Casual observers of the business news may wonder why the head of the British Monarchy, Queen Elizabeth, or the famous cruise ships named in her honour get so much press.
Others may know that the letters “QE” over the last 5 years have referred to Quantitative Easing. The more astute readers will be aware that QE3 refers to the 3rd time QE has been used since the 2008 financial crisis, and that much of the volatility that the markets have experienced in recent months relates to speculation about the “Tapering” of QE3.
But few investors really understand what it all means.
Quantitative Easing is just a fancy term for printing money. The US Federal Reserve (AKA: “the Fed”) is not alone in using this strategy. Others include the Bank of England, the European Central Bank, and the Bank of Japan.
QE3 currently involves printing $85 Billion of new US dollars each month. To put that in perspective, it’s enough to pay off Canada’s national debt in just 7 months.
Tapering refers to the expectation that instead of turning the printing presses off over night, the Fed is likely to slow them down gradually. So to use a car analogy, it’s like gradually lifting your foot off the accelerator, as opposed to hitting the breaks or shifting into reverse.
So what is the Fed doing with all the money it’s printing? The answer is that they are buying US government bonds and US mortgages. And the primary goals of their actions are to reduce unemployment and keep inflation in the desired range.
Since the Fed can’t directly create jobs, it uses indirect methods. Buying mortgages, for example, keeps the cost of borrowing low. This keeps the interest cost of existing loans low, thereby increasing the money that families and companies have to spend on other things. It also increases the availability of loans for productive activities such as expanding factories, building houses and growing businesses.
As for inflation, the Fed believes that a small amount of inflation (2% per year) is healthy, and that QE has been successful in keeping a weak economy from causing a deflationary spiral (when inflation is negative and prices keep dropping).
The challenge is to provide enough QE to encourage activities that lead to full employment, without going overboard and causing inflation to shoot above 2%.
But for now, the focus remains on how quickly to ease up on the gas pedal, not when or how to shift the printing presses into reverse. Most experts expect the tapering to begin in the next few months and be completed in mid to late 2014.
Should you have any questions about the economy, the markets, or your portfolio, please give me a call.