In what optimists will see as a sign of times returning to normal, the US Federal Reserve announced an end to its asset purchase programme on Wednesday. At its height, the scheme saw the purchase of an astonishing $85 billion worth of assets per month. The asset purchase scheme used newly created cash (electronic credits) to buy government bonds and mortgaged-backed securities. The aim of this was two-fold: firstly, by creating a strong market for these asset classes, it kept the cost of borrowing low (the Fed used the scheme to swap out shorter term, expensive sovereign debt with cheaper longer duration bonds and so reduced the nation’s borrowing costs somewhat); secondly, it hoped to increase liquidity in the financial sector through the commissions it paid to financial houses to make the purchases on the Fed’s behalf. The hope was that the financial institutes would use these commissions to lend to business and so stimulate the economy, but it didn’t quite work that way.
The Global Financial Crisis exposed the fact that many banks held inadequate funds in their cash accounts to cope with the demands of a fresh crisis which might trigger a run on the banks. This meant that some of the money that the Fed hoped to see lent out went to shore-up the finances of the banks. Money that did “escape into the wild” found its way (in part) into foreign, emerging stock markets where the prospects of a decent return on investment where higher.
The Federal Reserve has added something like $3.7 trillion to its asset portfolio since the start of the Global Financial Crisis in 2008. At the outset of the Quantitative Easing adventure, it was suggested that the funds created would be liquidated once normality had been achieved. Concerns were raised that the creation of money to prime the economic pump could lead to hyper-inflation or destroy international trust in the global monetary system. In the event, neither of these worries came to anything, but the Federal Reserve will be earning interest on the assets that it holds – real money earned on the back of money that never quite existed. QE remains a potentially harmful tool of extraordinary monetary policy that has the potential to derail the global economy by undermining trust in fiat money.