Since the end of the last recession, the state of the global economy has remained fragile with many countries struggling to sustain growth. Several remain in dire straits financially and are teetering on the edge of another collapse. The actions available to Central Banks are reasonably limited and with interest rates lowered to record levels, there is really only one option left to consider and that is quantitative easing.
Quantitative easing, or QE as it is known, is effectively a way of printing more money, although in reality it is usually achieved via electronic means. QE is a measure that can only be taken in countries where the Central Bank is responsible for the currency. This makes it viable in both the UK and the U.S. but across the Eurozone the individual member banks are powerless in this regard. Any QE in the Eurozone must be undertaken by the European Central Bank.
Despite how it is often phrased in the media, quantitative money does not literally mean more banknotes being released into circulation. Instead, it is a complex process that involves the Central Bank purchasing newly created financial assets, which in turn inject money into the economy. This is achieved by the bank`s excess reserves increasing and freeing up more cash to be lent out to customers.
If, however, the banks do not loosen their lending criteria despite the increase in their excess reserve, QE will fail. It will also be unsuccessful if an insufficient amount of QE is released. When QE works as intended, the yield on bonds is lowered as the price of the financial asset increases. With a lower yield, businesses should find it cheaper to raise any capital required, thereby driving growth in the economy.
QE also has an impact on the stock market because as the yield on bonds falls, many will switch to alternative forms of investment, such as the stock market. This inflates the price and encourages trading. The International Monetary Fund (IMF) has previously said that it believes the end of the recession in G7 countries was at least in part caused by the QE policies put in place by the Central Banks. However, while the stock market can expect to be stimulated by QE, there is not such a positive effect everywhere.
An increase in the amount of money will have the effect of pushing down the value of a currency compared to others. This can be a distinct disadvantage for those importing goods as it means the drop in value of the domestic currency inflates the price. It also is bad news for any investors or creditors who are holding the devalued currency as it means their money is worth less. Conversely, a devalued currency is of great benefit to exporters as well as those who hold a debt in that currency`s denomination.
With several rounds of QE employed in recent times, some of the world`s biggest currencies have seen their value dip and none more so than the U.S. dollar. The greenback is lower in value than it has been for some time and there has even been speculation that it may be replaced as the global marker in the not too distant future. However, while the dollar is still loitering in the doldrums, there is currently no indication that the U.S. is about to embark on a further program of QE. This could mean that during 2012 the dollar starts to strengthen again, particularly as countries such as China are deliberately holding back their own currency rate.
The euro`s future is less certain and at the moment, all banks are purely focused on its survival. With the Eurozone debt crisis still a major threat and no approval for the ECB to embark on a mass round of QE, it wouldn`t be unthinkable for those in the forex market to see the single currency potentially disappearing in the next two years.