Friday, November 5, 2010

QE2: will your ship stay afloat?

It's called "quantitative easing" -- the latest buzzword -- and it's the second one by the Federal Reserve Board. It will definitely affect your wallet.

Here's a definition from the WalletPop website:
Technically speaking, it's when the Fed goes into the markets and buys financial assets like Treasury securities. In layman's terms, it's when the Fed prints more money and floods the economy with it to reduce long-term interest rates and encourage growth. The goal: to get consumers -- the backbone of the economy -- spending again.
Another definition from National Public Radio: It means creating massive amounts of money out of thin air with the hope of getting the economy back on track. NPR has a good explanation of how it works here.

QE2 is a $600 billion gamble. A lot of people are doubtful that it will do much good. Since when has that stopped anyone in Washington?

Here's how it's going to affect you:
1. One of the most expected results of QE2 is a weaker dollar. While a weaker dollar helps make our exports more attractive to foreign buyers because it makes our products less expensive to purchase (if it's less expensive, they will buy more), it makes imports more expensive. Expect to pay more for things like French wine, Dutch cheese, German cars, Belgian chocolates, Scottish cashmere sweaters, and overseas vacations, for example.
2. When the dollar falls, commodities -- from oil to gold, corn, cotton, wheat, sugar, and more -- often rise because they become cheaper to investors holding other currencies. As speculators pour money into these goods, you pay more-- at the grocery store to the pump.
3. The last round of easing triggered a huge stock market rally. Equity prices will likely rise again (That's why you're seeing investors put money into stocks and other assets) because quantitative easing compels investors to assume more risk; move their money out of safe, low-yielding investments and into other securities. Conversely, quantitative easing means lower rates on things like money market accounts and certificates of deposits.
Fed Chairman Ben Bernanke suggests that QE2 will help every part of the economy, including job creation and lower mortgage rates. The observers I've read are doubtful. Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City described the move before the meeting as a “bargain with the devil.” It is an inflationary move, which could create more asset bubbles. Bernanke must be more concerned about deflation of that kind that has infected Japan.

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