Saturday, March 17, 2012

The Peril of Printing Money

Traditionally, printing money supposed to be the last resort to the monetary policy. However from the recent sovereign debt crisis in the Euro zone and the U.S., we can see these policy makers are embarking on large scaled quantitative easing process to avert the collapse in the financial system.

The US embarked on the QE1 and QE2 with each over US$1 trillion respectively in the last 2 years, similarly, the Bank of England had its first QE1 in Mar 2009 and the QE2 in Oct 2011 with £75b and £50b respectively. And recently, in saving the mess in the Euro zone, the ECB has engaged in the so called long-term refinancing operations (LTRO) which is equivalent to the back-door quantitative easing, with €409b and €529b for the last 2 months.

Essentially, what is QE and LTRO? QE refers to the central bank implements quantitative easing by purchasing financial assets from commercial banks and other private sector businesses with printing new money. While LTRO refers to the central bank lending money at a very low interest rate to euro zone financially troubled banks with printing money, which has led to the term “free money" and these banks are suppose to pay back at a much later date.

For the LTRO, the injection of cheap money means that banks can use it to buy higher-yielding assets and make profits, or to lend more money to businesses and consumers – which could help the real economy return to growth as well as potentially yielding returns.The best part, the banks can borrowed these money and pay back to the ECB after 3 years rather than the usual 3 months or 6 months.

So what's the consequence?

The biggest consequence is the income gap between the rich and the poor will widen significantly!

As we have too much money supply in the market it will result in "too much money chasing too few goods", which means the food prices will increase in tandem which drives up the cost of living. This is the demand-pulled inflation that is brewing in the economy.

On the other hand, during inflation, asset prices will rise accordingly while the paper money will lose purchasing power. Hence, the poor being not able to invest in stocks and houses, will be the greatest losers in the economy.

On top of that, commodity prices such as precious metals and energy will escalate too. The poor definitely do not benefit from this because not only do they own minimum precious metals, they need to face up to the consequence of the rising oil price that make their living even worse off. The rising energy prices will act as a double wammy to the economy because this cost-driven inflation will push the inflation rate higher. Hence, demand-pull inflation coupled with cost-push inflation, the economy will likely to run into "hyperinflation"!

Does the policy makers know the consequences? Why did they do this?

Well, with the QE, bank rates are artificially kept at an ultra low levels which makes borrowing easier for the business sectors. At least that's their intention - to promote more borrowing which in turns stimuate groth in the economy. But whether the low interest rate helps to revive the economy really depends on the business confidence because we can have the lowest rates in history but if the public shows lack of interest in borrowing the "free money", the economy can't move forward! Hence, QE did pump lots of money into the banks but this only improves banks' liquidity, not the economy. Even though, the minority rich will get richer as asset prices like stocks, properties and commodities will soar, but the majority of the population is still poor and unemployed!

Now with the fear of inflation, how would the business confidence improve? Whether the central banks print money or not, it will take time for any economy to recover. If I were the Fed, I'll stop printing money, let the economy go through the cycle, let the commodity prices fall and hopefully tommorrow will be better!

Happy investing,

Pauline Yong

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