What the Heck is Quantitative Easing???

“Quantitative easing” is when the Federal Reserve purchases bonds (normally treasuries but since the credit crisis mortgage-backed securities as well) which pours liquidity into our financial system.  It it is the way the Federal Reserve prints money.  It sounds more innocuous to call it “quantitative easing” than “printing money”.  Most people grasp what happens to the value of their dollars if the Fed prints more of them.  Wall Street can make money in a rising or falling dollar environment.  They’re not particularly excited about the value of the dollar declining but they know how to profit from it.

The value of the dollar (and all currencies) are in constant flux.  A strong dollar means we can buy more stuff relative to other currencies.  It’s great for the American consumer but not so great for the American manufacturer.  A weak dollar makes American goods more affordable for foreigners to purchase.  This provides a tailwind to American manufacturing and stunts consumer spending on foreign goods.  A weaker dollar policy would, in theory, increase American manufacturing and demand among Americans for goods that are made in America.

The problem with devaluing our currency is that other countries will react in kind.  Commonly by devaluing their own currency or enacting regulations, tariffs and taxes to make American goods more expensive to foreign consumers.  It’s a vicious cycle and it has a profound impact on the structural level of unemployment in the United  States and the standard of living of billions of people around the world. 

In a falling dollar environment, investors buy “stuff” to preserve their purchasing power.  Gold is a common hedge, but I believe it’s too speculative and it’s very difficult to determine its intrinsic value.  It could be in bubble territory  based on the volume of commercials on television that exhort Grandma and Grandpa to buy it.   Stocks do relatively well because companies have balance sheets with plants, equipment and most importantly, innovative people with good ideas to bring to market.  They have revenues and earnings which can rise in an inflationary environment (so long as it’s not “excessive”).  Real estate is also a great asset to hedge against inflation.  It is also one of the most reviled asset classes at the moment, which makes it particularly appealing.  Investing in bonds is very tricky right now.  Hapless bond investors will be the biggest losers over the next three to five years, and the sad thing is they think they are being “safe”.

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Filed under + Economics, Politics and Financial Planning

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