Fed Buying Bonds Again...

Before I start this post, I just wanted to write a big thank you to HongT, a recent follower who wrote a wonderful compliment about my blog. If you ever have personal requests or even questions I don't normally discuss on this blog, please comment or find me on Facebook (please include a message who you are so I don't ignore your request) and I'd be glad to talk to you.

The Federal Reserve will be meeting Tuesday and Wednesday this month and economists expect the Fed to announce another round of bond purchases as a way to stimulate economic activity by keeping borrowing costs low. A majority of economists polled predict purchases will exceed $500 billion, adding to their never-ending debt. But continued reckless spending by the government will be in focus today, as millions of unemployed, angry, and hopeless Americans cast their votes for or against change in levels of federal government.

Bond purchases by the Fed is nothing new and it's recently been occurring at an outrageous pace. The plan, more famously termed as Quantitative Easing (QE), is to ignite the economy through lowered borrowing costs. Sound familiar? That's because it's the same description used to explain low interest rates. But because rates are so low, QE has been a strategy continued to be played out by this administration that continues to fail 300 million people.

Very little positives have resulted through QE measures, but the Fed insists on maintaining their course of action. Meanwhile, 17 million Americans are still out of work and jobs are being shipped out of the country because major corporations are hesitant on hiring with no clear signs that economic growth is sustainable. Don't be surprised if drastic changes occur in Congress, the House, and the Senate later today.

Many investors and even non-investors ignore these headlines, thinking that it does not affect them, but this is simply not the case. So why does the Fed keep trying it if so many believe it's not working? Their decision is based on the fundamental theory of a loose monetary policy.

It all starts with the Federal Reserve. The Fed, which by the way is a not a government agency, but a private cartel of its member banks overseen by the US government, buys bonds in the Federal Reserve Market, not the bond market. This is done by printing money, which creates inflation. The purchases of the bonds are done to work with the member banks in keeping rates low. This allows consumers the ability to borrow from banks at low rates or increase investment spending by businesses, also known as capital goods. If the business is successful, it expands and hires more workers, expanding spending, and expanding the overall economy... well that's the theory.

QE has done none of the sorts, at least not yet, and probably won't do anything in the near future. All it has done is decrease the US currency, in turn, increasing the value of nearly every asset in the financial market, except housing.

Low interest rates and an appetite for risk has pushed the stock market higher over the last six months because the yields in the bond market have been just plain ugly. Even corporate bonds are trading extremely high because their prices are in direct correlation with government bond prices.

You may have noticed that many companies, like Microsoft and IBM, recently announced major bond offerings. With rates in the bond market so low, they are selling debt and using that cash to buy back shares or pay for dividends. When a company buys back shares, it reduces the outstanding shares or the supply of shares, which results in a small increase in its price. This is important because public companies are valued by the EPS, not always the actual net income. Instead of trying to create more profit during poor economic times, they can sell debt for cheap and maintain their dividend payments, pleasing shareholders.

Hewlett-Packard mentioned that it plans to buy back up to 25 per cent of their shares. That's a significant amount! HP's market capitalization is roughly 97 billion (at the time of this posting). If 25 per cent of their shares are bought back, and the value of the company does not change for the worse, then the shares, which are $43 right now, would be valued at $57 in the future, an increase of 33 per cent. I bring this point up because more and more companies are issuing bonds, and it is very important that you review your investments and see how this will impact your portfolio.

A devalued US currency has also sent gold and many commodities to record prices. It has been a joyride for those enjoying the second gold rush, without having to set foot in California or the Yukon, but the rally in gold is a sign of inflation. Gold is often used as a hedge against currency devaluation and inflation. And with America printing more and more money to buy bonds, it is only a matter of time before the inflation bomb really affects America and the rest of the world. 17 million Americans are still out of work and another estimated 18 million are not making enough today... how in the world are they going to be able to afford food after inflation ripples through the economy?