(AP) — The Federal Reserve is about to take a huge risk in hopes of getting the economy steaming along again. Nobody is sure it will work, and it may actually do damage.
The Fed is expected to announced today that it will buy $500 billion to $1 trillion in government debt, and drive already low long-term interest rates even lower. The central bank would buy the debt in chunks of $100 billion a month, probably starting immediately.
Economists call it “quantitative easing.“ It gets the name ”QE2″ — like the ship — because this would be the second round. The Fed spent about $1.7 trillion from 2008 to earlier this year to take bonds off the hands of banks and stabilize them.
Here‘s how it’s supposed to work this time: The Fed buys Treasury bonds from banks, providing them cash to lend to customers. Buying so many bonds also lowers interest rates because demand for Treasurys leads to higher prices and lower yields. Interest rates are linked to yields. Lower rates encourage people to borrow money for a mortgage or another loan.
At the same time, lower interest rates make relatively safe investments like bonds and cash less appealing, so companies and investors take the cash and buy equipment or other investments, like stocks. The S&P 500 takes off and Americans celebrate with a shopping spree. Businesses see a rise in sales and begin hiring again, and a virtuous cycle of more spending and more hiring ensues.
But many analysts and even supporters of the plan see dangers. It could make the weak dollar even weaker and lead to trade disputes with other countries. It could lead bond traders to believe that higher inflation is on the way, and they could derail the Fed’s efforts by pushing rates higher. Many investors argue that it may create bubbles as hedge funds and other speculators borrow cheaply and make even bigger bets on stocks, commodities and markets in developing countries like Brazil.
“It’s a desperate act,” says Jeremy Grantham, co-founder of the investment firm GMO. Grantham says it’s a clear message from the Fed to the rest of the world: “The U.S. doesn’t care if the dollar weakens.”
Here is a look at the ways the Fed’s strategy could backfire:
—DOLLAR DROP
As word trickled out over recent months that the Fed was planning a new round of bond purchases, the dollar sank. It hit a 15-year low to the Japanese yen Nov. 1. Why? In the simplest terms, a country that cuts interest rates makes its currency less attractive to the worlds’ investors. The interest rate is also the investors’ yield, the payout they receive. When that yield falls, the world’s banks move their money into countries with higher rates. They may exchange U.S. dollars for Australian dollars then invest the money in higher-paying Australian bonds.
“The Fed aims to push up the prices of stocks, bonds, real estate, and you name it,” says Bill O’Donnell, head of U.S. government bond strategy at the Royal Bank of Scotland. “Everything is going to go up but the dollar.”
A drop in the dollar can help companies like Ford that sell their products abroad. When the dollar weakens against the euro, for example, one euro buys more dollars than before. Foreign customers notice the price of the Explorer they’ve been eyeing is lower in their currency, yet Ford still pockets the same number of dollars for every sale.
The downside is that a weakened dollar pinches people in the U.S. because anything produced in other countries becomes more expensive, like oranges from Spain or toys from China.
“Look around you,” says Thomas Atteberry, a fund manager at First Pacific Advisors. “How many things can you find that were made in the U.S.A?”
—BLOWING BUBBLES
Buying bundles of Treasurys knocks down interest rates, making borrowing cheap. But it also motivates investors to move out of safe investments into riskier ones in search of better returns. The stock market, for instance, rises in value and everyone with some of their savings in stocks feels wealthier. Ideally, it produces what what economists call a “wealth effect”: People who feel better off spend more.
The problem, according to some critics, is that cheap borrowing costs and buoyant markets make a fertile environment for bubbles, which eventually pop. “The effort to help the economy sets up another more dangerous bubble,” says Grantham, who warned of Japan’s surging real estate and stock markets in the 1980s, soaring Internet stocks in the 1990s and the housing market in the 2000s.
