QE3: 5 Things to Know

The previous rounds of quantitative easing involved the purchase of U.S. Treasuries, but not this time

Ben Bernanke answering questions at a press conference. (Photo: AP) Ben Bernanke answering questions at a press conference. (Photo: AP)

The Federal Reserve unveiled another stimulus plan to help the U.S. economy to recover faster on Sept. 14. Weeks ahead of the official announcement, financial markets were clamoring for a move.

And when the Fed finally pulled the trigger, stocks and gold surged.

Here are five things you need to know about QE.

1) What Is QE3?

QE3 refers to a third round of quantitative easing by the Federal Reserve Bank and is not the same as QE1 or QE2. The previous rounds of QE involved the purchase of U.S. Treasuries. This time the Fed is buying $40 billion per month in mortgage-backed securities (MBS).

Here’s another big difference: Previous versions of QE had specific limits to the amount of money that was going to be spent whereas QE3 doesn't. QE3 is supposed to be ongoing until after the economy and employment situation improve. How long that will be is anybody's guess.

2) Is the Fed’s Balance Sheet Becoming a Problem?

Before the 2008 financial crisis, the Federal Reserve’s balance sheet stood around $900 billion. However, from 2008-09 the Fed’s balance sheet nearly tripled, as it rescued the financial system by snapping up diseased mortgage assets.

Today, the Fed’s balance sheet is around $2.85 trillion and its largest holdings are U.S. Treasuries ($1.6 trillion) and mortgage backed securities ($834 billion). And with QE3 guaranteeing open-ended multibillion bond purchases, $3 trillion by 2013 looks like an easy target. (See Chart on Next Page)

3) How Bad Is Inflation?

The Federal Reserve projects inflation of just 1.2 to 1.7% this year or just below the FOMC’s 2% inflation target. But this doesn’t necessarily prove that inflation is tame.

Since 2010, the iShares GSCI Commodity Index Fund (GSG), which tracks a basket of 24 different commodities like oil and corn, has increased 15.36%. Inflation is showing up elsewhere too, particularly in precious metals, which are viewed as hedge against inflation.

Over the past five years, gold has soared 134%. Official inflation figures provided by quasi-governmental agencies like the Fed along with the U.S. government frequently understate actual inflation.

4) Does QE Hurt Savers?

The short answer is “yes.” The Fed has pledged to keep its zero interest rate policy (ZIRP) effective through at least 2015. While that might be good news for overstretched borrowers, it’s bad news for investors who depend on yield from their fixed income investments.

The 7-day yield on money market funds hovers between 0.07 to 0.10 percent, according to Crane Data. How depressed is that? At that rate, it would take a conservative saver 697 years to double their money! As a result, previously conservative investors have flocked into higher risk/higher yielding assets like junk bonds (JNK), emerging market debt (EMB).

5) Has QE Improved the Job Market?

At the news conference after the QE3 announcement, Fed Chairman Ben Bernanke said: “The weak job market should concern every American. The objective of the new policies, he added, “is to quicken the recovery, to help the economy begin to grow quickly enough to generate new jobs.”

Despite the impressive efforts of QE1, QE2, and Operation Twist, national joblessness is higher today than it was back four years ago.

For comparison purposes: In late 2008, U-3 (the headline unemployment rate) and U-6 were 6.8 and 12.7%. Fast forward to today: In August 2012, the U-3 and U-6 jobless rates were up to 8.1 and 14.7%. Although lowering joblessness has been one of the primary reasons for more QE, it’s been an ineffective tool at reducing national unemployment.

In medical terms, here’s what QE equivalent is like: It’s tantamount to injecting the wrong patient with a drug prescribed for someone else. While the broader economy – QE’s intended patient – is still very sick, precious metals (SLV), stocks (DIA), and bonds (TLT) have gotten a huge boost. 

The bull market in global stimulus by central bankers was highlighted in the “Investment Theme Report” in the October edition of the ETF Profit Strategy Newsletter. QE is hardly unique to the United States.

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