01-21-2014 02:40 PM
By Wasif Latif,
Vice President, Equity Investments
Like many people, I hate going to the dentist. A regular visit can be tough, but special procedures, like a root canal, can be unbearable. But we get through them because we have to. To help with our recovery, we get painkillers. Thank God for painkillers.
Why am I telling you this? Well, I was recently asked to explain the current situation with the markets, the economy and the Federal Reserve. People wanted to know what to make of all this talk in the news of “tapering” and “QE.” To make it relatable, I came up with a dental analogy.
When you have a painful, decayed tooth, your dentist performs a root canal and offers you painkillers. When the nation has financial pain and decay caused by the rotting loans in the banks, the Fed may administer huge amounts of painkillers to keep the country from feeling the economic misery.
Fed Chairman Ben Bernanke has been doing just that to stem the economic crisis that started back in 2008, instead of allowing it to fester.
Bernanke started administering the medicine with about $800 billion that he “printed” (electronically, of course). This is called “quantitative easing” — lowering interest rates by printing money and using it to buy Treasury bonds. When bond prices go up, yields go down. When yields on Treasury bonds go down, borrowing rates go down.
At first, we were still reeling from the economic pain. But gradually, things started to get better. Banks that were near death because they didn't have enough cash began to recover, and the stock market began to reflect the relief. When the $800 billion ran out in 2010, Bernanke waited to see whether the economy had recovered or needed another dose.
It was a short wait because the stock market began to hurt and ask for more medicine. So the Fed came up with another influx of new money. This time, it was $600 billion. Then came another round, and finally when that dose ran out in 2012, Bernanke and his team came up with the most innovative solution yet in this saga. Instead of administering the painkiller in doses, they decided to just hook us up to an IV and set the flow at a continuous drip of medicinal money — $85 billion a month — until the economy got better.
So where are we after all that treatment?
The economy is on a path to recovery, and the Fed’s efforts seem to have worked. But we haven’t come off the drugs yet. The plan to wean us is called “tapering” — going from $85 billion in monthly purchases to $75 billion. That’s still $900 billion of QE for the year.
The market consensus is that the U.S. economy is stabilizing. But the question is: Are we fully healed?
My guess is not completely. History tells us that recoveries from the kind of economic crisis we have suffered take a long time. When all the QE bond buying ends and rates rise, the economy should start slowing. Then the Fed may introduce some new type of QE program.
In short, the dentist’s work might not be finished yet.
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