If you’re following global economics, you may hear people asking, “what is quantitative easing?”. Quantitative easing, or QE, is a monetary policy of last resort. It aims to restore liquidity within the financial ecosystem by purchasing bonds and securities to encourage borrowing and lending among banks while preventing interest rates from climbing too high. However, it’s unclear how effective these programs are in the long term. Also, many economists cite QE as a serious problem in modern finance.
Injecting liquidity into the economy is akin to printing money. Historically, currency devaluation has led to entire economies' collapse, highlighting the potential risks associated with QE. That said, economic policies such as QE have ripple effects in asset markets, including crypto. Furthermore, central banks worldwide participate in this economic practice to varying degrees of success. Although each central bank has a slight variation in how they execute QE, the end result is essentially the same. So, if you're wondering, "what is quantitative easing?" and "how does QE impact cryptocurrency?" – read on!
In this article, we dive deep into quantitative easing. We explore how it works and how it affects the money supply and people. Also, we explore the impact of QE on the cryptocurrency markets. Plus, we look at some of the reasons people turn to cryptocurrencies like Bitcoin during periods of economic uncertainty. Furthermore, we explore the reasons for implementing QE and some potential side effects.
What is Quantitative Easing?
So, what is quantitative easing? Quantitative easing (QE) is a type of monetary policy whereby central banks buy government bonds and mortgage-backed securities in an attempt to reduce interest rates. In essence, QE increases the money supply to enhance liquidity and encourage lending, borrowing, and investment among commercial banks and other financial institutions, while attempting to encourage economic activity and spur growth.
When economic growth comes to a standstill, central banks and governments have few options at their disposal. One option is to reduce borrowing rates. However, when this occurs, long-term savers and those on lower incomes bear the brunt. In turn, lowering interest rates can result in people having less money to spend, which does little to stimulate an economy. On the other hand, a rise in interest rates usually coincides with a spark in mortgage prices. Accordingly, many central banks turn to QE instead.
Furthermore, QE relies on the strategic inflation of the money supply via government bonds and securities. This process is designed to lower interest rates by injecting more liquidity into the banking system, which also helps to create more favorable terms for borrowing and lending. Moreover, governments and central banks must align monetary and fiscal policy with QE goals to execute this method.
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How Does QE Work?
QE varies between countries and central banks. In the US, QE relies on both the expansion of the money supply - as a result of fiscal policy - and the creation of new money by the US Treasury Department. Also, the Treasury Department can establish new tax policies to aid QE. Plus, it can inject new money into the economy both directly and indirectly. As such, QE can combine both monetary and fiscal policy.
Furthermore, QE is often cited as being pivotal in tackling the 2008-2009 financial crisis. However, some analysts suggest that QE merely delays the onset of economic crises and provides backdoors for some of the perpetrators. Nonetheless, the implementation of QE usually aims to avoid recession and deflation. Moreover, while QE tends to be effective at stimulating stock markets in the short term and reducing interest rates, the long-term effects of this economic policy are unclear.
Increasing the supply of money in an economy runs the risk of inflation. When this occurs and economic growth fails, economies can experience stagflation. Stagflation is when an economy experiences slow growth, high unemployment, and a rising cost of living. Another effect of QE is the "credit crunch", whereby lending activity slumps despite an increase in liquidity. During a credit crunch, the availability of loans decreases due to uncertainty in the markets.
Because QE involves the creation of new currency, the value of a given currency often falls when the policy is implemented. That said, currency devaluation can make exporting goods from a country more attractive to a global market. However, currency devaluation generally makes goods and services more expensive, reducing consumer purchasing power.
Quantitative Easing Variations
So, now that we have addressed the question of "what is quantitative easing?", let's take a look at how it can vary between nations. Not every country or central bank implements QE in the same way, so it can be useful to understand their differences.
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United States
The United States implemented a QE initiative between 2009-2014 to tackle the looming recession and stimulate economic growth following the 2008 financial crisis. During this time, the Federal Reserve added more bonds and mortgages to its balance sheet. In 2008, the Federal Reserve had around $1 trillion in reserves. However, this number increased to over $4 trillion by 2014.
Furthermore, the QE program of 2009-2014 resulted in commercial banks holding more than $2 trillion in excess reserves. This money was supposed to be filtered through the economy. However, the introduction of new liquidity did little to stimulate lending.
By 2020, the COVID-19 pandemic caused most of the developed world to shut down. The United States is one of many nations that introduced QE to help stabilize the markets during this period. As a result, the Federal Reserve announced it would buy $700 billion in assets as part of an emergency QE program. On the other hand, the Federal Reserve adapted its monetary policy in 2022 to raise interest rates and reduce its holdings in an attempt to curb inflation.
