I used to love playing with secret decoder rings when I was a kid. They would come in cereal boxes and I fancied myself quite the spy, able to decipher all kinds of “secret messages” that my friends and I would make up and pass around to each other.
Well, like most seemingly useless things you learn in life, it all comes back around, and today I often find myself wishing I had a “secret decoder ring” for much of the economic and financial gibberish that comes out of the mouths of our fearless leaders and press.
QE? Operation Twist? LTRO? Target 2? Yield Curve? Say What?
Hmmm….if only I had a secret decoder ring…
After searching high and low for one all over the Internet and coming up empty, I decided to create my own…our very first Kung Fu Finance secret decoder ring.
And what better place to start with than with the gibberish that came out of the U.S. Federal Reserve today.
Today the “big news” here in America was the Federal Reserve’s statement from their latest meeting of the Federal Open Market Committee (FOMC). (The secret decoder ring is twitching already with just that one sentence!)
If you’re a glutton for punishment, you can read the full text of their statement here, but let me hit the highlights and see if we can decipher what’s really going on:
First, the Federal Funds Rate:
“…the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent…”
Well that’s clear as mud, unless you are a classically trained economist, so let’s see if our awesome secret decoder ring can help:
First, what on earth do they mean by “highly accommodative”?
Luckily this one’s easy for our magic little ring to decipher…
“Highly accommodative” translates to:
- “easy money” (for the banks)
- “very low interest rates” (for the banks, the government, and for us savers)
- “more money printing” (devaluation of the dollar)
All those are synonyms for “highly accommodative”.
But since I know you are very smart and savvy, I bet you’ve picked up on the key question here that remains…
Just who exactly is being accommodated by this “easy monetary” policy?
You? Me? Senior citizens and those on fixed incomes who could certainly use some help?
Let’s use our secret decoder ring…
Answer: the banks and large financial institutions, who will continue to be able to borrow money from the Fed at 0% interest rates and immediately make a positive spread…the very definition of “easy money”.
(Let me know if you want me to decode “positive spread”.)
I wish we could borrow money at 0%! We would quickly become billionaires!
Moving on, we have…
“…and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”
Secret Decoder Ring Translation:
And banks will be able to sit on this money and make a positive spread for at least another 18 months…
Not bad at all (as long as you’re a bank!).
(If you’d like a little background on the Federal Funds Target Rate and how it works, I answered a question about it in a QnA here, and my friend and fellow La Estancia owner Gary Kinghorn provided a little more info. here).
Next, we have the extension of “Operation Twist”:
Operation Twist is the cutely named (hah) program for the Federal Reserve purchases of “government securities” (aka “U.S. Treasury Bonds”). This is the main way in which the Fed is able to reduce the federal funds target interest rate mentioned above—they increase the money supply by writing bad checks to the government.
(I’m not joking…that’s honestly how it works, and if that doesn’t make sense to you because you are a normal person, I wrote about that process here.)
So what does their newly issued statement say?
“The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities. Specifically, the Committee intends to purchase Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. This continuation of the maturity extension program should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative.”
Secret Decoder Ring Translation:
The Fed is trading its short-term bonds (those in the 1 – 3 year range) for longer-term bonds (those in the 6 – 30 year range). Basically, they are pushing the yield on long-term bonds down (the interest rate) to encourage borrowing/lending (and to benefit the government who would have a difficult time making interest payments at a higher rate).
They have been doing this since September, but it was scheduled to end at the end of this month. However, now they are extending this “program” until the end of the year.
So what does all this mean for you?
They left the door wide open for more “QE” (money-printing), which suggests that gold (and other hard assets) will continue to do well over time.
I hope the secret decoder ring helped…please let me know if you have any questions (and whether you think the Fed did the right thing or not…) in the comments!
To your financial success,
— Kung Fu Girl
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