> TEOTWAWKI Blog: Quantitative Easing 3 - What it means



Quantitative Easing 3 - What it means

There's been some speculation around a 3rd round of quantitative easing this fall, also known as "QE3." While the Federal Reserve hasn't announced anything, there's talk, and you'll probably hear more in the next while. Here's a quick run-down on what the heck quantitative easing (QE) is and what it might mean for the economy.

QE works as follows:

  • Central bank (Federal Reserve) prints up (actually, just types up these days) some new money
  • Central bank uses new money to buy back government debt (bonds/t-bills, etc.) on the secondary market.
QE has two major consequences (for our purposes):
  1. Pumps some liquidity into the market...bond holders now have cash to reinvest elsewhere
  2. The overall supply of cash is increased.
Consequence #1 is why the central bank does quantitative easing; normally, they would lower rates, but rates can't go a whole lot lower. So, they're hoping the debt buyback will get things moving. Unfortunately, there's low confidence levels in the economy, so people are likely to put their money back into low risk investments (like government bonds), which doesn't net us a whole lot of growth.

Consequence #2 has the side effect of potentially lowering the value of the dollar. Laws of supply and demand and all that--as supply increases, demand generally decreases. Along the same lines, QE can also lead to inflation; the value of the dollar is decreased, so businesses increase their prices accordingly.

So, what does that mean?

First, it's not the end of the economy. It's actually intended to stimulate the economy with some liquidity and move new investment. How well that would work is uncertain. It's a gamble.

Second, a third round of QE will probably further devalue the dollar. I would expect a spike in prices of commodities like gold and silver, and an increased demand for low risk investments. After a few months, some inflation would be a fairly safe bet to make too. 

The effect of QE3 would be correlated with its size. If I remember right, QE2 was a massive $900 billion--these aren't drops in the bucket. That's more than the market capitalization of Apple, Microsoft and Amazon combined--a lot of money.

If you're worried about QE3, I'd look at rolling any large cash holdings into a "safe haven" like gold/silver, or looking at investment options. If we're talking a lot of money, you might want to talk to a financial advisor expert person, and not just take my word for it.