What is Quantitative Easing? 

Quantitative easing is a monetary policy central banks use to stimulate the economy. QE indirectly lowers interest rates and encourages lending and investing. During quantitative easing, the central banks create new money electronically to buy assets such as bonds, stocks, or mortgage-backed securities and increase the monetary supply.  Quantitative easing is typically used when conventional financial policy methods do not have the desired effects to reach goals set by the central bank.  

Who Uses Quantitative Easing 

Central banks implement quantitative easing. In the United States, the Federal Reserve determines financial policy, which means they decide when to begin quantitative easing or tightening. The Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank are all other central banks that use quantitative easing to stimulate the economy by purchasing assets from the open market.  

How Quantitative Easing Works 

Quantitative easing occurs when central banks make large-scale asset purchases. They do this by essentially printing money or creating bank reserves on their balance sheet that gives banks access to more cash. Central banks, like the Federal Reserve, buy large amounts of financial assets, usually government bonds, like treasuries, on the open market. The Federal Reserve does not buy directly from the US government. This increases the money supply in the economy, making it easier and cheaper for businesses and consumers to borrow and spend. This is intended to stimulate economic growth and stave off potential deflation.  

Quantitative Easing in Action: 

• Central bank purchases assets: The central bank buys government bonds and other financial assets from banks and institutions. 

• Bank reserves increase: The banks receive new reserves, increasing their overall money supply in the economy. 

• Interest rates decrease: With more money in the system, interest rates tend to fall, making borrowing cheaper for businesses and consumers. 

• Lending and spending are boosted: Lower interest rates encourage borrowing and spending, which can help stimulate economic growth. 

Another impact of the government buying bonds is the price of those bonds increases. This is just like when central banks buy large amounts of gold, the price of gold goes up. This was recently seen when the People’s Bank of China bought record amounts of gold, leading to new all-time highs for the precious metal. But unlike gold, bonds have yields, meaning that when bond prices rise due to government purchases, the yield decreases.  

Investors looking to maximize returns might invest more in the stock market to compensate for the lower bond yields. This can boost stock prices, generating more confidence in the economy’s condition. When people believe the economy is strong and borrowing money is easy and cheap, they are more likely to make big-ticket purchases. Companies spend more money expanding, which can create more jobs and even more confidence.  

Quantitative easing works in theory and some attempts to use it have been deemed “successful.” But, as with any economic policy, there are risks and failures.   

Risks of Quantitative Easing 

The primary risk is increased inflation. By expanding the money supply, QE can lead to higher prices for goods and services if the increased liquidity isn’t matched by economic growth.  

Another risk is asset bubbles. Increased liquidity in the economy can lead to excessive speculation, driving up stocks, real estate, and other assets beyond their fundamental values. When these bubbles burst, they can cause economic downturns and instability.  

Another argument is that quantitative easing contributes to wealth inequality. When asset prices increase, this typically only benefits those owning the financial assets. Some pundits believe this widens the gap between the upper and lower classes. However, it is also argued that the increased spending resulting from QE leads to more jobs and better wages for the lower and middle classes.  

Quantitative Tightening 

Quantitative tightening is the opposite of quantitative easing and involves reducing the central bank’s balance sheet. When a central bank begins quantitative tightening, it sells previously acquired assets or allows them to mature without reinvestment. This action decreases the money supply, which can lead to higher interest rates and tighter financial conditions. Quantitative tightening generally cools down economic activity, reduces inflationary pressures, and stabilizes financial markets by gradually removing the excess liquidity introduced during periods of QE. 

Historical Examples of Quantitative Easing 

Multiple nations have used quantitative easing throughout recent history. The 2008 global financial crisis and coronavirus pandemic led to cycles of quantitative easing, each with varying degrees of success.  

Does Quantitative Easing Work?  

It is difficult to measure the effectiveness of quantitative easing. Experts are split about whether the policy has been successful in the past. While it generally succeeds in lowering interest rates and increasing lending and borrowing, its overall effect on economies is hard to measure.  

In the United States, it is thought that implementing quantitative easing after the global financial crisis was a good move by the Federal Reserve. They purchased bad debts from banks, allowing them to recover and operate normally again.  

Japan’s history of QE is considered to be less successful. From 2001-2006, Japan’s financial policies, which included QE, failed to improve the country’s economy in a substantial way. Japan bought only healthy assets instead of bad debts, which led to very little new money and didn’t increase liquidity enough to increase lending and spending.  

How Quantitative Easing Affects Gold 

When a government implements quantitative easing, it prints money electronically. The increased money supply leads to inflation. According to Milton Friedman, inflation only exists when there is a rapid increase in the monetary supply, therefore quantitative easing is a direct cause of increased inflation. Gold is used as a hedge against inflation, and investors turn to the precious metal as a haven against inflation.  

Quantitative easing also leads to lower interest rates, which could diminish the appeal of some interest-bearing assets. This shift can drive more investors towards gold, which doesn’t rely on interest rates for its value. When the demand for gold increases, it results in higher gold prices. 

Finally, gold performs best when real interest rates are low or negative. Real interest rates equal interest rates minus inflation. Since quantitative easing reduces interest rates and increases inflation, it sets up the right conditions for gold to thrive.  

Currently, we are nearing the end of a tightening cycle, with the Fed expected to reduce the fed funds rate in September 2024. Gold has already reacted in anticipation of rate cuts throughout the year, leading to the highest trading range seen in its history. Analysts expect gold to perform well in the near future if the Fed ends the tightening cycle by cutting rates.