Wednesday, September 19, 2012

QE3 Explained

Since the blog was down for a week, I have a backlog that I am in needing of posting. Bear with me if the news seems a bit dated. I promise it wasn't when I wrote it.

He is not who you want to face off against on a trading floor

Can you explain what these sentences mean: The Fed has begun an open-ended QE3 to buy 40.5B MBS and 44.5B of T-Bills per month. The Dow rose 206 points on the news. Nailed it.

The Federal Reserve - also called The Fed for short - is the central bank of the United States. They control the number of dollars out there and on what terms you can get your hands on them for.  Assuming "you" is a bank that is part of the Federal Reserve system. In all likelihood, the place that you keep your money at night is. Unless you stuff your money under your mattress, or bury it in your backyard, or believe that buying gold bars is a sound investment strategy. All equally effective.

Open-ended means that it has no predetermined sunset clause to end. The program will end whenever the Fed wants it to - basically if they hit their target of 5% unemployment (unlikely to happen anytime soon) or if inflation becomes uncomfortably high (much more likely to happen). Both QE1 and QE2 had predetermined end dates, which makes logical sense because if they didn't end then there would be no need for QE3 as they would be still happening. Anyways, the earliest that they will re-visit the policy is December. 

The Federal Reserve decided to make $85 Billion a month in purchases with money they decided to create out of thin air. Split slightly in favor of buying Treasury Bills (T-bills) over Mortgage Backed Securities (MBS). T-bills are bonds issued by the Treasury Department that are bought and sold on the open market. They are considered the safest financial asset in the world and the whole global economic system is based off them. Yes, the global economy is literally based on US Debt. The Fed also announced that they were going to continue to buy long term t-bills (10 years) over short term t-bills (6 months to a few years) to continue to drive down long term interest rates. Mortgage Backed Securities, for simplicity's sake, are just bundles of home loans. I'll get into that later when I cover that part of the financial crisis.

The Dow Jones Industrial Average (the Dow), which is the imperfect pulse of the stock market, thought this to be very good news. More people bought stocks than sold them, which means that people have confidence in the future of the economy. It closed at a post-recession high.

Nailed it. Although I wasn't 100 percent accurate (pretty darn close), this is the exact policy prescription that I said the Federal Reserve should use to lift the economy, stabilize the banks, and mitigate the debt. 

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