Quantitative Easing: The Good and the Bad
One thing apparent from both the interest rate adjustments and QE decisions in 2008-09 was how closely the Federal Reserve watched the movements of the stock market. On Martin Luther King Day in 2008, stock markets around the world plunged. What caused this drop? At the time, nobody was quite sure but many believed that investors were panicking as the global economy cooled. In response to the sharp decline in global financial markets, the Federal Reserve held an emergency meeting on that Monday and decided to lower the federal funds rate by 75 basis points (0.75 percent). A few weeks later the real reason for the drop in the markets was revealed. At Societe Generale – one of France’s largest banks - a rogue trade, Jerome Kerviel, had accumulated approximately 50 billion euros in unauthorized positions. In order to unwind these trades, Societe Generale had to sell securities in many markets throughout the world. Consequently, the Fed had lowered its main interest rate by 0.75 percent because a French bank was trying to unwind positions in various stocks.
By focusing on the stock market, the Federal Reserve hopes to increase consumer spending through the wealth effect. The wealth effect is the theory that when the value of stock portfolios rise as the stock market increases, investors feel more at ease and confident in their wealth, and as a result they spend more. “If people feel that their financial situation is better because their 401(k) looks better or for whatever reason — their house is worth more — they’re more willing to go out and spend,” Chairman Ben Bernanke told reporters after the most recent decision for QE3. “That’s going to provide the demand that firms need in order to be willing to hire and to invest.”
What direct effect could quantitative easing have on an individual? Matthew Heimer contemplated this in an article on MarketWatch. “Couple X is retiring. They’ve decided to split a $600,000 portfolio into three equal piles and invest it on in 10-year Treasurys (sic), 5-year CDs and a mix of investment-grade corporate bonds that yields the average for that sector. And because they’re a hypothetical couple who live in my head, they’re making all these investments on the same day. If they’d retired five years ago today—before our most recent recession kicked in—they’d have nailed down annual yields 4.81% a year on the Treasurys (sic), roughly 5% on the CDs and roughly 6% on the investment-grade bonds, according to data from the Treasury Department and the BondsOnline Group. Annual pre-tax income from their portfolio: $31,620, not a bad supplement to the monthly Social Security checks. If they’d retired today, based on yesterday’s closing prices they’d be earning 1.83% on their Treasurys (sic), 1.37% on the CDs, and 2.92% on the corporate portfolio. Now we’re talking annual income of $12,240—less than 40% of what they might have earned with different timing.”
*The opinions and forecasts expressed are for informational purposes only and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. The representative does not guarantee the accuracy and completeness, nor assume liability for loss that may result from the reliance by any person upon such information or opinions. All investments involve the risk of potential investment losses and no strategy can assure a profit. Past performance is not indicative of future results.
Clark, Nicola. Rogue Trader at Societe Generale Gets 3 Years. 5 Oct 2012. NY Times. 18 Sept 2012. <.>
The Wealth Effect. 14 Sept 2012 The Washington Post. 18 Sept 2012.
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