Stocks in developing countries are a likely candidate for the next bubble. Cash from Europe and the U.S. has plowed into emerging markets, such as Brazil and Chile, since the financial crisis, largely because these countries have less debt and faster economic growth than in the developed world.
Another concern: Hedge funds borrowing cheap money can magnify their bets, taking a loan at 2 percent to buy a security that’s rising 10 percent. They sell the security, pay off the bank and pocket the rest. That’s true whenever interest rates remain low. Falling rates allow speculators to borrow larger amounts. In the extreme, losses from hedge funds and other borrowers can put their banks at risk and leave governments to clean up the mess.
The game only works as long as the investment keeps climbing. When the bubble breaks, the fallout can devastate an economy.
“I think bubbles are the main villain in this piece,” Grantham says.
Cheap debt provided the fuel for the housing bubble, allowing home buyers to take out larger loans on the belief that somebody else would buy the house at a higher price. Fed chief Ben Bernanke’s answer, Grantham said, is to start the cycle over again by blowing a new bubble. “All they can do is replace one bubble with another one,” he said.
—FALLING FLAT
For others in the bond market, the greatest worry isn’t that the Fed will flood the economy with dollars and lets inflation run wild. It’s that the Fed will prove too timid.
“Whether QE2 works or not will be decided by the bond market,” says Christopher Rupkey, chief economist at Bank of Tokyo. “Without a big number that gets the market’s attention, the program they announce could be dead on arrival.”
News reports that the Fed may spend less than the $500 billion bond traders have been betting on has helped push long-term rates higher in the last three weeks. David Ader, head of government bond strategy at CRT Capital, sketches one scenario if the Fed shoots too small. Say the Fed announces a $250 billion plan. The yield on the 10-year Treasury note, which is used to set lending rates for mortgages and corporate loans, could jump from 2.6 percent to maybe 3.2 percent.
“If the Fed’s efforts fail we suddenly look like Japan,” Ader says. “Japan started off wimpishly, then did it again, and again and then they wound up losing a decade.”
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Comments (67)
charliego
Posted on November 3, 2010 at 10:09amI wish I understood financial stuff better. At base-line reading of this article, it seems this is a potential and very frightening move by the fed reserve. I do understand bubbles and money manipulation for corrective purposes do burst and not truly solve the problem. Rather it appears as a ‘robbing Peter to pay Paul’ scenario to me which presents a no-win, temporary bandaid effect. The structure and credibility of the fed reserve is dubious; there appears to be no accountability. Rather, if something does not work, it is a big oops, let‘s try this out while the economy flounders off Jekyll Island’s egoism of financial ignorance or ill gotten gains. I apologize to those who understand money details for my daring to voice this opinion in my ignorance. Perhaps, I should delete……….
Report Post »crossdraw
Posted on November 3, 2010 at 9:58amJust be sure you have a good store of ammunition. Our “commies” do so you need to as well. If anyone thinks this is anything but destruction on a grand scale, well, you are on your own. This is now a two system country. On one side you have the commie union pigs and the other side you have the freedom fighters. I place my bets on freedom fighters. Maybe if your stinking president would keep his dumb ass home instead of spending 200 millions dollars a day on a vacation to India he could put that money towards the deficit. But “Nero” Obama seems to think he is deserving and is owed this travesty of injustice. THIS A SLAP IN THE FACE OF EVERY “REAL” AMERICAN. Bring it on progressives. What a war this is going to be. WOW
Report Post »libertyordeath87
Posted on November 3, 2010 at 3:24pmI’ve been buying ammo for the last year, little by little. Lock and load commies! All I’m waiting on is Glen or Sarah to tell me where to muster.
Report Post »sbenard
Posted on November 3, 2010 at 9:51amI forgot to mention the TITLE of the Fed’s conference this weekend. From the Fed’s website:
‘A return to Jekyll Island: Origins, history and future of the Federal Reserve’
Report Post »sbenard
Posted on November 3, 2010 at 9:45amThe beast from the Book of Revelation LIVES!
