Bond Issuance, Purchases Central Bank – Part V By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

August 30, 2016 | Posted by bobbysrinivasan << back to blog

This is an ongoing conversation between a Student and his Professor.

Student: I am curious about how the US has brought down the unemployment rate to 5%. What role did the Central Bank play?

Professor: This will be a long answer. During the sub-prime crisis, many major institutions like Lehman Brothers, Merrill Lynch, AIG, Bank America and Citi Bank were on the verge of bankruptcy. The then Fed Chairman Ben Bernanke who had a detailed knowledge about the 1930 depression acted boldly and swiftly. He decided to pump money into the economy until whatever it took to reduce the massive unemployment and to revive the stagnant growth. During the period between 2009 and 2013 he pumped in 4 trillion US dollars in to the US economy. (Remember our annual budget is 275 billion and a GDP of nearly 2 trillion dollars).

The economy gradually stabilized. More jobs and taxes happened. In the current economic scenario, the US alone is standing tall. The entire Eurozone, Japan and even the mighty China are all facing economic deceleration. In summary pumping the money worked at least partially.

Student: How can a country add to the economy unearned money? Is it not like diluting the ownership?

Professor: You bet it does. Euro currency has tumbled nearly 40% from its peak. Japan is creating negative interest rate to create artificial demand and also want to push the value of its currency down. China has devalued 6.6% in 2016 so far.

In summary the value of a currency will take a hit because of the Quantitative Easing. However in the case of US this does not appear to be the case partly because the Quantitative Easing has benefited the entire economy largely creating consumer demand.

Student: The more I hear about the Central Banks role the more I realise how important they are to an economy.

Professor: Yes, of course. Later you will learn in trading course that how the Central Banks decision affect the currency and commodity markets. The statements from the Central Bank Chairman are enough to rattle the market. Such statements are called dovish or hawkish. If it is dovish, it is market friendly and then stock prices move up. If it is hawkish investors look quit markets and run for shelter. Currently the US is contemplating withdrawing atleast part of the fiat money that they pumped in during 2009-13. Yet they are afraid to do so because the US may revert back to recession. The US election is in November 2016. Between now and then there will be many ups and downs in the market and clarity will prevail only after the election. But as students you must get interested in understanding as to how the global economy works and its impact on your country. The value of all that you own or plan to acquire can change in value due to devaluation. You need tools to survive these economic volatility. The rest will be taught in class. OK.

Student: Thanks Professor.

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