Thursday, 8 March 2012

Sterilized QE: What is it?

Its impact the market barely registering as FED's highly accomodative monetary policy (that's low rates and QE) was given a hint of its future courtesy of the wall street journal.


Hilsenrath (of the WSF) told us that the FED were considering steriliz(s)ed QE as the US continue to engineer their way out of recession. Just one question on everyone's minds, just what is sterilized QE?

Sterilization in its usual sense refers to the used of foreign exchange (buying or selling your currency) in order to neutralise the effect that your operation has on the money supply of your currency. In this case it is ever so slightly different.

As I understand it (and I could be way off the mark!)...

1. FED prints money...

2. Fed then purchases bonds and other securities (speculation of Mortgage backed ones)

3. Fed now have bonds and money managers have loads of cash on their balance sheet, which they have until now simply re-deposited back into the FED (so much so that the yield is negative - ie saving could lose you money).

4. Bernanke doesn't want the money to remain idle and so simultaneously borrows the money that he has just paid the money managers for a small amount of interest.

5. As well as having more assets on the balance sheet (re bonds), they also now have liabilities (interest to be paid on the borrowing of money).

So in a nut shell money managers swap their bonds for a loan. As opposed to a lump sum, they get interest payments making it less convenient to deposit in a bank.

Why the change in tact?? Some commentators say it is to alleviate fears of inflation down the road. As the Weimar Republic showed us, inflation came only 5 years after the printing presses were turned on and once it reared its ugly head, well

Is this guy looking for an understudy?

Personally I am less inclined to think that the FED's operations thus far are inflationary...... The money created has

1. Hoarded with banks and institutions and has not joined the monetary in circulation (this could well change in the future).
2. The crisis was caused by rampant credit creation and so as credit is reduced, the money supply is reduced. In order to increase money supply, new money must exceed the contraction in credit.

Trying to get back on topic I hope the post explained what sterilized QE means. As for what it will do to the economy, your guess is as good as mine!



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