Report Post »sbenard
Posted on November 3, 2010 at 9:43amULTIMATE POST-HALLOWEEN NIGHTMARE:
I WISH this was a joke, but it’s reality. This weekend, the Fed will return to the scene of the 100-year-old crime!
In November 1910, Senator Nelson W. Aldrich and Assistant Secretary of the Treasury Department A.P. Andrews, and other top financiers,arrived at the Jekyll Island Club to discuss monetary policy and the banking system. The secret meetings led to the creation of the Federal Reserve.
Forbes magazine founder Bertie Charles Forbes wrote several years later:
“Picture a party of the nation’s greatest bankers stealing out of New York on a private railroad car under cover of darkness, stealthily riding hundred of miles South, embarking on a mysterious launch, sneaking onto an island deserted by all but a few servants, living there a full week under such rigid secrecy that the names of not one of them was once mentioned, lest the servants learn the identity and disclose to the world this strangest, most secret expedition in the history of American finance. I am not romancing; I am giving to the world, for the first time, the real story of how the famous Aldrich currency report, the foundation of our new currency system, was written… The utmost secrecy was enjoined upon all. The public must not glean a hint of what was to be done. Senator Aldrich notified each one to go quietly into a private car of which the railroad had received orders to draw up on an unfrequented platform. Off the party set. New York’s ubiquitous reporters had been foiled… Nelson (Aldrich) had confided to Henry, Frank, Paul and Piatt that he was to keep them locked up at Jekyll Island, out of the rest of the world, until they had evolved and compiled a scientific currency system for the United States, the real birth of the present Federal Reserve System, the plan done on Jekyll Island in the conference with Paul, Frank and Henry… Warburg is the link that binds the Aldrich system and the present system together. He more than any one man has made the system possible as a working reality.”
Now, THIS COMING WEEKEND, the Fed is going to have a conference. Guess where! Yes, at Jekyll Island, where the Fed Frankenstein’s monster was created! The topic of the conference? The PAST and FUTURE of the Fed! If THAT’S not a creepy nightmare, I don’t know what is!
Report Post »sbenard
Posted on November 3, 2010 at 9:35amULTIMATE POST-HALLOWEEN NIGHTMARE:
In November 1910, Senator Nelson W. Aldrich and Assistant Secretary of the Treasury Department A.P. Andrews, and other top financiers,arrived at the Jekyll Island Club to discuss monetary policy and the banking system. The secret meetings led to the creation of the Federal Reserve.
Forbes magazine founder Bertie Charles Forbes wrote several years later:
Picture a party of the nation’s greatest bankers stealing out of New York on a private railroad car under cover of darkness, stealthily riding hundred of miles South, embarking on a mysterious launch, sneaking onto an island deserted by all but a few servants, living there a full week under such rigid secrecy that the names of not one of them was once mentioned, lest the servants learn the identity and disclose to the world this strangest, most secret expedition in the history of American finance. I am not romancing; I am giving to the world, for the first time, the real story of how the famous Aldrich currency report, the foundation of our new currency system, was written… The utmost secrecy was enjoined upon all. The public must not glean a hint of what was to be done. Senator Aldrich notified each one to go quietly into a private car of which the railroad had received orders to draw up on an unfrequented platform. Off the party set. New York’s ubiquitous reporters had been foiled… Nelson (Aldrich) had confided to Henry, Frank, Paul and Piatt that he was to keep them locked up at Jekyll Island, out of the rest of the world, until they had evolved and compiled a scientific currency system for the United States, the real birth of the present Federal Reserve System, the plan done on Jekyll Island in the conference with Paul, Frank and Henry… Warburg is the link that binds the Aldrich system and the present system together. He more than any one man has made the system possible as a working reality.
