Unlikely Topic of Conversation 1: Quantitative Easing

That feeling you should or think you kinda know something, but you don’t really know it. This is what this new occasional series* tries to address: I deconstruct and untangle to provide digestible personal finance-related nuggets for the regular person, which let’s face it, rarely come up as a topic of dinnertime conversation! At least for me it doesn’t. Well, next time it does, you can tell them all about… quantitative easing!

Page 3 | Royalty-free Pound photos free download | Pxfuel

(*Find out more about this series and my disclaimer at the end of the post, thanks.)

In brief:

Quantitative Easing (QE) is something the central bank (e.g. Bank of England) does when the country is in financial dire straits (e.g. a recession) to get things moving again (people spending, people able to spend) by ‘purchasing assets’.

Um, come again?

QE is used when the central bank can no longer do its usual thing of lowering the interest rate to get people and companies to spend (e.g. when it’s already very low). So, the Central Bank tries to pump money into general circulation ‘directly’ (says the Bank of England) but does so (not very directly in my mind) by creating new ‘central bank reserves’ that are used to buy government bonds (which itself is a form of government borrowing or debt, hmmm).

Because the central bank buys these government bonds from ‘places’ like pension funds and insurance companies, now these financial institutions have the money to invest in the stockmarket (which is what these companies naturally do to make more money). This spending spree raises share prices etc, leading to (or ‘creating’) further demand. Businesses and people with shares become wealthier, or at least they feel wealthier (if they’ve not cashed in), so they then go on to spend more, which on a population level is seen as the desired outcome as we boost the economy.

And because the central bank has bought up a load of (usually) government bonds, the bond value increases. This is the rule when there’s high demand, and because the yield (interest rate) doesn’t alter from when originally issued, the percentage yield decreases (e.g. original bond 5% yield, bond price on the market doubles: yield 2.5%). This fall in bond value gives the regular banks the opportunity to reduce their own interest rates. So then, borrowing is cheaper and spending is more attractive. The good times are a-rolling again.

File:EH1079134 Bank of England 06.jpg - Wikimedia Commons
Bank of England: Full of printing presses, according to the papers

It seems very hard to calculate though whether QE is actually effective. One Guardian article says no, but this does reflect also its left leaning nature, of course. But here’s the logic: Since 40% of the stock market is owned by the wealthiest 5% of the population (plus some FI-seekers, especially since Bogle got his foot in with index funds!), it’s mostly the better-off households who benefit (by up to £128k in the last recession, according to the New Economics Foundation). And they (and FI-seekers, myself included) tend to keep hold of their wealth, when the government was pinning their hopes on you spending, gawdamnit!

So therein lies the issue with the QE cogs: Lowered interest rates only lead to spending and borrowing if regular peeps have the money to spend in the first place. If you’ve lost your job or (irrespective of the stockmarket) if you feel you may lose your job, then it’s not going to be you. While those losing their job risk losing their mortgaged house, the main reapers are those who benefited from asset price increases (e.g. shares) and can buy up that property, potentially inflating property prices.

I guess the most balanced and unspeculative assessment (and believe me, there is a tonne of bias out there!) would be that QE leads to two actions, which in effect help money to start exchanging hands again (remember, not literally), but is likely to benefit most those who are invested in assets, and it’s been debated whether it has the trickle down effect that the government hopes for. Perhaps it’s a small fallout compared to an economic depression though.

Three myths

1. But, isn’t QE the government printing money on their presses and giving it away?

As has hopefully been established above, the government doesn’t get its printing presses out! It’s all digital money – the number of numbers in the number. That’s my definition of a large amount of money. These digital numbers (and somehow I imagine a calculator or LED screen but it’s not even that!) basically pop out of nowhere created by an organisation created by the government (the central bank) in exchange for IOUs created by the government (bonds).

So, basically, digital numbers shifting between one abstract entity to another, which hopefully trickles down to the common person. If you feel you’re living in a farce sometimes, you’re probably not far wrong! Money is a concept we all buy into so it kinda works. I remember being in Zimbabwe back in 2006 when it wasn’t working so well, since no one was trusting banks and all bank notes had use-by dates on them, but that’s a story for another time…

2. True, it sounds weird, but isn’t it something that’s always been done by government as an emergency measure to avoid a recession?

Yes, if you class the following in the UK as emergencies:

November 2009 (200 billion) / July 2012 (375 billion) / August 2016 (435 billion) / March 2020 (645 billion) / June 2020 (745 billion!!!)

