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Will QE2 Lead to Massive Inflation?


The Federal Reserve has announced there will be a second round of “quantitative easing” – to the tune of $600 billion – designed to counteract deflation.

If prices fall on a widespread level, an event known as deflation, it means you could be faced with lower prices at the mall and the gas pump. However, the major downside to deflation occurs when companies can no longer make a profit off of whatever it is they’re selling. This leads to cuts in production, job lay-offs, salary decreases, lower consumer spending and ultimately an increasingly shaky economy.

Further, falling prices often persuade consumers to put off large purchases in hopes of getting an even better deal in the months to come, which further taxes the economy. Deflation also essentially makes the value of debts greater, since their value remains fixed while prices deflate.

As the Christian Science Monitor reported:

“While much of the public sees the run-up of growth in government and exploding deficits as keys concerns, [Federal Reserve Chairman] Bernanke, continuing his soft stance on deficits, has argued that fiscal restraint would threaten the recovery.

Instead, he argues that monetary policy still has arrows in its quiver that should be used to lower the unemployment rate and rejuvenate the economy while also preempting the dreaded prospect of deflation.”

The end result, dubbed QE2, is the Federal Reserve buying $600 billion or more worth of U.S. Treasury bonds.

What is Quantitative Easing and What are the Risks Involved?

“Inflation is the one form of taxation that can be imposed without legislation.” --Milton Friedman

As the Wall Street Journal reported, quantitative easing is:

“ … the electronic equivalent of starting up the Fed’s printing presses to create money for buying financial assets in the market – in this case long-term U.S. Treasury bonds. Buying bonds pushes down their yields, and the interest rates across the debt markets that are closely tied to U.S. Treasury rates.”

As for the risks, they continue:

“No one, inside or outside the Fed, knows the precise effects, or the unintended consequences, of more bond-buying. Giving investors incentives to seek higher yields in riskier assets raises the likelihood of creating asset-price bubbles …

At some point – well before the economy has completely recovered — the Fed will need to withdraw all the money it’s printing now in order to avoid a surge in inflation down the road. Some investors don’t believe the Fed will be able to do that quickly enough, and fear inflation will result.”

There are also potential impacts on the value of the U.S. dollar, with experts stating its value could easily crash. As Business Insider wrote:

“Each time you add a new dollar to the system, it decreases the value of each existing dollar by just a little bit. Now the Federal Reserve is pumping 900 billion dollars into the system and that is going to have a significant impact. Bill Gross, the manager of the largest mutual fund in the entire world, said … that he believes that more quantitative easing could result in a decline of the U.S. dollar of up to 20 percent...”

As for what the Federal Reserve’s QE2 really means NPR translated the statement into “plain English” as follows:

“The economy still sucks. People are spending a little bit more, but they're stretched thin: One in 10 workers can't find a job, wages are basically flat, home prices are way down and nobody can get a loan. Companies are buying more stuff, for now, but they're not building new factories or offices. Nobody's hiring. Nobody's building. Inflation has gone from low to super low.

The Fed has two main jobs: Keep unemployment low and prices stable. At the moment, as you may have heard, unemployment is really high. And inflation is so low that it's making us nervous. We keep saying that unemployment's going to fall. And it keeps not falling.

So to give the economy a kick in the ass—and to pump up inflation a little bit—we decided to go on a shopping spree. First of all, we're going to keep buying new stuff when our old investments pay off. Second—and this is the big news for today—we're going to create $600 billion out of thin air and use it over the next eight months to buy bonds from the federal government. We hope this will make interest rates go so low that people will borrow and spend more money, and companies will start hiring. By the way, this is an experiment, and we don't really know how it's going to work out. We reserve the right to change our plans at any time.

Of course, we'll continue our policy of letting banks borrow money for free. If you're worried this is going increase inflation and destroy the dollar, please reread everything we've said to this point. We plan to keep rates near zero for as long as it takes, but we won't tell you how long that is. In the meantime, we'll keep an eye on things.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy was Thomas M. Hoenig. He's the president of the Kansas City Fed, and he's voted against Fed policy at every one of our meetings this year. He thinks this whole creating-$600-billion-out-of-thin-air thing is going to do more harm than good.He also thinks that all this money we've pumped into the economy could inflate another bubble and create widespread worries about inflation. That could lead us right into another crisis.”

Now is the Time to Give Thanks for What You Have

With the U.S. economy as shaky as ever, now is the time to take stock of what is truly your greatest asset: your health. Your health is your greatest wealth, and is one of the only true “things” worth investing in.

It may now be a good idea to replace costly recurring expenses, like your monthly gym fee, with a one-time cost for a high-quality personal trainer DVD you can do in your own home. You can even go in on it with a friend and workout together daily.

The idea is that you can cut costs while still making sound purchases that will support your long-term health and well-being.

Further, as unemployment rates are still high, work to assure you have savings in excess of 3 to 6 months or more of what you will need to pay your bills if you become unemployed.

Likewise, many investors are turning to gold and other precious metals as a more stable bet than the dollar.

Gold, silver and other precious metals offer a sense of security, an insurance policy, if you will, that you will have something to fall back on if the economy crashes.

SixWise Ways!
SixWise Says ...

“What a country calls its vital economic interests are not the things which enable its citizens to live, but the things which enable it to make war.”
            --Simone Weil


Recommended Reading

What is Deflation, Why Should You be Concerned -- And What Can You Do?

10 Top Predictions for 2010 and the Coming Decade


The Wall Street Journal November 3, 2010 November 3, 2010 October 18, 2010 November 8, 2010

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