Japan
Japan slipped into recession in the aftermath of the Asian financial crisis in 1997. In response, Bank of Japan used drastic QE measures in an attempt to minimize inflation and stimulate the economy. During this time, Bank of Japan went from purchasing government bonds to private stock and debt. However, the program was unsuccessful. Following the QE program, Japan's GDP fell from around $5.45 trillion to $4.52 trillion.
The UK
Bank of England undertook a QE program in 2016 to address the economic outfall of Brexit. This involved purchasing around £60 billion in government bonds and £10 billion of corporate debt. This QE program was designed to curb interest rates and make business investments in the UK more attractive. However, the result was a 0.4% drop in gross fixed capital formation. Between 2009 and 2021, Bank of England purchased £895 billion worth of bonds through QE, £875 billion of which was spent on government bonds, while £20 billion was spent on corporate bonds.
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How Does QE Impact Cryptocurrency?
Before we consider how QE impacts the cryptocurrency markets, it's worth noting that Bitcoin, the "All-father" of cryptocurrency, was born out of the financial crisis in 2008-2009 - partly due to QE. The underlying architecture of Bitcoin aims to provide an equitable alternative to fiat currencies. Bitcoin is verifiably sound. No central authorities can manipulate its supply or unfairly distribute it to their powerful friends.
When borrowing rates are unfavorable, investors often seek to diversify their portfolios to include higher risk and compensate for lower interest rates. In many cases, this involves adding Bitcoin and other crypto assets into the mix. One of the biggest drivers of the 2021 bull market was the institutional adoption of cryptocurrencies. As such, QE could encourage another wave of high-net-worth investors and hedge funds into the crypto space.
Furthermore, many investors see Bitcoin as a hedge against inflation. In parts of the world where national currencies are unstable, Bitcoin is a viable solution for preserving purchasing power. As such, if QE fails to curb interest rates and spur economic activity, we may see more people turning to Bitcoin and other crypto assets to preserve their wealth. Additionally, some of the liquidity afforded by QE could be channeled into Bitcoin and crypto if faith in the traditional financial system is not restored. Moreover, QE serves to bolster the Bitcoin community’s stance on sound money principles and the inevitable decline of the fiat system.
Bitcoin as a Response to QE
The underlying architecture of the Bitcoin network serves as an alternative to the monetization of debt present in QE programs. QE often props up failing financial institutions and banks. Plus, it allows endless currency units to enter an economy and encourages reckless attitudes among bankers. On the other hand, Bitcoin serves as a hedge against economic uncertainty.
Every fiat currency in history has fallen to zero. Many cite currency devaluation and money printing as playing a key role in the downfall of every major economy. However, the economic reward structure and distributed nature of Bitcoin prevent this from ever becoming an issue. What's more, Bitcoin presents a viable alternative to fiat currency in the event of economic collapse. If the current variations of the fiat model fail and plunge to zero, Bitcoin will likely continue to thrive.
Moreover, Bitcoin is immune to many of the instabilities present in the current financial system, which relies on the monetization of debt to keep existing institutions afloat. Furthermore, just like digital gold, Bitcoin is a robust unit of account and medium of exchange with high fungibility, making it an ideal store of wealth in unfavorable economic circumstances. Nonetheless, while people may turn to Bitcoin to mitigate the effects of QE, there is little evidence to suggest that QE directly affects the price of Bitcoin.
What is Quantitative Easing and How Does it Impact Cryptocurrency? - Summary
Quantitative easing (QE) is a monetary policy central banks can implement to generate liquidity within the financial ecosystem by purchasing government bonds. In theory, QE should make borrowing more favorable. However, outcomes tend to vary. Some economists view QE as a form of money printing, which often leads to hyperinflation. However, some claim that QE reduces the possibility of inflation compared to giving cash handouts to businesses and individuals.
Despite the many central banks that participate in the practice, the long-term effectiveness of QE is still unclear. While some claim it is a necessary part of modern economics, others see QE as a slippery slope that creates more problems than it causes. Nonetheless, QE is considered to be a measure of last resort to curb interest rates, prevent a recession, and encourage economic activity without causing inflation and currency devaluation. Moreover, some analysts believe currency devaluation can be a good thing. This is because it often leads to cheaper exports. Nonetheless, many in the Bitcoin community view QE as a sign that the existing financial system is nearing collapse. Hopefully, after reading this "What is Quantitative Easing?" article, you'll clearly understand how QE works and its impact on the crypto markets.
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