It sounds like the Federal Reserve Board of Governors is planning a holiday cruise. The financial media has recklessly been throwing around the term QE 2, which before the financial crisis was a widely known abbreviation for the large cruise ship – the Queen Elizabeth II. The context of today for QE 2 is stimulation of the economy through a practice known as quantitative easing. The 2 in the term refers to the fact that this would be the second round of quantitative easing as we have emerged from the 2008-2009 financial crisis.
Quantitative easing is a method a central bank has at its disposal to help provide liquidity and growth for the money supply by purchasing assets which are sitting in the possession of large institutions, primarily banks. Most of us learned in school that the Fed would lower short term interest rates to help stimulate economic growth by making money cheaper to borrow, and the resulting purchases by businesses and individuals would get the economic ball rolling down the road to prosperity. Of course, when things get too good, the Fed then raises rates to slow the economy and prevent runaway inflation.
With the interest rates the Fed controls very close to zero, as all your CD buyers know, they have run out of fuel to stimulate economic growth from the perspective of directly reducing short-term interest rates. But, the Fed can have an impact on long-term interest rates by effectively printing money, purchasing existing mortgage securities and bonds from large banks and holding them on what is known as the Fed’s balance sheet. The demand for these securities by the Fed will force the prices of these assets up and have the effect of reducing the prevailing rates of interest on long-term treasury bonds, as well as the rates on financial products, such as mortgages, which are tied to the Treasury bond yield.
It’s no secret that the economic recovery is settling into a slower pace of growth and it’s also no secret that the Federal Reserve would rather err on the side of too much economic stimulus than too little. If the economy were to re-enter recession, we could potentially enter a deflationary scenario which isn’t really good for anyone. Just ask the folks in Japan who’ve been fighting deflation for almost 20 years now. In other words, a little inflation would imply that at least there is demand for goods and services, and that would be a positive sign from the standpoint of potential job creation.
Quantitative easing has many critics and at the surface level it could be perceived to have a certain hocus – pocus feel to it. It is easy as a taxpayer, when listening to the press coverage and the opinions of whether QE 2 will work or not, to wonder if anyone really knows what is going on with our tax dollars. I’ll be the first to admit the no decision is perfect from all perspectives, but I tend to give the Federal Reserve the benefit of the doubt.
My article here in the Sun on October 20th reviewed how the Federal Reserve has been the most profitable bank in the world for many years. Their activities in the bond, mortgage and currency markets have been consistently profitable for many years and have returned profits to the U.S> Treasury of $18 to $45 billion in each of the last ten years. 2010 is on a record pace with over $32 billion in the first six months of the year.
In any event, QE 2 is not a vacation plan. It is a strong effort by the Federal Reserve to increase the rate of economic growth and to get the job creation process started where it than then self-perpetuate as the economy recovers.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.