Is it not the most beautiful concept you have ever heard? Quantitative Easing; the best solution for any economic problem ;-). Until recently, when facing a recession, central banks would drop their interest rates. Low interest rates encourage both businesses and individuals to borrow. Companies will create jobs while individuals will inject money into the economy. However, what do you do when your interest rates are already at their lowest? This is when Quantitative Easing comes into play.
Quantitative Easing in short
In a simple terms; quantitative easing can be describe as a central bank buying back their bonds in order to inject money into the market. Since investors receive money from their bonds, they have to invest it elsewhere. This creates enough liquidity to “make the capitalism motor run”. The FED is already at its second round of quantitative easing (QE2 was announced back in fall 2010). They will be injecting $75G per month up to $600G. Until recently, we thought this would be the last quantitative easing measure required… until Japan’s earthquake.
Quantitative Easing & The Impact on Your Investments
So now that the FED is printing more greenbacks, what’s in it for you? Regardless if you are Canadian or American, there will be an impact on your investment portfolio. You can probably feel the impact if you look back at the month of November and December 2010. If you have a part of your portfolio invested in the market, I bet it did great ;-).
Quantitative Easing has such a positive effect on the stock market because it comforts investors with the fact that Governments won’t let the economy down. The market knows that no matter what is happening with the economy, there will be money available. This encourages investors to keep on investing.
Long term effect of Quantitative Easing
This is the tricky part. We are not quite sure of the long term impact of QEs. On one hand, some people fear that it will generate too much inflation. On the other, some people think that the capitalist system will regulate itself as it always has (a bit too simple, isn’t?). In the end, the FED didn’t have many options (once the rates were down and the economy was still slow). Therefore, instead of doing nothing and watching the train hit a brick wall, they have decided to switch directions and add more fuel to see where the train will be headed. This is also the reason why the FED did QE2 over several months instead of injecting $600G in one shot.
Looking for more Quantitative Easing Measures
As Japan runs into another recession (not that the economy was already thriving!), more quantitative easing measures should be applied. The first move will obviously be the Japanese Government. In fact, they have already announced they will inject money into their economy. If the slowdown is too important and affects the global economy, I would bet on a QE3 from the FED in the summer of 2011. Let’s just hope that this doesn’t happen, I’m not too excited about “unknown long term results solution” !
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