Does Quantitative Easing Really Work?
Hi Plebs,
Many people ask if quantitative easing (QE) is effective. The short answer is no. Some believe QE was needed, but it only delayed problems for the future when more QE would be required. The root issue was that the financial system had taken on too much debt. At the time, every dollar in the banking system was leveraged 150 times over. There was way too much debt compared to actual dollars.
This extreme leverage was only possible because the Fed kept pumping new money into the system during recessions in the years before the crisis. Instead of letting the markets correct themselves by reducing debt levels naturally, the Fed's approach was to just create more dollars. This allowed debt levels to keep increasing by making it easier to get new loans and credit.
By continually adding more money, the Fed didn't fix the core problem of too much debt. It just kicked the can down the road. So when the financial crisis hit, the system couldn't handle the strain of that massive debt load, causing widespread collapse.
How the Fed Created a Fragile System
The Fed's actions before 2008 accidentally made the financial system very fragile and unstable. By continually expanding credit, the system became extremely leveraged over many decades. Similar policies were used before, but the 2008 crisis forced the Fed to take much bigger actions. Simply put, they needed a much larger solution.
To understand the scale, the Fed increased the money supply by $3.6 trillion through QE1, QE2, and QE3 over five years after 2008. This was 36 times larger than the $100 billion increase in just the five years before 2008. This time was very different. The real problem was the huge imbalances in credit that built up over many years, leading to excessive debt levels.
Eventually, this debt bubble was going to burst no matter what. An outside event triggering a collapse was inevitable as the problem got bigger and bigger over time.
The Fed kept inflating the balloon further than it could stretch. Each round of credit expansion pumped more air into an already expanded system. Finally, the balloon popped in 2008 when it couldn't handle any more strain.
What made 2008 so severe was the enormous imbalances that developed from years of over-leverage. Debt levels became absolutely massive, making the system extremely fragile to any disturbance.
The Fed's Catch-22 Trap
In the economy the Fed created, the amount of credit became much, much larger than the actual money supply. This made the credit system, not the money supply, the main driver of price levels. Since the Fed aims to control inflation, it must maintain the huge credit system to keep prices stable.
During the 2008 crisis, the credit system started collapsing, causing asset prices to drop rapidly and disorderly. To stop this, the Fed had to massively increase the money supply to support the enormous credit system - more than ever before. But even after the worst was over, the Fed decided it needed to create trillions more dollars after QE1 just to keep the sputtering system going, despite admitting its policies had limits.
This is the Fed's Catch-22 trap. Even when it knows better, its knee-jerk reaction is always more money printing, not less. Trying the same failed approach again to fix instability. It's insane.
The Fed allowed the credit bubble to inflate to a dangerous size. Now it feels forced to keep inflating that bubble to prevent total collapse. Each new QE is a desperate attempt to keep air in the balloon as it stretches thinner and thinner.
But this approach cannot last. The fundamental imbalances cannot be resolved by the very policies that caused them. Until the Fed allows a real purge of bad debt, it will remain stuck in this insanity cycle, just kicking the can down the road until the next, even bigger crisis hits.
Cheers, and onwards with Bitcoin.
