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Dear ,
A Nudge in the Right Direction, That's It?
Well the Fed did as expected and announced the beginning of QE3 (Quantitative Easing 3). Before we talk about what that means I thought it might be helpful to present a definition so that we are all on the same page.
"Quantitative easing (QE) is an unconventional[1][2] monetary policy used by central banks to stimulate the national economy when conventional monetary policy has become ineffective. A central bank implements quantitative easing by buying financial assets from commercial banks and other private institutions with newly created money, in order to inject a pre-determined quantity of money into the economy. This is distinguished from the more usual policy of buying or selling government bonds to keep market interest rates at a specified target value.[3][4][5][6] Quantitative easing increases the excess reserves of the banks, and raises the prices of the financial assets bought, which lowers their yield.[7]
Expansionary monetary policy typically involves the central bank buying short-term government bonds in order to lower short-term market interest rates (using a combination of standing lending facilities[8][9] and open market operations).[10][11][12][13] However, when short-term interest rates are either at, or close to, zero, normal monetary policy can no longer lower interest rates. Quantitative easing may then be used by the monetary authorities to further stimulate the economy by purchasing assets of longer maturity than only short-term government bonds, and thereby lowering longer-term interest rates further out on the yield curve.[14][15]
Quantitative easing can be used to help ensure inflation does not fall below target.[6] Risks include the policy being more effective than intended in acting against deflation - leading to higher inflation,[16] or of not being effective enough if banks do not lend out the additional reserves. [17]"
(Source: http://en.wikipedia.org/wiki/Quantitative_easing)
OK, now for the Reames Financial translation. The first thing that I'll point out is that QE3 doesn't even really meet the definition of QE. It very clearly says the QE means injecting a pre-determined amount of money into the economy. Well as you know, QE3 is open ended. They are going to buy $40 billion a month as long as they see fit. That in no way is a predetermined amount.
When all else fails, print money and use it to buy longer term assets which will hopefully drive down longer term interest rates. A couple of the risks are that it can cause inflation and the other risk is that the banks won't or can't lend the money, thereby losing the stimulating effect of the newly printed money.
The hope is that more and easier money will stimulate the economy in several ways. Some of the ways could include more home building which will generate jobs and consumption throughout the economy. Keeping interest rates low keeps the interest service on the national debt low freeing up money for things like Social Security, National Defense, and the like. Hopefully easy money will also make it easier for small businesses to get the money that they need to expand and create new jobs.
The Wikipedia article goes on to say the following:
"If the nominal interest rate is at or very near zero, the central bank cannot lower it further. Such a situation, called a liquidity trap,[20] can occur, for example, during deflation or when inflation is very low.[21] In such a situation, the central bank may perform quantitative easing by purchasing a pre-determined amount of bonds or other assets from financial institutions without reference to the interest rate.[5][22] The goal of this policy is to increase the money supply rather than to decrease the interest rate, which cannot be decreased further.[23] This is often considered a "last resort" to stimulate the economy.[24][25]
ALL IN!
Any Texas Hold'em fans out there? Does the term "all in" sound familiar? Typically there are two basic times when you go all in. When you have a hand that you can't lose is one of those times. The other time is where you are being bled dry and your current hand represents your last and best chance of winning some chips that will allow you to at least stay in the game longer. If it fails, oh well, you were going to be eliminated soon anyway!
As you look at the world around you today, which do you think it is? Let me give you a clue.
Fed to buy more debt in effort to boost sluggish economy
"He (Bernanke) added that while he doesn't think the Fed's moves are a panacea, they could nudge the economy in the right direction."
Nudge the economy in the right direction? Are you kidding me? They are going to print almost a half trillion dollars a year out of thin air and all they really expect is a nudge? Of the two scenarios I described above, which do you think nudge more accurately describes?
Your answer to that question should be a major factor in developing your long term investment strategy in my opinion.
Contradictions Don't Exist!
There are so many other things that I'd like to point out in this strategy but it would make this article way too long. Let's just focus on one glaring thing. What, to many, may appear as a contradiction. First take a look at this quote.
"Contradictions do not exist. Whenever you think you are facing a contradiction, check your premises. You will find that one of them is wrong."
Ayn Rand
The Apparent Contradiction-We have been in this easy money monetary policy for a couple of years now and because not enough loans are being made, it is obvious that it isn't working that well so the obvious answer is to make monetary policy even easier to stimulate those loans.
The Premise-Money policy is too tight so we need more money in circulation for the banks to lend and we need lower interest rates to make it more affordable for people to borrow money.
Check the Premises-Is that what is really stopping expansion. Interest rates are already at historic lows. Do you really think that is what is stopping those that qualify for mortgages or business loans from taking out new loans? While I'm sure that is what stops a few I don't really think that is the major issue. I think the major issue is that most of the people that have good credit and qualify already have the credit that they want or need.
What was the major cause of the downturn that started at the end of 2007? Lending to people that couldn't afford to pay the money back. The obvious result was to tighten lending standards so that we no longer did that. Well the natural extension of that policy is that you have a much smaller pool of people that qualify for loans. What's the old saying? Those that really need the credit don't qualify and those that qualify don't really need it!
I think that is really the major reason that we don't see a lot more loans being made. Therefore I think that the Fed is misreading the situation and QE3 is going to be even less effective than QE1 and QE2 have been.
So what does it mean for your wealth? If you're not sure, give us a call or send us an email at preames@reamesfinancial.com. We'd love to talk with you about it.
Until next week , Protect Your Wealth!
Sincerely,
  
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