QE looks to increase the money supply of a country; this is done by the central bank buying financial assets to inject new money into the economy.
The idea is to stimulate the economy, usually after ultra low interest rates – near 0% – have lost their power to do the same.
It can be referred to as printing money, which could be accurate, new money is created by the central bank to fund the financial asset purchases, but no physical money is created, it’s only electronic.
Central banks generally buy government bonds from financial institutions in the secondary market as the central bank can’t directly buy those same securities directly.
In theory, those financial institutions – now sitting on a great deal more capital – should be trying to promote lending to business and consumers.
Another result of QE is it serves to push up the price of government bonds, while pushing down the yield.
Clearly this makes government bonds a less attractive investment and according to some it’s responsible for world share markets’ sharp moves upwards in 2009.
When investor’s yield from bonds drops at the same time as their price goes up, it’s expected they’ll chase better returns in riskier assets.
It could also be argued that instead of actually promoting and increasing lending, the financial institutions now flush with liquidity from central bank bond purchases would push that money into share markets.
QE is also often seen as the reason gold has been ripping upwards in recent years and why it gyrates up or down depending on whether Chairman of the US Federal Reserve, Ben Bernanke, hints at more QE.
The reasons for the gold increase are also reflected in exchange rates, the idea being that increasing the money supply only serves to debase the paper currency, with gold remaining a true store of wealth.
Peter Mancell is a director of Mancell Financial Group and FYG Planners AFSL/ACL 224543. This information is general in nature and readers should seek professional advice specific to their circumstances. Need help with your financial your financial future, we think we’re the best financial adviser in Australia.
