Quantitative Easing is the economic equivalent of a tactical nuclear strike – if all goes well, then the conflict is quickly brought to a close; if not Armageddon beckons. This might sound dramatic, but QE really is an immense gamble which, fortunately, seems to have paid off. In essence, central banks simply shook “the magic money tree” and trillions of Euros, Pounds, Yen and Dollars fell out of it. The central banks created cash electronically and handed it to financial institutions to purchase specific assets with (to meet certain objectives). The brokers were paid for these services on a commission basis and that cash was supposed to be used to stimulate the economy. The risk involved in this activity was that markets would lose faith in fiat money, triggering an economic collapse as traders sought to exchange fiat money for hard assets such as gold and commodities which have some inherent value. Fortunately, that process and the hyper-inflation that it would bring never happened, the economic nuclear strike was surgical.
The total value of assets purchased by the US Federal Reserve under the various phases of its QE programme is truly immense. The Fed has an asset portfolio in excess of $4.2 trillion – by comparison, US public debt is approximately $20 trillion. Naturally, the assets that the Fed holds generate income (it paid $89 billion to the Treasury in 2012) and may appreciate in value in response to market factors (or not). It is worth noting that before the QE experiment, the Fed portfolio was worth “just” $900 billion.
The Federal Reserve has announced that it will start the process of winding down its holdings. In principle, the revenue from the sale of these assets is supposed to be used to cancel out the electronic cash generated in the first place. The process of asset sales needs to be handled carefully to avoid a glut of assets coming onto the market and artificially (I appreciate the irony involved in that word choice) pushing market values down due to oversupply. The initial phase will be to end the reinvestment phase which has seen bonds in the portfolio replaced when they reach maturity (currently, something like $10 billion a month). If this was all the Fed were to do, it would take 400 months – more than 33 years to unwind the existing holding!