. Therefore, if there was economic growth due to prosperity or population growth, you couldn’t cater it with money supply which itself could hinder prosperity as the money supply was unable to facilitate higher volumes and values of economic transactions.
The debate on the merits of the Gold Standard ended with The Great War. Paper money had gained ubiquitous acceptance and nobody checked in with the depository anymore to audit-check the money’s convertibility into gold. The government had to expand money to pay for the wars. However, after the utter devastation of the Second World War, the USA was the sole standing super-power with more than 50% of global production and a good chunk of the world’s gold. The European currencies were ruined. The USA offered the dollar’s convertibility into gold so countries could hold the Dollar as a reserve rather than gold directly and start rebuilding their economies and currencies. However, in the 1950s and 1960s due to the burgeoning world economy, the problem of a peg to gold reserves resurfaced and the Kennedy Administration finally parted with the dollar’s obligation. Since then the USA’s economic domination, albeit still intact, has diminished and given its whopping trade and budget deficit leads many to believe that the Dollar’s domination, validation and underpinning to the world monetary system has become questionable.
The Here And Now
Since then the world economy has been mostly growing and Central Banks have been printing money to keep up with it – nothing wrong with that. In 2008, given that the financial system was gridlocked in crises and there were trillions in toxic debt, quantitative easy seemed like an acceptable risk especially when it was known that a lack of bank-assistance was one reason why it took a decade to recover out of The Great Depression. Recently, the Fed announced that it would introduce another round of $600 billion worth of ‘Quantitative Easing’ over eight months or so in a bid to sprite-up the sputtering and sluggish 1% economic growth rate. Now, the doom-and-gloom pundits are up in arms about throwing so much money out there with little economic activity to back it up. But, the Fed isn’t all stupid. They’ve done some homework. They would emphasize that since there is such low demand in the economy this leaves little risk of inflation or devaluation of the currency – the money could move around and not do much at the worst. If it looks like there is too much money out there and its value is dropping, they can pull it out quickly. And, if they throw cheap capital out here with people willing to borrow it and spend it, then that itself creates incremental economic value.
Here are a few things to keep in mind as we go through the motions. This is not a science. The problem is that people are being cautious, reserved and measured. They are also de-leveraging out of debt. Despite normalization of bad debts and higher corporate profits, industry leaders are not investing and consumers aren’t borrowing. The issue with Quantitative Easing is that it relies on debt and interest as the instrument of economic leveraging. And people may not see eye to eye on that anymore. If banks started offering cheap credit cards again, are we then looking to go back on the hell-road to highly leveraged household credit card debt? I believe that a better way of achieving the same objective is to provide tax relief or refunds to the consumer. This has moral equity on its side. Firstly, people feel better about a tax refund. There is far greater positive emotional response with it. Taxes are our money. We own it. We own the government, which lives off our tax-money. If we get it back, it’s ours, and ours to spend. Now, if I have to go back and borrow to spend and create economic activity, that’s a sour sentiment. I probably just won’t do it.
Our economic masters may argue that then they won’t have control. Once it’s out the bag, it’s gone; for better or for worse. Pulling it back in with a tax charge is politically impossible. Well, then cut it in half or less to $250 billion and at least give it half a chance.