QE was first used by an advanced economy by Japan by 2001 and I see no record of the UK using this ‘unconventional monetary policy’ until 2009, so it’s a pretty recent phenomenon. Some commentators say it’s used often enough that it can’t really all be emergencies. Obviously Covid-19 is behind the last 2 ‘injections’.

3. By essentially injecting money into UK society, there’s going to be a lot more cash circulating around, right?

In theory, but not necessarily all around. My layperson’s guess is that there’ll be some trickle down effect, but it feels reasonable to think that most of it never becomes real money (in that way when we think of ‘cash’) in the sense of exchanging between people.

Optimistically, the trickle down maybe gets so far for most of the ‘new money’ – perhaps to the upper to middle middle classes, if you can call it that. After all, the government is wanting to reach those who are spending the most, not those who are just about getting by with little surplus money beyond survival.

Take someone who’s very well off; well, their stock portfolio has gone up recently despite the ailing ‘economy’ around them. It may be a while, but they decide to spend. What on? Okay, say it’s lockdown, so not holidays, but instead – wine, the latest very expensive gadget, and a new car since showrooms are open now. How much of that money stays in the UK? Maybe some Naked Wine employees and car salesmen benefit, but most of the intermediaries benefit very little and the makers are unlikely to be in the UK. On a large scale with a load of versions of this fortunate person, the wine, car and gadget company will grow in share price.

money makes the world go round | Peter-Ashley Jackson | Flickr
Hey big spender

On an even larger scale, QE devalues the pound (and inflation rises) and makes us less attractive to the international markets. So, the benefits of QE to the UK (domestic) market damages our competitiveness internationally.

So, not so much a load of cash circulating around as a result of QE, but at best some positive impacts on people, perhaps more people retaining their job than otherwise would, but those people, well, they will probably be keeping tighter hold of their purse strings than usual. That’s where the trickle down effect stops, but it enables them to pay their mortgage. This is helpful for circulating money only if then other people take out loans and mortgages. Crazy.

How is this relevant to me or Financial Independence?

It’s probably pretty crap for those on the lowest income, in all honesty, and crap for social equality, but if you’re on the FI path and hold assets (like me), you will likely benefit from QE.

What it does though is make money less valuable as there’s more of it around (especially around the well off), leading to prices going up; i.e. a high rate of inflation (which you may recall is a basket of a lot of items, including housing and whatever lots of people buy like prepared mash!).

Therefore, there are checks and balances. Celebrate your portfolio increasing to its pre-Covid levels, but remember also that this is the indirect products of QE, which has some other consequences down the line. Inflation is the enemy of the FIer, especially if you hold non-inflation-proof assets. Those who’ve switched to cash may think again. Not a recommendation, but a thought.

What this has made me realise is the extent to which we FI-seekers throw a bit of a spanner in the works of our economic machinery. We are likely to benefit from QE, and not pass the spending on for a good, good while! It’s the economic machinery, including actions like QE, that keeps most of the jobs going – which of course is the main/sole source of income for most FIers.

What did I learn?

Me? A helluva lot! I’d say 5/5.

It might also encourage me to hold less cash in future, as QE looks like it’s here to stay.

Shoot me a quick message if you learned something new or if something is unclear, or if you have thoughts on what you’d like to see next in this occasional series, thanks.


Main sources

I briefly consulted some research papers, but did not use any of the information except to gain more of an impression of what QE is and its contemporary issues. I also read up on bonds from a number of websites to understand that mechanism.

Note also that other countries like the US and Eurozone may operate QE slightly differently.


No financial qualifications: My aim with this occasional series is to increase financial knowledge and understanding, to make it accessible to regular people generally while learning myself. It’s not designed for those in or wishing to go into finance and economics.I can guarantee I have checked a number of sources but I can’t guarantee I have a complete view of the subject to make it entirely accurate. I would go as far as to say I almost certainly haven’t.

Bias: I acknowledge and reflect on my biases and try to avoid bias in how information is presented. I will always try to check a range of sources; e.g. the Guardian will have a different view from the Bank of England’s website. I will try to reconciliate and strike a balance between descriptions and I will try to be clear when I’m being speculative or making a reasoned assumption. I work in a not-very-businessy environment (and hate that education is a commodity). Feel free to politely pull me up on anything that is incorrect or biased, thank you!

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