Federal Reserve Announcement to Taper Quantitative Easing

Recent Financial and Economic Events

The stock markets around the world have dipped and currencies lost ground along with the bond market (the market for sovereign debt) showing signs of stress. This has happened over the last two weeks and particularly so in the last week as the Federal Reserve has announced that its bond buying program or Quantitative Easing would begin to taper off from the end of this year.

If just an announcement by the Fed can cause so much of damage in the markets, imagine what would happen when the actual process ends with the Fed removing the liquidity. This nightmare scenario is keeping all financial professionals awake at night as they begin to assess the impact of the Fed’s announcement on the markets around the world. The key aspect here is that the Federal Reserve from the time the financial crisis started has been pumping money into the bond markets and the market for mortgages thereby creating asset bubbles and flows of hot money to the emerging markets.

In other words, by printing money, the Fed has been able to pump the markets, which have gotten used to easy money and boundless liquidity.

Is a Perfect Storm about to hit the Financial Markets ?

The other aspect here is that the balance sheets of almost all banks in the western world are full of toxic debt and hence, they need capital infusion to make up for the losses suffered by them because of the bursting of the real estate bubble.

Further, the excess liquidity floating in the western world has made its way to the emerging markets like India where the hot money has created high equity prices and asset bubbles.

Coupled with the fact that the Chinese economy is also contracting, these events have the potential to cause the next big crisis in the world. The ensuing liquidity crunch would leave the banks in the western world gasping for breath and the emerging markets witnessing a flight of dollars out of their markets. This is the reason for the steep fall in the value of many currencies of the emerging economies.

Apart from this, the borrowing costs of governments seem to be going up because there is no confidence in the system with the central banks on the verge of losing control. All these conditions are creating a perfect storm in the financial world and therefore, it is in the interest of investors, professionals, and anyone who follows the business world to be prepared for any eventuality.

More Debt is not the answer to Existing Debt

While not getting completely into the solution mode, it needs to be mentioned that the way to salvaging the financial system would be to let the “Too Big to Fail” banks go under thereby creating conditions for a revival in the markets.

The point here is that unless the banks that have toxic debt and have huge derivative positions are allowed to collapse, the present method of pumping money into them to prop them up would result in more debt being created to solve the problem of existing debt.

The clear implication of all these events is that there are hard times ahead for all stakeholders and especially for those who have taken mortgages or student debt to finance their homes or pay for their education.

In this grim scenario, sacrifices are required and hardship to be borne as the world starts to pay down the existing debt and return to the debt levels of the pre crisis world.

Concluding Thoughts

In brief, the road ahead for the financial system around the world is perilous and therefore, it is better for professionals and students to reassess their careers and their education and evaluate the returns that they are getting on their investments.

Unless there is some magical method by which debt can be written off and everyone starts afresh on a blank slate, the world is going to witness more financial volatility and economic chaos in the months to come.

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