Quantitative Easing Definition & How it Impacts you
Quantitative easing has become somewhat of a infamous economic term as of late. If you pay attention to economic and financial news, you’ve probably heard the term thrown around quite a bit lately. It’s a somewhat controversial and very hot topic at the moment, so I’ll make an attempt to explain what it is, how it impacts you, and why it could produce some unwanted results.
Quantitative Easing Definition
Quantitative easing (QE) is a government monetary policy in which the total money supply is increased through the Federal Reserve purchasing its own Treasury bonds from banks on the open market. Instead of printing the cash to make this purchase, the government simply creates it out of thin air, electronically.
The purpose in creating this additional money is to give money to banks so that they lend more, which theoretically in turn, stimulates the economy. In reality, it is much more complicated than this layman’s description, but that is the gist of it.
What is QE2 & QE1?
QE1 occurred back during the beginning of the financial crisis, when the Federal Reserve (the U.S. central bank) cut short-term interest rates, essentially down to 0%, to stimulate lending by banks to businesses and consumers. Since this measure has been exhausted, it is now shifting its focus to long-term interest rates. When the Fed buys all of these bonds, it will have the impact of driving the yields on them lower, which should theoretically make other investments more attractive.
The Fed is also attempting to avoid deflation, and creating additional money should have inflationary impact.
The Risks of Quantitative Easing & How it Impacts You
Devaluing of U.S. Dollar vs. Other Currencies: This is not so much a risk as it is a given. When you create more dollars out of thin air, you are devaluing the existing money supply versus other currencies. As one consequence, travel will be more expensive as your U.S. dollars will buy you less elsewhere.
Inflation: Currency devaluation also means that your dollar will buy you less as the goods that are imported into the U.S. will cost more. Prices are driven upwards because your dollar is worth less compared to other currencies. At this point, we don’t really know what kind of an inflationary impact quantitative easing might have.
Investing Dangers: What makes inflation, or hyper-inflation scary from an investment perspective is the danger of holding on to money that is worth significantly less over time. Many investors have simply given up on the stock market and turned to more predictable positive (and usually abysmal) returns. With inflation potentially going upwards, this conservative investment strategy could be an extremely dangerous one. In effect, if we see inflation rates start to significantly increase, my bet is that you’re going to see much of those who have been sitting on the sidelines with their cash all of a sudden jump back in to the stock market. This could drive stock prices significantly upwards, and those sitting behind with their cash will have lost much of the value of their cash to inflation.
Going Back to what Got us Into this Mess: Maybe my analysis is off base here, but I find it ironic that the Fed wants to stimulate the economy through banks lending more money. Isn’t banks lending too much money to people who couldn’t pay them back exactly what caused the financial crisis that sent us into the Great Recession in the first place?
Quantitative Easing Discussion
I’m not convinced that quantitative easing will have a positive impact and the risk involved seems to be significant. Is the result worth the risk? The Fed seems to think so.
- What do you think?
- If you can give a better explanation of quantitative easing, please do, I’m no economist.
- Does fear of inflation impact your investment strategy?