Report Post »sbenard
Posted on November 3, 2010 at 9:23amThe Fed’s decision and statement will be released at 2:15 EST today. It will affect the economic well-being of Americans more than yesterday’s elections EVER will! The markets will likely be somewhat subdued until then. We are in waiting mode.
And not a SINGLE person at the Fed was EVER elected! Welcome to Fed tyranny!
Report Post »EqualJustice
Posted on November 3, 2010 at 9:11amI can see a CRASH coming from my front porch.
Report Post »GittleShel
Posted on November 3, 2010 at 8:55amThey don‘t know what’s on the other side of this, no one knows! STOP while we still have a country! This sounds like a Sci-Fi movie! There isn’t a pot of Gold at the end of the Rainbow!
Report Post »sbenard
Posted on November 3, 2010 at 8:48amThe whisper rumor in the financial markets is that the Fed will START with $500 billion of debt to be monetized (quantitative easing is just a fancy term for monetizing the debt), with the promise of MORE to come as they deem necessary.
But the greatest risk to QE2 wasn’t mentioned in the article. Just the TALK of QE2 has caused commodity markets to skyrocket. It takes 6-9 months for commodity prices to hit the stores. Expect significant inflation to show up in late spring next year! But the Fed has officially stated twice in the past month that it is determined to create MORE inflation! Yes, MORE!
The greatest risk is that they create hyperinflation even while the economy remains very weak. This is a very high stakes gamble on the part of the Fed. They have doubled down on the roulette wheel, and the consequences, if they get it wrong, could be economic armageddon. They are like a teenager with a chemistry set that won’t stop until they blow up the neighborhood!
Prepare for a catastrophe, America. I hope you have a garage filled with food. You may soon need it!
Report Post »MR_ANDERSON
Posted on November 3, 2010 at 8:35amI transfered the legal max amount of US Dollars without being hit with fees a while back, I’m not looking to enjoy this, but I am more prepared than anyone I’ve been trying to convince that this is coming. We are in the barrel on the river, and the falls are finally here. Hold on to everything you have, because this is going to get rough..
Report Post »senah
Posted on November 3, 2010 at 8:35amWho gives them the authority to do this?
Report Post »sbenard
Posted on November 3, 2010 at 8:57amThey have had the authority to do much of it since the Fed was created in 1913. The Fed has zero accountability to the American people, or their elected representatives. They wanted the Fed to be “independent”. What they really wanted was total power without ANY accountability.
But the recently-passsed Financial Reform Bill, known affectionately as Franken-Dodd), gave even MORE power to the Fed without ANY oversight from Congress whatsoever. This is how Obama recently appointed a powerful new czar without ANY approval from the Senate. She was appointed to a position in the deep dark depths of a new office underneath the Fed. Sounds like the “beast” from the Book of Revelation has been given life! FRANKENSTEIN’S monster!
Tyranny is HERE in America.
Report Post »stinkybisquit
Posted on November 3, 2010 at 8:28amI’m buying stock in pencils and tin cups.
Report Post »vennoye
Posted on November 3, 2010 at 1:12pmI’m afraid we are all going to be right there with you!! But………..in the end we will all be OK!!! When I grew up, we were all so poor that none of us really realized how poor we were…we were all in the same boat…………and we all got through it!!
Report Post »iwalkalone
Posted on November 3, 2010 at 8:22amThe real outcome will be world war 3. The chinese are not going to let us steal what they stole from their people. They didnt have all those slaves making worthless gadgets to trade us for our wealth just to have the fed devalue the booty. I believe they already warned the kenyan Usurper directly, and tightened the noose of rare minerals on Japan as warning.
Report Post »Tyson
Posted on November 3, 2010 at 8:02amBullets, beans, bullion and rice are the investment stratety for today!
Report Post »printdesignchicago.com
Posted on November 3, 2010 at 8:00amthis isn’t going to work… banks have tightened credit requirements in the wake of fannie, freddie and the ‘financial rapeform bill’, and MANY small businesses are in financial trouble now, making them unqualified for this ‘help’ from banks.
if the feds really wanted to stimulate things, they’d undo health care and extend the tax cuts. this would improve business morale and get things kick-started.
