Here’s a short explanation of QE3.

It’s not a big British cruise ship.

You’ve probably seen countless discussion of the Federal Reserve launch of QE3 last week. But what does that acronym mean?

Quantitative Easing is a monetary policy under which a central bank tries to stimulate growth by lowering borrowing costs by buying up debt, thus pushing yields lower. It also puts a lot of money in the hands of people who otherwise had those securities it just bought, so they can go out and buy something else, which has included U.S. stocks.

In the U.S. this has been done through the Fed’s purchases of Treasury and mortgage-related debt, also called MBS or Mortgage Backed Securities (the latter specifically targeting home loans, with the idea that lower borrowing costs would revive the battered and important housing sector.)  Throughout the history of recession or financial recoveries, housing has always led the way.

The first two rounds of quantitative easing — QE1 and QE2 — are a big part of what pushed mortgage rates and Treasury yields to record lows recently. So, in theory at least, QE3 would be good for bonds because you have a new, deep-pocketed buyer.  (Psst…it’s the same buyer…but how it plays out in real life is more complicated because of lots of other influences, such as the European debt crisis.)

But it’s a fairly controversial policy, because having a central bank buy up a lot of securities is essentially the same as if it printed money.

It is easily argued that the Fed is throwing in the towel and the only play they have is QE.  Did QE1 or QE2 work?  The pundits described that it saved the financial system from a disaster that we did not endure or delayed the inevitable or coming financial disaster that is on the horizon.  Advocates of QE say it’s a necessary risk to help the U.S. avoid a depression, which would be even worse for the dollar.

QE is seen as potentially creating inflation, and devaluing a country’s currency because they’re making more of it available. Some central banks, such as Germany’s Bundesbank, are strongly against adding extra money to their financial system through special measures like bond buying; critics cite examples like the hyperinflation Germany faced between World War I and World War II as a reason QE is a bad idea.

In general, QE tends to be negative for the dollar, and positive for gold and other hard assets seen as an alternative and hedge against devaluation and inflation.  (Have you adjusted your retirement account allocation lately to include gold or commodity related stocks?)  That’s been the case for gold since 2008.

The Fed has completed two similar programs already since the Great Recession, so this is seen as the third round – hence called QE3. And Fed Chairman Ben Bernanke has made pretty clear he thinks the policy has been helpful to the economy.  The Fed has stated that they will be purchasing (aka-printing money) a minimum of $40 billion per month up to $67 billion in Treasuries and Mortgage Backed Securities.  Bernanke left the door open and said there is no ending time table for the purchases.

Upon this announcement, we saw mortgage rates decline by about a .25 point.  Where is the bottom?  How much lower can rates go?  Only time has the answer…stay tuned – it’s gonna be a ride…


Quantitative easing

Quantitative Easing Definition

Quantitative Easing | Finance | Khan Academy

QE3: What is quantitative easing? And will it help the economy?


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