Wednesday, November 3, 2010


Later on this morning, the Federal Reserve will announce that it is going resume purchasing treasuries, a strategy it used in 2009 to drive interest rates lower by essentially creating money to purchase IOUs (notes), which will need to be repaid in the future. 

What does this mean in English?  In simplest terms, the Fed will once again be pushing large quantities of currency into the system with a promise to pull it back later on.

There is legitimate debate among economists about whether flooding the economy with money will create runaway inflation and, ultimately, much higher interest rates.  Right now, with unemployment at 10% (much higher when you consider the number of people who have simply quit looking for work), the Fed simply has to take a stand.

Inflation, at least in the short term, is the goal.  Prop up home prices, encourage banks to lend more, kick start the economy... that's the intention here.

If it works... we will likely see a short term drop in interest rates, we'll see home prices stabilize, we'll see banks start to lend and companies will hire and expand because of the availability of "cheap money".  The stalled economy will get moving again.  Once there's traction, the Fed will then aggressively start pulling money out of the economy, which it will do by raising short-term interest rates.

If it fails... well, this is not a good scenario.  The Fed would likely have no choice but to keep pouring money down a hole until it finally has some effect, at which point runaway inflation will be almost inevitable.

This is a high stakes move and it will impact almost every American household, one way or another.  We had better hope it works.