Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2018 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Bring on the Printing Presses! - Outside View by Asad Dossani

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks


Login Failure
(Please do not use this option on a public machine)
  Sign Up | Forgot Password?  

Bring on the Printing Presses!
Nov 8, 2010

The long awaited and big news event this week was the decision by the US Federal Reserve to launch a new program of quantitative easing, also known as QE2. They committed to purchasing US$ 600 bn of assets (mainly government bonds), in an effort to stimulate the economy. The market response was as expected - gold and stocks went up while the dollar fell. This had already happening for some time in anticipation of this.

Let's examine some of the rationale behind the Fed's decision. What is the aim of QE? When a central bank wants to stimulate the economy it will usually lower interest rates. The rate that the Fed and other central banks have control over is the rate on overnight borrowing. Bringing down this rate is supposed reduce interest rates across the board. This should lead to more borrowing, and hence more investment and consumption to stimulate the economy. This is all well and good, but what's a central bank to do once it can't lower rates anymore?

The QE program is going to be used to buy government bonds, and in particular it will be used to buy long-term bonds. The purpose of this is to lower interest rates on these bonds, which should then feed to lower rates everywhere. Like before, the lower rates should stimulate the economy. So we can think of QE as a method by which to lower long-term interest rates.

So who are the winners and losers? QE is usually expected to result in higher inflation. Therefore, people in debt will benefit (as the real value of their debt decreases), while people with savings will suffer (as the real value of their savings decreases). Such policies are often criticized because they effectively bail out people in debt while punishing those who have been prudent with their money. This of course only affects people with savings or debt denominated in US$.

Aside from domestic effects, we know QE has a big international effect too. The biggest consequence of this policy is the weakening of the dollar. This in theory should increase US exports and reduce their imports. There has been much criticism from countries across the globe (emerging markets and developed countries) that their economies will suffer as their own currencies get stronger against the dollar.

My belief is that the Fed's real aim of QE2 is a weaker dollar (as interest rates are already low I don't believe that lowering them more will have much effect). They want the US economy to come out of its slump by exporting more and importing less. Unfortunately, most other countries want the same thing too. They all want to grow their exports and reduce their imports. It is obviously not possible for all countries to do this at the same time.

The US has one of the largest trade deficits in the world. They are frequently characterized as the consumer of last resort. Some countries are highly dependent on exports to the US, and this is one of the reasons there has been so much objection to the Fed's attempt to weaken the dollar.

While the objections are understandable, in the long run these attempts are futile. The large trade imbalances that characterize the world today are not sustainable in the long run. Deficit countries will currencies weaken and surplus countries will see their currencies strengthen. It is not a question of if, but a question of when. The answer depends a lot on political factors. Despite the short term objections to dollar weakening, I'm sure in the long term no country wants to continue the status quo whereby when the US sneezes, the rest of the world catches a cold.

Asad is an Economics Graduate from The London School of Economics who has also been a part of the currency derivatives team of Deutsche Bank in London. Currently pursuing his PhD at the University of California San Diego where he's researching on Algorithmic Trading Strategies, Asad will be your direct line for answers to all the questions you might have on short-term investing. A part of the Equitymaster Team since 2010, Asad has been sharing his knowledge on short term trading strategies with our valued readers, like you, through our various services. In fact, at the last count, his weekly newsletter, Profit Hunter, was being delivered to more than 100,000 smart traders across the world!


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "Bring on the Printing Presses!". Click here!


More Views on News

Sorry! There are no related views on news for this company/sector.

Most Popular

These Are the Kind of Blue Chips You Should Invest In(The 5 Minute Wrapup)

Nov 9, 2018

All blue chip companies are large caps but all large caps are not blue chips.

Get this Small Cap Logistics Company at a 16% Discount Right Now...(Profit Hunter)

Nov 6, 2018

If you turn the clock back, the current macroeconomic climate is nothing new. The markets have seen them all, and every downcycle has been succeeded by gravity defying gains...more so in the small cap space. This time will be no different.

This Was a Large Cap. But Was It Safe?(Chart Of The Day)

Nov 9, 2018

Investing in large caps is not always safe. Consider the right metrics to judge the safety and quality of large caps.

Why the Realty Sector's Recovery Has Been Delayed(Sector Info)

Nov 15, 2018

NBFC and IL&FS crisis have worsened the realty sector woes. Is there a light at the end of the tunnel for real estate sector?

Does it Make Sense to Invest in Offshore Funds?(Outside View)

Nov 6, 2018

Many investors prefer to invest in offshore funds because of the rupee depreciation and on-going downtrend in the markets, but it is to be invested only when there is no option available to invest in India.


Small Investments
BIG Returns

Zero To Millions Guide 2019
Get our special report, Zero To Millions
(2019 Edition) Now!
We will never sell or rent your email id.
Please read our Terms