On Quantitative Easing…

To QE or not to QE, that is the question…

As many of you know the U.S. Federal Reserve has been kicking around the idea of doing a second round of Quantitative Easing… Scratch that… Its a done deal…

In simple terms, this just means increasing the money supply so as to artificially create inflation. This is one of the main weapons the Fed has to use in a deflationary environment…

In an inflationary environment the Fed often raises interest rates to help slow inflation. By raising interest rates they make it less preferable for businesses to borrow and thereby artificially slow growth.

Currently, we have interest rates that are practically ZERO and we are still precariously close to a deflationary environment. Why? It’s not that people can’t borrow, its that they don’t want to…

When we have high inflation it encourages people to borrow more because they can pay of the debt in the future when their money is worth more. When there is deflation it destroys people with debt because the money they have now is worth less then when they originally borrowed it. They essentially are losing money on the deal, regardless of the interest rate they borrowed at.

Think about it. If you borrow money at 4% and inflation is moving along at 3-4% then inflation quickly overcomes anything you might lose through paying the interest. Assuming you are still making money at today’s inflated rates.

Who does inflation or deflation benefit?

“Deflation benefits low debt consumers and those on fixed incomes, because they receive a fixed number of dollars but can buy more with each dollar.” – InflationData.com

All these things go hand in hand…

U.S. citizens went from a negative savings rate to a savings rate as high as 6% because they were hedging their bets against inflation. If you have high inflation it makes no sense to save money that will simply be worth less in the years to come. However, if deflation is occurring the money you save now will be worth more in the years to come.

Back to QE2… Why is it happening? What does our government have? LOTS of debt! What environment benefits debtors the most? An inflationary environment. What does QE do? It puts more money into the money supply thereby creating artificial inflationary pressures. Therefore, it is pretty safe to say, the U.S. will continue to do everything it can to create inflation.

Now let’s look at China real quick…

They don’t want to let their currency appreciate. Why? They are the savers of the world. They will benefit more by keeping their money supply where it is at rather then letting it appreciate. All the money they have saved and invested will be worth less if their currency becomes inflated.

It is a financial war that is going on not unlike the Cold War. Except this time it is a war over who has the most money stockpiled rather then nuclear arms. The U.S. has always won this game by creating inflation. Will China bend to their will or try to play the game on their own terms?

Time will tell, but for now, I would certainly say that inflation will continue and we should plan for it…

This entry was posted in Economics, Investing, Politics and tagged , , , , .