Yesterday, while Congress and the media were obsessed with the $165 million AIG bonus outrage, the Fed decided to create another $1.2 trillion of U.S. currency. Numbers like this can seem absurd. How much bigger is $1.2 trillion than $165 million? Think about what gaining or losing $1,000 would mean to you. $1.2 trillion is to $165 million as $7 million is to $1,000. That’s how much more important the Fed’s action was.
Financiers have a fancy name for what the Fed did — “quantitative easing”. When you hear some kind of gee-whiz phrase in the finance industry that sounds kind of like something you understand, but somehow isn’t really clear, then it’s a lead pipe cinch that that you’re being had. Quantitative easing means that the Fed creates new currency out of thin air, and then uses it to buy assets. The moment after this happens nothing has changed about the real economy except that there is more currency. What do you think happens then? More dollars + the same assets = more dollars per asset = inflation.
If you’re in a deflationary period, the idea is that this is good because you head off some of the deflation. The hope is that this makes banks more likely to lend, “gets the economy moving again”, etc. Does this sound at all familiar to you?
Welcome to Japan.