On 13 September 2012, the U.S. Federal Reserve embarked on a third round of quantitative easing (QE3), by promising to buy $40 billion worth of mortgage-back securities every month, to support the U.S. housing market and economy as a whole.
Three months later, they increased this amount to $85 billion per month.
Normally, the Fed would set a limit to the total amount they’re willing to spend on QE, like they did with QE1 and QE2.
For QE3 however, they have not set a limit, which indicates that in theory, they are willing to spend unlimited amounts on it.
Thus, QE3 has been affectionately nicknamed “QE-Infinity”.
Upon hearing the news that Fed will spend unlimited amounts of money to support the economy, the global market went full risk-on and started buying up anything that produced decent yields.
Stocks, bonds, currency, real estate, you name it, people bought it.
As a result, financial markets all over the world began to go up in price.
It was like the world had been given an unlimited supplementary credit card.
There were spending sprees everywhere.
As it turns out, there’s a cost to using this credit card, as inflation began to rear its ugly head in – interestingly enough – other parts of the world.
At the moment, inflation in the U.S. remains low.
And according to official economic data, the U.S. economy seems to be recovering.
That’s good news… right?
But there was just one fear: what if the economy was just being artificially inflated by the Fed’s QE dollars, rather than having real increased productivity?
The Music Almost Stops
On June 19, 2013, Federal Reserve chairman Ben Bernanke announced that the QE3 program would be reduced (or tapered) from $85 billion to $65 billion per month in September 2013.
Upon hearing the news, the stock market had a mini crash and a few bankers were seen jumping out of office buildings that day. (just kidding)
But seriously, the stock markets did drop quickly and significantly.
Seeing this, Mr. Bernanke quickly ate his words and came out to remind everyone that the tapering will only occur based on the economic data they’re seeing, and that it wasn’t a sure thing to happen.
Upon hearing this, the market stopped panicking and went back to business.
Everything starting going up again.
Phew… disaster averted!
The Game Of Musical Chairs
The truth is, the Fed can’t keep going with QE forever as there is a real cost to it — a loss of purchasing power for anyone holding on to U.S. Dollars.
This is why we’re starting to see countries like China and Russia striking deals to pay each other in their own currencies, rather than in U.S. dollars.
Just the mention of a potential QE reduction was enough to send stock prices reeling into the abyss.
So it’s up to you to decide if the current stock prices are based on unrealistic expectations, or actual improvements in the U.S. economy.
In the meantime, tapering remains a closely watched topic.
FOMC September 2013
Just yesterday, the Fed decided not to go ahead with tapering, even though three months earlier, they said it was a distinct possibility.
This has surprised many people, and as a result the spending spree has gone on overdrive.
Stocks, bonds, Australian dollar, British Pound, Euro, pretty much everything has gone up in price, immediately after the “no tapering” announcement.
Yay! Free champagne for everyone!
Meanwhile, as the champagne is being popped, the United States goes deeper and deeper into debt.