QE is a monetary policy measure of injecting money into the system to drive the economy: What investors need to know

Amid concerns about a slowing economy, central banks around the world are implementing special measures often called QE or Quantitative Easing — a form of monetary easing where large amounts of money are injected into the financial system to help the economy recover from crises. What is QE, and why do investors need to understand how to respond to such measures?

What is QE? Quantitative Easing — a decisive policy that transforms the financial system

In essence, QE is a tool used by central banks to distribute money into the economy by purchasing long-term financial assets such as government bonds, mortgage-backed securities (MBS), and other assets. The goal of QE is to increase liquidity in the system, lower interest rates to very low levels, and encourage businesses and individuals to borrow and invest rather than save.

This may sound like general advice, but QE is one of the most powerful tools central banks have. As a result, such measures are usually implemented only during crises, such as the 2008 financial crisis or the COVID-19 pandemic.

How central banks implement QE mainly through asset purchases

The mechanism of QE involves two main approaches. First, central banks can buy assets directly from commercial banks, increasing the banks’ cash reserves. These assets, which no longer generate income, are converted into cash ready to be used for lending, thereby expanding credit. Additionally, purchasing large amounts of long-term securities pushes down yields and interest rates, reducing borrowing costs for businesses and consumers.

The second approach involves central banks buying specific types of assets in markets showing signs of distress, such as purchasing MBS to boost confidence in the real estate market and prevent prices from collapsing. The indirect effect is a decline in yields, prompting investors to seek higher returns elsewhere, which drives up prices of stocks, gold, and other assets accordingly.

Side effects of QE: inflation, inequality, and asset bubbles

While QE helps lift the economy out of downturns, it also comes with negative side effects that cannot be ignored. First, flooding the system with money can lead to currency depreciation. Countries relying on imports of raw materials and goods may face higher costs, pushing up domestic prices.

Second, the abundance of cash in banks fuels a search for higher yields worldwide. This increases risky investments and raises the risk of asset bubbles, especially in real estate and stock markets.

Third, QE does not necessarily stimulate real economic spending as intended. Those without assets do not benefit from rising asset prices. Wealth accumulation among asset holders widens the wealth gap and exacerbates social inequality.

How investors should respond to new QE measures

Understanding that QE involves large-scale money injections affecting financial markets, investors should consider how to adjust their investment allocations. Since QE often leads to increased credit and investment, and low interest rates tend to encourage speculation in other assets, caution is advised.

In stock investments, while capital flows into markets may be strong, the current market environment differs from ten years ago because QE measures are implemented more quickly, and markets may not fully price in economic damage.

For currency trading, investors can take advantage of currency depreciation by using tools like CFDs to sell the currency of countries implementing QE and buy more stable currencies, such as those of countries with less or no QE, to reduce risk and enhance returns from exchange rate movements.

Additionally, speculative assets like Bitcoin are attractive options, as QE tends to push holders to seek safe havens. Gold may not benefit as much as expected, since its intrinsic value might not increase proportionally with nominal prices.

Common questions about QE

1. How does QE relate to Bitcoin prices?

The massive amount of money created through QE continues to be a significant driver pushing up the prices of speculative assets like stocks and Bitcoin to very high levels. Unlike other markets, Bitcoin has a capped supply, making its value increase more fundamentally than other assets.

2. How does QE affect gold?

Although gold prices appear to rise numerically, when considering real value relative to other assets, gold often does not follow the same pattern. In many cases, the real value of gold may decline during QE periods.

3. Does QE increase the money supply in the system?

Yes. Quantitative easing directly involves large-scale money injections, leading to an expansion of the money supply to stimulate economic growth. That’s why QE is typically used only during economic crises.