Prior to the market’s open yesterday, the Fed announced unlimited asset purchases that also include corporate bonds, municipal bonds and securities backed by consumer loans.

Wow!

There is a long-term downside of taking this measure. I am not going to write about it until the market calms down. Today I am going to write about the short-term upside for the economy, for the market and for investors like us.

Whether it is called QE (quantitative easing), asset purchases, or balance sheet expansion, it means the same thing: the Fed is creating new money. Just ten days ago, the Fed announced they would create $1.5T new money, but the market pretty much ignored that. Now the Fed is essentially saying that they will create as much money as possible to back-stop this financial crisis.

Why can the Fed create money with abandon?

Remember when I wrote about the dollar being the new gold? In a time of crisis like this, everybody is trying to convert everything into dollars since the dollar is considered the safe-haven currency. All currencies are dropping, gold is dropping, municipal bonds are dropping, even treasuries are dropping because everybody (bar me and my clients) is hoarding $ cash. Since the market craves the dollar, if the Fed can create it, someone will take it. That’s why the Fed has the audacity to announce an unlimited dollar supply. And this is indeed the privilege of the US, which owns the true world currency.

Why does the Fed need to do this?

Because everybody and their grandma is hoarding dollars, there aren’t enough dollars in circulation to facilitate normal market activities. This is called liquidity crunch, and it is causing the near collapse of the corporate bond market, the municipal bond market, even a mini crash in the treasuries market. If allowed to continue, this liquidity crunch could create a domino collapse of financial institutions a la Lehman Brothers. By infusing these markets with unlimited liquidity, the Fed is backstopping this domino effect. We should expect the bond markets to stabilize in short order.

What’s the ripple effect?

This unlimited liquidity could spill over to the equity market and cause a rally once the fear that has been gripping the market loosens. With this much liquidity, an equity market rally is almost certain with or without a recovery of the economy. When that happens, most of my clients and myself will be well positioned to benefit from that since we have been rebalancing into the market when stocks were selling at deep discounts.

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