[Ed. note: This article was originally posted in November of 2010 – we have decided to republish it with updated charts, as it has proved to be very useful as a reference – the mechanics of QE are less well understood than they should be, and this article explains them in detail.]
Printing Money
We have noticed that lately, numerous attempts have been made to explain the mechanics of quantitative easing. They range from the truly funny as in this by now ‘viral’ You Tube video with two robotic teddy-bears discussing the Fed chairman’s qualifications (‘my plumber has a beard too’), to outright obfuscation such as the propagation of this ‘Bernanke explains he’s not printing money, it’s just an asset swap‘ notion. This was apparently repeated by NY Fed president William Dudley on one occasion as well.
Are they printing money? You bet they do.
However, ‘quantitative easing’ does amount to printing money, even if it does not involve the issuance of currency in the form of banknotes. Probably readers have heard the term ‘high-powered money’, which is often used as a description of the monetary base. Why is base money considered ‘high powered’? To explain this we must briefly consider how the central bank-led fractionally reserved banking cartel in a fiat money system actually works.
Let us first take a step back and consider a free market. In a free market, a highly marketable good will be chosen as money. Historically, all sorts of goods have been used as money (from salt to cowry shells), but wherever gold and silver were available, the market eventually settled on these metals. It is obvious why: there was a preexisting strong demand for them, they are highly durable, divisible, fungible and scarce. In the case of gold, its scarcity furthermore ensures a high per unit value, making it feasible for large scale transactions.
A bank in a free market would accept deposits in the form of gold. As we pointed out in a previous essay on fractional reserves banking, a deposit contract is essentially different from a loan contract. It is a warehousing contract, not a ‘loan to the bank’ (even though modern-day jurisprudence disagrees on this point, by ignoring both legal tradition and logic).
Nonetheless, banks have throughout history succumbed to the temptation of embezzling the money of their depositors and using it for their own business ventures. Once a bank has built up a reputation of solidity, it will be fairly easy for it to just keep a fractional reserve at hand – this is to say, instead of actually warehousing the entire amount on deposit, it will only keep a certain percentage at hand that it estimates will suffice to satisfy withdrawal demands in the ‘normal course of business’.
A Brief Look at History
In times past there were two methods of engaging in this type of fraud, both of which can be illustrated by the practices of English goldsmiths in the 18th and early 19th centuries, the …read more
Source:: Acting Man
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