The Federal Reserve and its Money printing - What happens when the Fed starts printing money? During the market cycle, the Federal Reserve typically starts printing money (technically creating new money electronically) through a process called "quantitative easing" (QE) during specific economic conditions (typically in response to a recession or bear market). Quantitative easing is generally applied when traditional interest rate adjustments are insufficient to stimulate the economy or combat deflationary pressures. QE is implemented in an attempt therefore to lower interest rates, increase the supply of money and drive lending to consumers and business. The goal is to stimulate economic activity during a financial crisis, restore confidence in the economy and financial markets, and keep credit flowing. QE came into wide application after the 2007-2008 financial crisis to mitigate effects of the recession. The market cycle will typically repeat itself the moment the Fed starts printing more money. QE is introduced by the Federal Reserve under the following circumstances: Economic Downturn/Recession: When the economy is suffering, the Fed will use QE to funnel in more money into the financial system. In doing so, they aim to increase monetary supply and reduce interest rates, making it more affordable and appealing for business owners and individuals to borrow and spend. This is intended in order to ‘stimulate the economy’ and encourage economic activity, boost consumer spending and increase business investments. Deflationary Pressures: If there is a risk of deflation (a sustained decrease in the general prices of goods and services), the Fed may resort to QE to prevent deflation which is perceived to be worse than inflation. This is as deflation can discourage spending as consumers anticipate for lower prices, resulting in reduced economic activity and further deflation. The Fed aims to stimulate economic growth by printing money to drive up monetary supply thereby encouraging consumer spending. Financial Crisis: In times of severe financial crises or liquidity shortages, the Federal Reserve may resort to QE to provide liquidity to financial markets and prevent a collapse in the banking system. This was notably employed during the global financial crisis of 2008. In 2020 alone the federal reserve printed over 3.3 trillion dollars. Consequences of QE While quantitative easing can provide short-term benefits by stimulating economic activity and shifting market sentiment from negative to positive, it also carries issues along with it. Often when the Fed continues to print money it drives up inflation, decreasing the purchasing power of the dollar. The Federal Reserve is required to closely monitor economic conditions and adjust monetary policy accordingly in order to maintain price stability and promote sustainable economic growth. Whether it does this is highly questionable. Another concern is the increase in wealth inequality that can occur as a result of QE. Inflation can trigger wealth inequality as it erodes the purchasing power of money over time. Individuals who are dependent on fixed incomes, or pensioners and low wage workers will struggle to keep up with rising costs. Their buying power diminishes making it increasingly difficult for them to maintain the same standard of living. Rent and food costs increase, yet their wages remain static. With asset price inflation and the prices of stocks, shares, real estate, and crypto increasing as a result of QE, already wealthy individuals who have accumulated these assets only get richer, whilst these assets become increasingly less accessible and less attainable for regular working-class folk with limited or no exposure to these assets. Without the necessary capital to gain exposure, the working class miss out on the opportunity for wealth accumulation leading to the widening gap between the rich and poor.
The effect of QE on high-risk assets such as cryptocurrencies is bullish. As a result of lowered interest rates, investors get lower returns on safer investments, making higher risk assets more appealing for yielding potential profits. Also, with inflation, cash becomes a less appealing option as its value or buying power goes down. With increased monetary supply there is more capital/liquidity in the market in order for people to invest in stocks and higher risk assets. While QE has historically been associated with periods of stock market rallies, it is crucial to recognise that the relationship between QE and bull markets is not linear. Many other factors influence market performance, including economic indicators, corporate earnings, geopolitical events, and investor sentiment. Quantitative Tightening Quantitative Tightening (QT) is the opposite of quantitative easing. Whilst QE involves injecting liquidity into the market in response to a recession, QT involves the Federal Reserve selling financial assets to reduce money supply and withdraw liquidity from the economy. Central banks also increase interest rates. This is usually done after large scale QE programs in response to inflation. QT is implemented to prevent excess inflation and bring money supply back to a more sustainable level. QT works to reduce reserves held by banks and raise interest rates leading to a cooling effect on the economy by reducing the availability of credit. Often thereby we see lower consumer spending, lower asset prices, and a decrease in asset demand. The risk is that financial markets can become destabilised as a result and we often see the start of a bear market.
