Pham Draft 1

Federal Reserve Liquidity Initiative (Draft – 4/21/09)
By Chinh Pham
**This is a test

Test 2

During this challenging time of financial problems and high unemployment, the Federal Reserve has taken unprecedented steps to increase the liquidity of the financial markets within the US. Although these actions may solve today’s economic problems, the longer term impact of these actions could have major ramification to the US including significant higher interest rate, tightening of credits, devaluation of the dollar, hyperinflation, and a new world currency. Given these problems, savvy lenders should take necessary steps to protect their hard earned dollars including diversify to other currencies, evaluate purchase of hard assets, increase borrowing now, looking to short US dollar.
History of the Federal Reserve
The Federal Reserve is essentially a Central bank with a mandate to manage the nation money supply so that there would be sufficient currency in circulation to facilitate commerce. Under the “enlightened Federal Reserve” charter, the Federal Reserve seeks to strike a balance between low unemployment and low inflation. However, often these two aims are conflicting.
In recent years from 2002 until present, the Federal Reserve under previous chairman Alan Greenspan and now current chairman Ben Bernanke has pursued an expansive currency policy (increase the money supply) while maintaining very low short term interest rate. Under this policy, asset markets like stocks, bonds, and commodities have “thrived” until the major crash in the second half of 2008. However, one major dissent would be the forex market where it is most sensitive to interest rate and inflation. From 2002 until the worldwide economic collapse in 2008, the Euro has appreciated significantly against the dollar from $.8734 per euro in 2002 to a peak of $1.60 per euro in 2nd Quarter 2008 or an appreciation of 83 percent. Using the dollar spot index, from 2005 until 2nd quarter 2008, the US dollar depreciates against other major currencies.

Fed Liquidity Program
Given the current economic collapse, the Federal Reserve under chairman Bernanke began a series of very aggressive actions to add liquidity to the market to help stimulate the economy. The major steps taken by the Federal Reserve beginning in the fourth quarter 2008 include:
1. Lower the Federal Fund Rate (overnight interest rate that the Fed charges bank) from 2% in April 2008 to 0 to .25% by December 2008
2. Announce program to buy $100 billion of direct obligation of housing related government sponsored enterprises (GSE) include Fannie May, Freddie Mac, and the Federal Home Loan banks and $500 billion in mortgage-based securities backed by Fannie May, Freddie Mac, and Ginnie May
3. Add repurchase programs, lending facilities, and investments in money market funds and option agreements
4. Ease credit abroad by entering into swap agreements with several foreign Central Banks suffering from dollar shortage
5. Announce in March 2009 a program to add $1.15 trillion in liquidity by buying an additional $750 billion in mortgage-based securities, an additional $100 billion in direct debt obligation by GSE, and $300 billion of longer term Treasury securities
From October 2008 until March 2009 the Federal Reserve essentially cut short term interest rate to near 0% and announce program to add at least $1.75 trillion to the economy from its buying of longer term securities. With its buying of various long term debts, the Federal Reserve also drives down long term interest rate for a 30-year fixed loan to near historical low of 3.5% to 3.8% and 10 year notes of 2.53% to 3%.
While these actions by the Federal Reserve are seen generally as positive to the current economic situations, there are major concerns that these actions would lead to significant higher interest rate, ballooning budget deficit, tightening of credits, devaluation of the dollar, hyperinflation, and a new world currency.
With the massive injections of supply of money into the economy, the supply of dollar significantly increases while the amount of goods or services stay the same or decrease. In the near term, since the velocity of money is slow, there is minimal risk of inflation. However, in the longer term when the economy recovers and there is a large supply of dollars and the velocity of money significantly increases, this will drive high inflation. If the condition continues, this condition will drive hyper inflation until something will stop the process.
Devaluation of the dollar
To add liquidity to the economy, the Federal Reserve essentially printed money to purchase the various debts and longer term securities. As this happens, the supply of dollar significantly increases versus the demand for those dollars. As this happens, the value of the dollar will depreciate against other major currencies.

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