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The Hidden Motive Behind Quantitative Easing

April 19, 2014 in Economics

By Hunter Lewis

Foreign individuals and businesses long ago cut back on their purchases of U.S. bonds. Their place was taken by foreign central banks. The central banks simply created money in their own currency and used it to buy our bonds.

The Federal Reserve always knew that we couldn’t rely on foreign central banks to buy our bonds forever. This may be the main reason it began the program called quantitative easing, in which the Fed created money out of thin air specifically to buy back U.S. debt.

Quantitative easing may have been intended to be a kind of insurance policy. If foreign central bank buying of U.S. bonds collapsed, the Fed would already have a program in place to buy them back itself.

The Fed  said that quantitative easing was meant to create U.S. jobs, but this never made much sense. Even a hard core proponent of QE, Fed official William Dudley ( formerly of Goldman Sachs), admitted that the Fed’s own economic models could not explain how creating money out of thin air and using it to buy U.S. bonds would increase employment. Some link to rising stock prices could be demonstrated, if only through the cheap financing of corporate stock buy-backs, but then rising stock prices could not be shown to create jobs either.

One inference from this was that chairman Ben Bernanke, and now new chairman Janet Yellen, were just taking wild stabs in the dark. A more reasonable inference is that they had another reason for QE, one which they did not want to acknowledge.

Viewed in this way, the 2008 bail-out should be viewed not as a bail-out of Wall Street, but rather  as a bail-out of Washington. The Federal Reserve feared that the market for government bonds was about to collapse, which would lead to soaring interest rates, and a complete collapse of our bubble financed government.

The Fed did not have the option of creating money and buying debt directly from the Treasury. That would be illegal. The Treasury must first sell its bonds to Wall Street, after which the Fed can then use its newly created money to buy them back. Hence, in order to rescue the Treasury, the Fed felt it had to rescue Wall Street.

This is a simplification of what happened, and only part of the story, but it is the untold part of the story, and in all likelihood the most important part. The Fed …read more

Source: MISES INSTITUTE