Money Printing… A term used by many regularly these days. But what does it actually mean?

This story is the first in what I hope will become a series of “no-frills” explanations. In each article, I will attempt to explain, in simple terms, core concepts I think are useful to know about economics, trading, and investing.

In my experience, a lot of the terminology can confuse. I think it’s important to demystify some of this so everyone has a better chance to understand.

I will start with money printing as it is frequently talked about, particularly right now. So, what is “money printing” all about?

What Money Printing is NOT

Despite the name, “money printing” these days does not refer to the physical creation of notes and coins. Actually, most of the money supply is not physical cash but is electronic (e.g. your bank balance).

Money printing now refers to the way governments increase the supply of money in the economy in order to stimulate it.

Quantitative Easing (QE) – the core means of money printing

Quantitative Easing or QE is the primary mechanism governments use to add money to the economy. They do this via their Central Banks.

Effectively QE is the process where a Central Bank buys assets either from the Government itself or from non-government entities (e.g. companies). You may also hear this process referred to as “asset purchase”. It’s effectively the same thing and actually a much more accurate description of the mechanics.

There are two key forms of QE which I’ll explain in a little more detail.

QE1: Central Bank buys debt from the government

In this form of QE, the government issues debt (in the form of bonds) and the Central Bank purchases it. This process is also referred to as “Debt Monetisation”.

In essence, the Central Bank exchanges money it has created for the government bonds, which the Government can then use to service its deficit. This is an alternative to other means of financing public spending e.g. collecting more in tax revenues.

QE2: Central Bank buys assets from non-governmental bodies

This model is similar to #1, but rather than buy debt directly from the government, the Central Bank purchases assets from other bodies e.g. commercial banks or other financial institutions.

These assets may include things such as mortgage-backed securities and corporate bonds. Somewhat confusingly, it may also involve indirectly buying government debt (such as gilts) but from non-governmental entities who hold them.

Again, as with Debt Monetisation (QE1), this type of process has the same effect of increasing the amount of money in circulation in the economy.

How does Quantitative Easing stimulate the economy?

The effects of QE are relatively complex. However, in simple terms, there are two key ways QE is supposed to stimulate the economy. Firstly, it lowers interest rates and makes banks more likely to lend. This encourages borrowing i.e. consumers to spend and businesses to expand creating economic stimulus.

Secondly, the purchase of assets typically results in overall asset prices increasing. This creates a “wealth effect” i.e. it makes holders of those assets “feel” more wealthy. This, in turn, encourages consumers to spend more and thereby stimulates the economy.

Sounds great – so why don’t we do it all the time then?

To say QE or Money Printing is not without controversy is an understatement.

There are many (myself included) who believe QE can have very detrimental effects on the economy by artificially inflating asset prices and importantly leading to significant inflation risk over the long term.

Countries like Venezuela, Zimbabwe, and the Weimar Republic (Germany) are frequently used as historic examples of money printing gone wrong.

Furthermore, as holders of assets tend to be wealthier members of society, there is a credible argument that QE exacerbates income inequality. Those wealthier people benefit from the increase in asset prices whilst poorer people lose out.

In future stories, we will provide some thoughts on how you can protect yourself against the effects of Money Printing. In particular by owning inflation hedges such as gold, property and digital assets.