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What More Dollars In The Economy Means For You

It is official – quantitative easing round two is coming to the economy near you.  Often referred as QE2 in the popular press, the point of QE2 is the same as QE1’s open goal of putting more money into the economy and encouraging more capital flow.  In a consumer economy like that of the U.S., this can be readily interpreted as an endorsement of spending.

So what does this means for the average American?  The brainpowers behind QE2 will tell you that it means a better quality of life through a revived and stimulated economy.  However, this was the same promise that was extended with QE1, which happened in the latter half of 2008.  Where does the promise end and reality begin?  History and the markets make it clear.

Certain Inflation

One certain side effect of the Federal Reserve pumping more dollars into the economy is inflation.  In fact, the reality of inflation is such a concern that the Federal Reserve has had to make a case over several months that inflation levels are low enough that more stimulus money won’t lead to hyperinflation.  Using Consumer Price Index numbers and annualized inflation reports, the Federal Reserve has been justifying a “target” inflation rate of two to three percent.

For you as an individual, even with a low target rate of inflation, this means increased prices for any purchase made in dollars.  Should the Fed’s predictions about what QE2 will do for the economy be incorrect, then levels of inflation well above the target rate could be coming.  To fight against this effect on your wallet, you can buy larger ticket items now, or opt to postpone certain purchases indefinitely.

Lowered Value For The Dollar

Along with inflation, QE2 means lower value for the dollar overseas as the currency devalues.  The 2010 G20 Summit has centered in part on how this affects other economies, but on an individual consumer level, the effect is clear.  When you travel outside the U.S. or buy goods denominated in other currencies, you won’t be getting as much for your money.

To fight back against lower dollar values, consumers have the option of accelerating any international spending plans.  You can move up a trip to Europe, move quickly to buy property in a foreign country, or open a foreign reserve account now instead of later.  The extent of the dollar’s drop against international currencies won’t be fully seen until QE2 is well underway, making it prudent to act fast if you can.

Wealth Effect Spending

More dollars in the economy and inflation means that there is the chance that consumers will be driven into wealth effect spending.  Essentially what this means is that since assets will inflate, you will feel like you have more money even though in relative terms, the value that you own has stayed the same.  Still, feeling wealthier has been shown in economics studies to make it easier for consumers to open their wallets.

Wealth effect spending is a quiet goal of QE2.  Part of the problem with the U.S. economy at the moment is that it is a consumer-based economy, and consumers aren’t spending.  Unemployed, fearful about the future, and feeling poor, they are trying to save and pay down debt.  The Federal Reserve may not be able to truly do anything about unemployment or consumer fear, but they can do something about the feeling of poverty.  By making people feel richer as homes, stock investments, or even cars seem to be worth more, the Fed hopes to stimulate spending and in turn, the broader economy.

Possible Economic Stimulation

Building on the wealth-effect spending consequence, QE2 could mean a stimulated economy.  Having more dollars in the economy makes investment teams and banks feel like they have more capital to put into new development projects or business loans.  This can help new initiatives and business ventures off the ground, which can provide real stimulus for the economy.

However, as an experienced member of the public with QE1 as a reference, it doesn’t pay to count on this side effect of more dollars being pumped into the economy.  Previous rounds of economic stimulus have not strongly correlated with business-activity stimulus.  Instead, just like consumers, many businesses and public institutions are socking away their money to protect against the proverbial rainy day.

What does this mean for you?  It means that there is hope floating in the economy, but you will have to keep a sharp eye out for opportunities to catch that nebulous bubble of hope and turn it into true opportunity.

Final Considerations

The Federal Reserve is vowing to stimulate the economy for as long as it takes.  For an equal period of time, you as a member of the consumer economy will have to be careful to separate fact from fiction as you make your spending and saving decisions.  QE2 can mean many things, but only the informed will make it mean value and a more financial secure future.

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