Quantitative Easing, Stimulus and the Fed. Where is the U.S. dollar heading to?
Greetings, family! Today we will talk about three topics:
- Quantitative Easing (QE)
- Stimulus package and what would it mean for the USD
- Where is the USD heading to?
A while back we briefly talked about quantitative easing and what is the concept behind it. Now we will go a little more in depth about it. What is the purpose of running QE? Well the central banks around the globe use QE to stimulate GDP growth in a lagging economy. To make it easier to understand, let’s take a look at the block diagram below.
On the diagram you can see a perfect money flow. Central banks lend to commercial banks, commercial banks lend to us (the consumers) we spend the money on firms (buying goods or services) those firms reinvest the money in the commercial banks. Commercial banks conduct repo or reverse repo operations to lend capital in exchange for assets. For example if Bank “A” needs capital and owns assets and Bank “B” has free capital to use, they conduct a repo operation. Bank “A” gives assets in exchange for capital with the agreement that after XXX days they’ll conduct a reverse repo operation e.g. reverse the exchange of assets and capital with some % capital gain for the lender (Bank “B”). In the ideal situation, this is how things should look like. Right now things do not look like that. Why? Let’s review the same block diagram, but with little adjustments
In this situation, the banks continue to lend but the consumer spending is very low. Why is this a problem? Well basically no matter how much “cheap” money you lend to consumers, if they don’t want to spend it there’s nothing you could possibly do. This lower consumer spending breaks that free money flow chain that we talked about above. If consumers don’t spend enough, the firms will get lower profits and lower amounts of money will get reinvested in the system.
So far the Federal Reserve conducted three QE programs and currently since September we are officially running the fourth QE program. What did we learn from the past about QE? That it does not work that effectively and i will explain why.
First let’s explain what GDP is:
GDP =Supply х Velocity
After you saw this formula, this leads us to topic number two from the list and that is stimulus. How are they connected? The point of the stimulus is to increase the purchases of assets and to increase the money flow in the economy thus increasing the GDP growth. While stimulus increases the purchases more times than not that also means additional money printing and increase in the money stock. Looking at the formula this is good (increase in the Supply), but what we don’t get is the needed move in the velocity. Instead of rising (this would mean faster money circulation) this parameter has been declining since the 2000s. With all things explained, I will now provide some charts with data which will back what I am talking about and will also prove why QE is not as effective as many people think.
Let’s first review the money supply.
As we can see since the recession in 2000, the money supply has increased by 296.11%. Since QE 4 started until now the money supply increased by 23.15%.
While the money supply increased what did the money velocity do?
Well it declined by a lot. Since the recession in 2000, the money velocity has decreased by 49.97%. Since QE 4 started until now the money velocity decreased by 23.08%.
So instead of an increasing velocity, it has been dropping all along. The conclusion is no matter how much money you inject, if the consumer is not willing to spend it you’re doomed to failure.
After we explained this, what we have left is the last topic of this article and that is where exactly the U.S. dollar is heading to. Lately we have been monitoring the developments around the new stimulus package, but so far there is no solution to the debate. How would it affect the U.S. dollar if it gets effective?
From quite a while, we see the stimulus is preventing the indexes from dropping. So if the new stimulus passes I expect some more upside movement for the indexes and another portion of devaluation of the U.S. dollar since most likely the supply will continue to expand, while the velocity will continue to decline.
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