Quantitative Easing by the European Central Bank Could Ignite More Violent Outbursts around the World

Following the lead of the U.S. Federal Reserve Bank, the European Central Bank (ECB) is considering quantitative easing:

"A top European Central Bank policymaker has called for 'quantitative easing' to be used to boost the euro zone economy if deflation risks emerge across the 17-country region.

The comments by Lorenzo Bini Smaghi, ECB executive board member, are the strongest indication yet that the central bank would expand its policy tools to prevent a possible disastrous economic slump in continental Europe."

 In the U.S., we refer to it as QE.  According to Business Insider, QE

"...describes a form of monetary policy used by central banks to increase the supply of money in an economy when the bank interest rate, discount rate and/or interbank interest rate are either at, or close to, zero.

A central bank does this by first crediting its own account with money it has created ex nihilo ("out of nothing").  It then purchases financial assets, including government bonds and corporate bonds, from banks and other financial institutions in a process referred to as open market operations. The purchases, by way of account deposits, give banks the excess reserves required for them to create new money by the process of deposit multiplication from increased lending in the fractional reserve banking system. The increase in the money supply thus stimulates the economy. Risks include the policy being more effective than intended, spurring hyperinflation, or the risk of not being effective enough, if banks opt simply to pocket the additional cash in order to increase their capital reserves in a climate of increasing defaults in their present loan portfolio."

QE reduces the risk of deflation because the supply of goods and services doesn't increase, but the supply of money does, thus increasing the monetary value of existing assets.  "Inflating the economy" is another term used to describe this process, and while it does minimize deflation, it increases the risk of runaway inflation considerably.  It also reduces the value of debt because cheaper currency is used to pay off existing debt. 

Under QE, people, institutions, and countries holding bonds see the value of their bonds fall precipitously.  That's why countries like China, for example, don't think too much of QE:

"China Investment Corp. Vice Chairman Gao Xiqing said that central banks' quantitative easing policies are hurting the value of money just one day after the Federal Reserve maintained plans to buy $600 billion of Treasuries.

'You know money is gradually becoming not worth the paper it's printed on,' Gao said at an event sponsored by HSBC Holdings Plc at the World Economic Forum in Davos, Switzerland today. Recent gains in commodity and food prices reflect the 'long-term view' of investors that prices will accelerate, he said."

Gao's concern about commodity price inflation is well-founded.  Under QE, the prices of commodities increase rapidly as the currency supply expands thus making things like food and oil more expensive.  Those hardest hit by inflation in commodity prices are the poor, especially the poor in emerging countries. 

Commodity price inflation was the torch that lit the Arab Spring in Tunisia and the rest of the Arab world early this year:

"In Tunisia, it was Mohammed Bouazizi, a food vendor in the city of Sidi Bouzid, who, after years of taunting and abuse by the police, immolated himself in rage and frustration, and ignited the storm that subsequently erupted. But it was the price of food that had changed Mohammed Bouazizi's world, for the beatings were a regular feature of his life. And so too in Egypt, it is the price of basic foodstuffs -- that consume as much as half of a typical family's income -- rather than the denial of basic rights that marks a material change in peoples['] lives."

If the ECB decides to proceed with yet another round of QE, can we expect more violent outbursts around the world?  The simple answer to that question is "YES!"

Neil Snyder is a chaired professor emeritus at the University of Virginia.  His blog, SnyderTalk.com, is posted daily.  His latest book is titled If You Voted for Obama in 2008 to Prove You're Not a Racist, You Need to Vote for Someone Else in 2012 to Prove You're Not an Idiot.