I’m Quantitatively Eased

No. Sorry. I’m not about to lambaste Ben Bernanke. A quite informative article in the April 2012 Atlantic, titled “The Villain,” persuades me that Bernanke is all right. But he is merely another mortal in a world of subprime collective intelligence. Collective intelligence, of course, is always subprime. The Fed Chair has been trying his damndest to try to help the economy with what little in the way of tooling is available to the monetary ruler of the land.

Quantitative easing? Apparently it’s an innovation we have from Japan. They coined the phrase in 2001 using the words “quantitative monetary easing.” Functionally it consists of central bank purchases of financial assets—such as bonds. The money for this purpose is in fact “printed,” thus created (in our case) by the Federal Reserve Bank. It is intended to bring down long term interest rates.

To understand why the traded value of bonds changes the value of the bond’s yield, we must understand that bonds have a face or par value (e.g. $1,000) but, when traded in the market, they may be bought for less or for more: their market value. Bonds, however, have a coupon rate, set on the face value, say 4 percent of par, thus $40 a year. But when a bond’s traded value rises, say to $1,500, the yield remains $40/year, but the interest rate has now dropped to 2.7 percent.

The motivation behind quantitative easing is to stimulate the market by lowering the cost of money—the presumption evidently being that people aren’t borrowing because interest rates are too high. If only interest rates were lower! But what if people aren’t borrowing for some other set of reasons? Suppose that they do not borrow because they have no confidence? Suppose they do not borrow to build new factories because they don’t believe they can sell the goods they would be making? What if interest rate is, uh, irrelevant for the moment.

That being the case, let’s just suppose, the Federal Reserve is, in fact, facing a hopeless situation. Its tools are inadequate to influence collective behavior. Interest rates have been creeping at rock bottom levels for a long time. Our bank now offers an interest rate on savings of—are you ready?—0.1 percent. Why? They don’t need money. Nobody is borrowing. But the Fed wishes to do good. The other part of government, meanwhile, which could stimulate the economy by actually buying things and services, is entirely mesmerized by trillion dollar deficits.

I look at that headline of mine up there. Am I really quantitatively eased? Maybe not.