Report Post »Conservative Grinch
Posted on November 3, 2010 at 7:41amI’d also encourage the people to demand that Government Figures no be used when calculating the rate of inflation. We should demand that tax tables are properly indexed. We should refuse to pay taxes on interest income that doesn’t keep up with inflation. We should sue the Feds in court. We should demand that the corrupt elitists judges, that condone theft by inflation, are impeached and punished by the confiscation of their wealth. We need a path a non violent revolution.
Report Post »felina g
Posted on November 3, 2010 at 8:15amExactly and well put !
Report Post »RepubliCorp
Posted on November 3, 2010 at 7:39amwelcome to the 3rd world
Report Post »nostromo
Posted on November 3, 2010 at 7:34amOf course the dollar will fall in value again and the chance of a trade war increases when QE2 hits. The analysis is spot on. This isnt the fear. It is that this is too little too late. I would hesitate to bet against success here, however. There is too much riding on it for both the super rich Dems who own Wall Street thru Goldman Sachs and other investment banks and the blue blood country club Repubs including 2012 political results.
Report Post »jedi.kep
Posted on November 3, 2010 at 7:28amI think I’d rather play the lottery. Big risk. So not worth the risk. That’s desperation for you. I’m going to Wal-mart to stock up on groceries before coffee is 20 bucks a can…
Report Post »Samurai
Posted on November 3, 2010 at 7:28amQE2 should be called the Titanic!!
This is going to cause a rapid devaluation of the dollar, cause inflation, higher interest rates, increased debt, falling T-bill & U.S. bond prices, increase the trade deficit, which will eventually lead to a massive sell off of our bonds by our debt holders, a crash of the dollar and possibly the temporary collapse of our economy.
What could go wrong with this?
Once the U.S.$ currency index falls below 70, I wouldn’t be surprised to see 50 as a bottom.
I live in Japan and know for a fact that the BOJ is completely freaked about this reckless, insane and INTENTIONAL massive devaluation of the dollar.
You’re right LSX we are so screwed.
Don’t you love it that the FED announces QE2 (aka Titanic) the day after the Republican victory? Coincidence? I don’t think so…..
Report Post »lyndsey1977
Posted on November 3, 2010 at 9:21amIts all part of the plan. The administration knows exactly what they are doing. Very Scary!
Report Post »6.8 SPC
Posted on November 3, 2010 at 10:34amAnd Obama & family with the entire cabinet, staff, aids, some of their families, multiple security details, and extra military support are leaving within hours, taking every available VC transport aircraft, including all 4 Marine 1 helis, and every VIP armored limo in DC and innocently going on a 10 day trip to India & Asia……….Coincidence? I don’t think so…..(3000 people+, 40+ aircraft, 570 rooms at the Taj Mahal alone booked – trip will cost us 200 million a day!!!!!!!!!!!!!!)
If you were President and knew the financial markets were gonna totally collapse – wouldn’t you get out before riots in the streets & people with pitchforks came for you????? We all know he plans to F^#k us and the USA, do you really think he has the balls to be here when he does it??? Or goto the #2 democracy on the planet and hide……..on the other side of the world, literally!
FIllup your gastanks, get 3-6+ months DRY GOOD type food (rice/beans/pasta/flour) and canned goods, and pull as much cash as you feel comfortable with NOW……..Also ensure your 2nd amendment stocks are good too, and pray!
If the implosion does not happen in 2 weeks, then your guess beats mine on when it will happen, but there are many potentially BAD things happening later this week – and Obama will NOT be here to be thanked, personally.
Report Post »Conservative Grinch
Posted on November 3, 2010 at 7:26amIf we allow the Fed to destroy the currency we are through. Please contact you congress critter and demand responsibility from the uncountable Fed. This is just as important as was and is to oppose Obamacare and the Stimulus. It time to move back to the bimetallic standard of Gold and Silver.
