Today the Federal Reserve announced their highly anticipated program that Wall Street calls QE2 (Quantitative Easing 2). The Federal Reserve said today that they will buy 600 Billion dollars worth of treasury bonds, they also said they would re-invest 250-300 Billion in proceeds of bonds they purchased with their first round of quantitative easing (QE as they call it on Wall Street).
The first thing I want to explain is what the role of the Federal Reserve is and how it accomplishes this. Most Americans don’t have a clue what the Federal Reserve is or does. This is intentional; I received my Finance degree and only learned briefly about the Federal Reserve. The Federal Reserve is a quasi-government organization that is comprised of un-elected officials that are appointed by the President of the United States. The reason it is a quasi government organization is because nobody really knows who owns it. It is supposed to be watched by Congress, but Congress for the most part is not allowed to look at the books of the Fed (short name for the Federal Reserve). There was a bill that Ron Paul (R-Texas HR 1207) brought to the floor that would have forced the Fed to open its books up to Congress and the public. This bill (HR 1207) was sponsored by over 300 members of Congress. Funny thing is, once Ron Paul brought this Bill to the floor for a vote, the bill didn’t pass…hmmm. With over 300 sponsors this should have passed with ease. So what happened? Well there must have been some back room deals going on, because about 117 Congressmen who sponsored the bill ended up changing and voting against it at the last second. By the way…all 117 sponsors who changed their vote were Democrats (see this link for the list http://florida.tenthamendmentcenter.com/2010/07/hr-1207-hall-of-shame/). Politics is truly a dirty business.
The Federal Reserve has 2 main goals: to maintain price stability and full employment. Now how does the Fed accomplish this? They use the FOMC (Federal Open Market Committee). The FOMC is the policy making arm of the Federal Reserve. They meet 8 times a year to discuss the current market conditions and then decide what to do. The main way that the Fed tries to manipulate the economy is through the Federal Funds rate. This is the rate that banks charge each other to borrow money. The Fed controls the Federal Funds rate by effectively printing money. It is basic economics. If there is more money floating around in the economy then banks have more money to lend. If banks have more money to lend, then supply and demand tells us that interest rates will come down. This is known in Finance as the Loanable Funds Theory. So with the Fed lowering interest rates this leads businesses to want to borrow money to grow their businesses. This also leads regular people like you and me to put our money in the stock market since our money is earning basically nothing in interest at the bank. This is the way the Fed tries to spur economic growth, by effectively forcing you to take risks with your money. With all this new money going into the stock market asset prices rise. Only problem is…this is just paper wealth, the real economy hasn’t really gotten any better. People just feel a little better seeing their portfolios rise. Now if businesses take out loans to build factories, this can lead to jobs. But these are typically temporary jobs since eventually interest rates have to rise or we will see massive amounts of price inflation. Eventually these factories have to lay off people. This is the cause of our boom and bust economy. It is basically the Federal Reserve that causes these bubbles.
Now I want to explain a little about how the treasury market works. Wall Street likes to use big words to make us feel stupid. That way we need to pay gigantic fees for their advice. Well trust me, it’s not that complicated. The basic concept is the government needs cash to finance its day to day operations. They do this by issuing Treasury Bonds. They range from short term to long term, and go out as long as 30 years. If you would like to purchase these bonds you can do so through the Treasury department directly at www.treasury.gov (though I highly recommend NOT BUYING THOSE). So the Treasury issues these bonds to the public and also institutional buyers. Mainly China, Russia, and Japan are the buyers of these bonds. So essentially they are the Bankers of the United States. Now as you would expect, our economy looks pretty shaky right now, so these Countries are becoming more and more worried about buying our debt (loaning us money). Well what happens when creditors become worried about the credit worthiness of the borrower? They demand a higher interest rate for the increasing amount of risk. That is exactly what is about to occur and the Fed knows this.
So now where are we at today? The Federal Funds rate is at an all-time low of zero (officially the Federal Funds target rate is 0-.25%). This is an all-time low. But businesses and consumers still are too shell shocked to borrow money or put their money back in the stock market. The economy still appears to be on the brink of collapse. Our creditors (China, Russia, Japan) see this and are starting to scale back the purchases of our bonds (or in other words they are scaling back loaning us money). Well with less people interested in buying our bonds, interest rates will have to be increased by the Treasury in order to compensate these countries for the extra risk. But can you imagine how our economy would react if interest rates started to go up? Think of how bad the housing market is right now, now think how bad it would be if a 30 year mortgage rate doubled from 4% to 8%. This is why the Fed came out today and said they will be purchasing 600 Billion dollars worth of Treasury bonds over the next 2 quarters. They are trying every trick in the book to keep our interest rates where they are at.
Only problem is that this extra money WILL lead to price inflation. It is just a matter of when. This will devalue the dollar. The Federal Reserve has a mandate that they are supposed to maintain price stability. Well, since the Federal Reserve was created (1913) the dollar has been devalued by over 97%! How’s that for price stability? Their other mandate is to maintain full employment. Employment rates are officially 9.6% in the United States, but if you count all the people who are too discouraged to look for work that rate goes up to about 17%. Any way you look at it the Federal Reserve has been a colossal failure.
Over the last 2 years the Fed has pumped 2.5 trillion dollars into the system to try and keep housing prices from coming down and interest rates remaining low. This will create a massive amount of price inflation. We are already seeing it in the prices of essential items like food and energy. It is a shame that for the last 100 years there has not been a safe place to keep your money. If you want to keep your money in the bank, it will be devalued by the Federal Reserve. This forces you to put it into the stock market, real estate, or other risky assets. The older generation is really susceptible to having their money devalued by falsely thinking it is safe inside a bank. Bill Gross (largest bond fund manager in the world) recently said that with the Federal Reserve’s announcement of QE2 that the dollar will be devalued by 20%. That means the money you have in the bank will be worth 20% less most likely within about a year.
Prices soon will start to rise. Look for it first at the grocery store and at the gas station. The first thing our elected officials are going to do is start demonizing the Oil companies for raising prices. They are going to blame speculators, such as myself, for causing the price of food and energy to go thru the roof. This is because people like me will try to protect ourselves by buying commodity futures (this is basically a leveraged bet on the price of oil, gold, silver, wheat, ect increasing). The reason prices rise is because traders closely watch the amount of inflation and start buying real items such as oil, wheat, gold, silver ect when they see the government being irresponsible with our monetary system. So while the Federal Reserve and our elected officials overspending will be causing the increase in prices, they understand that the American people are not educated in Finance. They can easily deflect public anger away from the real cause and blame Capitalism and Wall Street greed for the reason there is a rise in prices. Don’t fall for this. Get prepared yourself by only having enough cash in the bank for an emergency and start putting your money in real items such as exchange traded funds that are backed by silver, gold, oil, agriculture ect. Yes, there is a risk to investing in these items. But there is also a higher risk of having cash in the bank as long as you have a reckless Federal Reserve and politicians hell bent on spending our way out of a problem caused by over-spending.
Well written and thought provoking!
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