Page 91 - Ultimate Guide to Currency Trading

If a currency pair is priced at one interest rate, and there is an announcement of a change in
one of the ends of the pair's interest rates, then the pricing of the currency pair will change. It usually
works that the lower interest rate will move lower and the higher interest rate will move higher. The
net effect is a change in the price of the currency pair.

Economic Announcements

There are other announcements that are related to interest-rate changes but these announcements
are a whole other concept. One example that has been in the news lately is what is often referred to
as quantitative easing. Quantitative easing is a way of altering a country's money supply by purchasing
large quantities of that same government's bills, notes, or bonds on the open market. When a treasury
or central bank purchases massive quantities of its own debt on the open market, the purchase has
the effect of pumping huge amounts of fresh money into the system. The way this works is simple. If
there is a $1,000 bond outstanding and held by a bank, the home country's central bank or treasury
will step in and buy the bond from the bank. Now the bond is on the balance sheet of the treasury and
the bank has $1,000 in cash. Since the bank is in business to make money, this $1,000 will be lent out
to its customers who are looking for loans. The borrowed money is spent by the consumer, and the
merchant puts the $1,000 in his (the merchant's) bank. Due to the fractional-reserve banking system,
only part of the money needs to stay in the bank while the rest can leave again in the form of a loan.
For the second time, money is lent out, spent, and deposited in a bank. The fractional-reserve system
means only part of that money needs to remain in the bank, and again, the rest leaves in the form of
another loan. The system repeats itself over and over again.

Quantitative Easing in 2008-2009 and 2011

It is quite impressive how an all-out quantitative easing campaign can work. It was done in full force
after the 2008-2009 banking crisis. Most of the major economies of the world engaged in some form
of quantitative easing. Naturally, the largest players in the world bought the most debt. This means
that Great Britain, Japan, Europe, and the United States were the most active in the process of buying
their own debt and thereby putting the most money in the system.

There has been some confusion as to whether quantitative easing has worked for these
countries. Even after the second round of easing in the Unites States, which was known as QE2, the
economy remained sluggish. In addition to this, the perceived value of the U.S. dollar went down
considerably.

In this case, there were concerns of added money supply as well as added debt problems. In
the summer of 2011, the Unites States had its debt downgraded from an AAA status to an AA status.
While the effects of this new development have yet to be determined, the currency markets
pummeled the U.S. dollar before, during, and after the news.