Report Post »OldFlyGuy
Posted on November 3, 2010 at 9:12amCongress Critter!! Great term, I love it!!
Report Post »HouseNegro
Posted on November 3, 2010 at 7:24amHey if ya’ll want to buy some debt call me. I assure you it will go to a far better cause than the pit you will throw it into.
Report Post »Anamah
Posted on November 3, 2010 at 7:22amWhat is Spooky Du doing in this e picture?
Report Post »LSX
Posted on November 3, 2010 at 7:12amWe are so screwed.
Destroy the Fed
Report Post »snowleopard3200 {mix art}
Posted on November 3, 2010 at 7:22amThe project should have been named the “Titanic 2: The Final Destruction of America” instead of this QE2 (not even going to try and spell it). Mr Obama is now making the push to destroy the country, and hopefully we can hang on til the storm is passed.
We have a small window of time to turn things about, and avoid the heart of the storm that will lead us right into the second great depression – and probable Socialism here in America.
Report Post »Nightstalker
Posted on November 3, 2010 at 7:39amThis is criminal, I believe it is the deliberate destruction of our economy!
Report Post »This will be remembered as the day our country started to collapse!
Everyone will run from the dollar to the euro!
The dollar ends it’s reign as the world trading currency today.
This will put it into freefall !
Go and stock up on food, your gonna need it!
Good luck, and may G-d have mercy on us all!
sickofitall
Posted on November 3, 2010 at 9:05amIt all fits in with the Progressives and NWO proponents plan to eventually bring about a global currency. It creates better controls over global governance. Even JFK spoke of the dangers of the Fed Reserve and was writing legislature to give control over U.S. currency back to Congress as it is written in the Constitution. He was conveniently assassinated within 5 months of signing Executive Order 11,110 which called for the issuance of $4,292,893,815 [4.3 trillion] in United States Notes through the U.S. treasury rather than the traditional Federal Reserve System. That same day, Kennedy signed a bill changing the backing of one- and two-dollar bills from silver to gold, adding strength to the weakened U.S. currency.
Report Post »ron the veteran
Posted on November 3, 2010 at 10:20amthese idiots need to be locked up for this. it was progressives that put the fed into law its been progressives whove done every screwed up thing thats causing us problems. its time for cuts alright that and some long jail terms for obama and all of his progressive buddys. this must stop!
Report Post »ILFarmer
Posted on November 3, 2010 at 10:36amMore like Audit the FED. make sure to contact your new and old Reps and Senators and make it known you want them to sign the petition to Audit the FED and finally get some real transparency going.
Report Post »2gether
Posted on November 3, 2010 at 11:43amI AGREE. Get rid of the Fed Reserve or get in there and open up the books and the hx of every board member. We need to do something.
Report Post »MissCherryJones
Posted on November 3, 2010 at 12:07pmWhere is George Soros?
Report Post »Nostraquedeo
Posted on November 3, 2010 at 9:27pmUncle Sam, Mr. FrED and China are sitting at the TAX PAYER BAR and uncle Sam asks China to buy him another drink. China says I can’t support your bad habit anymore. So Mr. FrED says don’t listen to that party pooper – I’ll get us another round.
Report Post »Rogue
Posted on November 4, 2010 at 6:58pmThe Republican leadership in the house needs to focus on the economy first and foremost. This includes investigations into the Fed (demand they open the books), physical inventories of gold and other precious metals, and complete freeze on descretionary spending.
Please contact your congressman. The Fed is on a course to destroy our already weakened economy, and must be stopped.
Report Post »tower7femacamp
Posted on November 5, 2010 at 10:25pmcriminals !
Report Post »http://www.youtube.com/watch?v=WA20Am0pwtA
this lady need a position in the SEC.