Money Printing in 2013

You hear a lot about central banks printing money at the moment. Everyone knows excessive money printing leads to higher inflation, in worst case to hyperinflation. But at the moment, most central banks are more worried about deflation than inflation. Here is a summary of the central banks current strategies.

Several large economies have adopted quantitative easing, QE. Some critics mean that quantitative easing is the same as money printing. The central banks on the other hand have pointed out that quantitative easing is not the same thing as traditional money printing. Quite clearly there is a difference between QE and money printing. While traditional money printing always expands the money supply, QE may not expand the money supply much.

But even if QE is not exactly the same thing as money printing, should not the huge amounts of QE money increase the inflation? It is impossible to answer that question, QE is an experiment and nobody knows how to end a quantitative easing program. You can read more about quantitative easing and inflation here.

The most important central bank in the world is of course the Federal Reserve in the US. The world has become used to huge US trade deficits that boost the economies all around the world. The US economy got into big trouble in 2008 when the credit bubble burst. The Fed cut lowered its interest rate to almost zero but that did not help. The only thing left that could avoid a deep depression was the printing press, in the modified form of quantitative easing.

The first round of quantitative easing in the US did improve the solvency of the banks and help to push the stock markets upwards. But the economy had not improved so the Fed announced a second round of quantitative easing. The decision was probably forced by the fact that the stock market had dropped almost 15% since the end of QE1. At the end of QE2, the economy was still on government life support and this time Bernanke announced an open-ended QE3.

At the moment, the Fed is buying bonds for $85 billion per month. It looks like this is set to continue, as soon the Fed starts to talk about scaling down on quantitative easing, the markets start heading south. As many have noticed, the markets should really be happy that QE is over. QE is a temporary emergency solution due to the slow economy. But when the Fed starts to talk about a sustainable recovery, the markets start to panic. Despite the fact that a economy that is recovering is good. A lot of people noticed this and they are very interested in how the Fed will be able to get out of QE.

Although the quantitative easing undertaken by the Federal Reserve in the US gets much more publicity, the UK is testing QE on a larger scale than the US. Japan was the first country to try quantitative easing back in 2001 but that was a limited round of QE. Towards the end of 2012, a much larger dose of QE was being planned as part of Abenomics. In April 2013, the Bank of Japan announced a $1400 billion QE programme. This is supposed to double the money supply.

The European Central Bank, ECB, has its own way of printing money without referring to it as quantitative easing or money printing. The ECB lends money to troubled banks at 1% interest for three years. Most of the money has been going to banks in Italy, Spain, Greece and Ireland. Much of the money is then used by the banks to buy government debt in these countries. This means that the banks make easy profits at the same time as the borrowing costs for the governments have gone down. This program adds an estimated 1000 billion euros to the money supply.

But money printing is also used by countries that have trade surpluses and a pegged currency. China has become the prime example of this but several other countries are using the same strategy, albeit on a smaller scale.

China’s huge trade surplus means that Chinese companies have a lot of dollars which they in most cases want to convert to Chinese yuan. If such huge amounts of dollars were converted into yuan on the open market, the value of the yuan would go up. To prevent the yuan from appreciating, the Chinese central bank, People’s Bank of China, buys the dollars at a fixed price. This prevents the yuan from increasing in value which would make Chinese products more expensive abroad. But from where does the Chinese central bank get such huge amounts of yuan? Easy, it creates the money out of thin air, printing as much paper money as it needs. Nowadays, China not only has a huge trade surplus, China also has a financial account surplus. This means that even more money printing is needed to prevent the yuan from appreciating.

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