Free money: dangerous to leave, dangerous to stay

Last week the Federal Reserve bought the last batch of bonds under the Covid-induced quantitative easing season.

These last $4Bn have put an end to the biggest QE season ever, with almost $5Tr created out of thin air during the last 2 years, more than doubling the Fed balance sheet.

? QE is a fancy term referring to the Central Bank buying state and corporations’ bonds with the newly created money.

Its proponents argue that together with low interest rates it’s a way to stimulate the economy: more money in circulation should encourage additional activity, and low rates – more investments. This also allows the government to borrow endlessly (the rates are low and the Fed is buying).

? The problem is that free money is not really free: new dollars dilute the supply of the existing ones, making them loose their value. Hence, inflation.

Also, more often than not the new money goes to the financial institutions’ pockets, which invest it into high-risk assets, inflating their price, while the commercial banks may still be reticent to lend money to the regular people and smaller businesses.

In the meantime, the rising inflation hurts low-income families the most, many of whom do not have a meaningful way or possibility to invest (unless they know about crypto ?). This further increases the income gap.

Last November the Fed started tampering (reducing bonds-buying) and this week it announced a 0.25% rate raise.

Next step would be quantitative tightening – selling the bonds or non-investing into the expired ones. The problem is, however, that the whole QE experiment is very new: it started only in 2008. The tightening is an even lesser-known territory: the Fed tried to roll it out only once in 2017, but was obliged to stop two years later because of market concerns.

? The QE put the US (and the whole financial world) in quite a pickle. With the inflation reaching 7.9%, it is obvious that money-printing should stop and rates be increased. However, this raises an important question: how will the government finance its gigantic debt? In the “free money” time it could always borrow to pay for its old debts. Things are changing though, and it may not be able to continue this way much longer.

We will soon be witnessing the first-of-a-kind QE rewind. Together with post-Covid consequences and the war in Ukraine this might be quite a ride.

Luckily, we have an alternative to this.