QE, as currently practiced by the Fed, simply swaps newly-created dollars for toxic assets clogging the balance sheets of commercial banks. This ploy keeps the banks from going bankrupt, but it does nothing for the balance sheets of federal or local governments, consumers, or businesses.
When old loans are paid off faster than new loans are taken out (as is happening today), the money supply shrinks. The purpose of QE is to reverse this contraction.
But if debt deflation is so easy to fix, then why have the Fed's massive attempts to pull this maneuver off failed to revive the economy? And why is Japan still suffering from deflation after 20 years of quantitative easing?
The answer has to do with where the money goes. Virtually all of the money the Fed creates sits in the reserve accounts of banks. Reserves are used to clear checks between banks. Banks can lend their reserves to each other, but they cannot lend them to us.
UK Professor Richard Werner invented the term quantitative easing while advising the Japanese in the 1990s. He had something different in mind from the current practice. He intended for QE to increase the credit available to the real economy. Werner contends that the Bank of Japan (BOJ) intentionally sabotaged his proposal, adopting his language but not his policy; and other central banks have taken the same approach since. He maintains that in the 1990s, the BOJ consistently foiled government attempts at recovery.
The post-war disappearance of the military triggered a power struggle between the Ministry of Finance (MOF) and the BOJ for economic control. While the MOF strove to maintain the regulated economic system that created Japan's post-war miracle, the central bank plotted to break the Ministry by reverting to 1920's free markets.
BOJ reckoned that the wartime economic system and vast powers of the MOF could only be overthrown with a large crisis, one blamed on the MOF. While observers assumed that all policy-makers were trying their best to kick-start Japan's economy over the past decade, the truth is that BOJ was deliberately killing it.
Werner contends that the BOJ not only blocked the recovery but also created the bubble that precipitated the downturn. Japan's central bankers who were in charge of the policies that prolonged the recession were the same people responsible for the creation of Japan's bubble. Thanks to the long recession, the Ministry of Finance was broken up and lost its powers. The Bank of Japan became independent and its power has now become legal.
DO YOU SEE A PATTERN YET?