Quantitative easing, Aussie style

Most everybody in Australia who has watched, listened or read the news over the past decade has heard of Quantitative Easing, also known as QE for short. And perhaps some of these same people might recall that QE is associated with the American central bank of The Federal Reserve, or The Fed for short.

But did you know that Australia’s central bank of the Reserve Bank, or RBA, has also been doing QE?

QE is an approach to monetary policy that involves trying to stimulate economic growth when interest rates are already quite low. It does this through increasing the money supply with financial institutions by purchasing government bonds and other securities from them.

This is supposedly new and unconventional. Perhaps it is, perhaps it isn’t. That is largely unimportant, in an economic sense.

What is important is that QE is about flooding the economy with more money. Money largely produced out of thin air by an unholy alliance of central banks and big banks. Thin air meaning not backed up by real savings, from real wealth, from real productivity. Or in other words, simply printing money.

So how much money has been being printed or supplied in Australia?

They say a picture is worth a thousand words. Right below shows the money supply as measured by the RBA’s M3 in billions of AU$. Further below shows prices as measured by the Consumer Price Index (CPI) and produced by the Australian Bureau of Statistics (ABS).

M3 money supply skyrocketed from 2008 until 2017, increasing over that period by a whopping 167%. Although, it had been ramping up quite a bit since the early 2000s.

Remember, the Global Financial Crisis (GFC) hit in 2007-08.

Even though it is commonly claimed that inflation, as reflected in CPI, has been low, it had, in fact, been taking off again from the early 2000s. CPI went from around 80 index points to 110, which is 30 more than the starting point of 80 or 38% greater.

The most common measures of money supply are M0, M1, M2 and M3, which goes from the narrow to the broad like building blocks. M0 is mainly physical cash and coins. M1 and M2 are mainly M0 plus digital bank accounts. M3 is mainly all the others plus other liquid assets.

The most common measure of inflation is CPI. However, all prices are not being directly measured. CPI prices are being selected, combined, averaged, weighted and turned into an index number with a base time period. In other words, it is a very indirect and quite imperfect proxy.

More importantly, rising prices are an effect of inflation not the cause. The cause of inflation is an increase in the money supply, with money demand remaining unchanged or not matching nor outweighing the supply change.

Not only has this been recognised for at least a century by economists of the Austrian School, like the legends of Ludwig von Mises, Murray Newton Rothbard and Nobel Laureate in economics Friedrich von Hayek. It has also been recognised by the greats from other schools of economic thought, most notably Lord John Maynard Keynes as well as econ Nobel Laureate Milton Friedman.

Money supply inflation usually means prices rising for all, or at least most, businesses and households in an economy. This is largely true at a macro level and over the longer term. But path and detail matter. At a micro level and in the shorter term, prices rise unevenly across an economy and over time.

Thus, there are many opportunities for investors, businesses and households to get windfall gains of revenues above costs ie profit. Both revenues and costs are each simply an aggregation of various prices (received or paid) times quantities.

For businesses, profit is the revenues from their sales and investments against their costs of doing business including land, labour and capital as well as tax and regulation. For households, profit is the income from their labour and savings against their costs of living including tax and debt.

The unevenness of price inflation is what leads to business or economic cycles. Price-driven revenues above costs manifests itself as a boom or bubble. For example in construction, equities and/or mining. Price-driven costs above revenues, in turn, creates the bust or burst.

Of course, price-driven ultimately means print-driven. In fact, inflation and cycles are actually the same phenomenon. Typically cycles happen over the short-to-medium term, with inflation over the longer term.

And cycles are notably reflected in Gross Domestic Product (GDP), with inflation in CPI. But, money stats like M3 are the leading indicators.

At the end of the day, the RBA is an agent of government. And all that any government can really do in the economy is reduce and redistribute wealth. Monetary policy is no different in this regard from fiscal and regulatory policies.

Cycles firstly redistribute wealth; inflation then reduces it. This redistribution is to the political entrepreneurs from the market ones; enriching the few at the expense of the many.

Matters are too often made worse by government with fiscal and regulatory responses that turn temporary downturns into lingering stagnation.

On the fiscal side, this can mean too high of taxes, spending and debt. On the regulatory side, this might be too many restrictions on prices, competition and innovation.

Even more sadly, loose monetary policy then helps to obscure and encourage bad fiscal and regulatory policies. Money inflation therefore facilitates yet higher and distorted prices through inflation of government itself.

Central banks, like the RBA and The Fed, are not the only players in the easy money that results from bad monetary policy. The big banks are also crucial. They are also government agents of economic chaos.

The oldest central bank in the world, the Bank of England, described the situation in a couple of 2014 research papers as follows:

Most money in the modern economy is in the form of bank deposits, which are created by banks themselves.

Of the two types of broad money, bank deposits make up the vast majority – 97% of the amount currently in circulation.

The reality of how money is created today differs from the description found in some economics textbooks.

Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.

This system is called Fractional Reserve Banking. FRB allows big banks to create yet more money out of thin air, but in orders of magnitude much greater than central banks.

In conclusion, the RBA along with the big Aussie banks have had an under-the-radar programme of QE since at least the GFC. This has been the real key to the economic stagnation in the past decade or so, along with the boom-busts in mining and housing.

Darren Brady Nelson

2 Comments on "Quantitative easing, Aussie style"

  1. Quantitative easing is a euphemism for printing money out of thin air, it’s the central bank’s way of eroding the value of your savings.

  2. When the RBA purchases bonds from the private sector, it credits money into private banks exchange settlement accounts. Exchange settlement account balances are not counted in the money supply because they are not available to be used in the economy. They are part of the monetary base, but not the money supply. This is how countries that made use of large scale QE since the GFC have not ended up with huge amounts of inflation.

    The hope in practicing QE was usually to stimulate private bank lending, which would have increased the money supply/put more money into the economy had the banks actually leant this money out, however this wasn’t the case as the amount of exchange settlement reserves banks hold is not a factor constraining their lending practices. This coupled with the fact that Australia has the second household debt in the world is why QE is very unlikely to do anything but drive up asset prices if ever practiced in Australia.

    And no, this system is not called Fractional Reserve Banking. FRB implies that banks lend out deposits, which is simply not true. It is in fact lending that creates deposits, not the other way around.

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