Quantitative Easing & What It Means To You:
The Federal Reserve met this week and announced on Wednesday that they had decided to pump another $600 BILLION into the banking system at a rate of $75 billion per month for the next eight months. The $10 term for this is, “quantitative easing.” In plain English, it’s simply “Printing money.”
There’s a lot of doom and gloom around this announcement and some optimism, and today we’re going to talk simply about what’s going on, talk about how it could effect you, and cover some steps you can take regardless of how this plays out. In addition, this story is getting a LOT of attention and you’ll probably hear conversations about it over the next few days. This is a good opportunity to ask people’s thoughts on inflation and hyper inflation and see if you find any like-minded people.
What is “quantitative easing”?
Basically, the Fed is going to literally create money out of thin air and then use that money to buy government and/or corporate bonds. I’m not going to cover how the Fed, Treasury, IRS, and the US Government all fit together. It’s fascinating, but the topic can quickly become a time vampire, suck up your time, upset you, frustrate you, and make friends and relatives look at you strangely when you try to explain it to them.
Governments historically have done quantitative easing when interest rates are as low as they could possibly go and the government wants to do SOMETHING (other than cut taxes) to try to stimulate the economy.
It’s been done before…in the Weimar Republic before Hitler took power, in Japan before the “lost decade”, in Argentina before their collapse, and in England and the US in response to the global financial crisis.
It is normally seen as a desperate attempt to defibrillate a dying economy…but it has a horrible track record.
What are some of the impacts?
The Fed could accomplish quantitative easing in a few different ways, but it will probably be done by buying treasuries. Money going into bonds will raise the price and cause the yield (interest rate) to drop. As a result, retirement funds and other big money put less money into bonds and more into stocks and commodities. The money going into stocks causes the stock market to go up, people’s 401(k)s to look good, and people to have the confidence to spend more.
It normally also causes banks to lend more. But with the current mortgage disaster, it’s likely that banks will hold on to as much of any reserves they get to simply stay solvent in light of the quantity of bad & over-leveraged mortgages on their books. Banks that get enough money might even be able to clear out their inventory of default mortgages.
Of course, printing money out of thin air also means that there are more dollars floating around. Unless we have a corresponding increase in GDP, that means that the dollar will probably drop in relation to foreign currencies. It means that anything purchased in Pesos, Euros, Rupees, Baht, or Yen will get more expensive…like fruits, vegetables, coffee, customer support for large companies, clothes, electronics, etc.
So far, we’ve been somewhat protected by this because of people moving out of Yen and Euros and into Dollars.
We’ve also been protected from inflation because of cheap goods flooding the market from “going out of business” sales and people who’ve lost their jobs selling “all that they own.” This, of course, is not sustainable.
In any case, if you keep pumping money into an economy without increasing production, you end up with more dollars chasing after the same number of goods and eventually get inflation or hyper inflation as well.
Inflation and hyper inflation.
There are a couple of aspects of inflation and hyper inflation that aren’t discussed much…and when they are, they’re discussed in such a complicated manner that it’s easy to zone out. They are the impact of inflation on gold owners and the impact of inflation on taxpayers.
Let’s say that you have an income and your top tax bracket is at 25%. That means that if you earn another $1000, 25% of it will go to the IRS. And, let’s say that we have a few years of high inflation, your income happens to keep up, and your income doubles. Everything that you buy doubled in price as well, so the same amount of effort is providing the same lifestyle, even though your paycheck is bigger.
But the IRS doesn’t see it that way…they’re only concerned about the dollar amount. So, instead of your next $1000 getting taxed at 25%, it’s going to get taxed at 28% or $33%. And you’re going to end up with less money, be able to buy LESS stuff, and have a lower standard of living–even though your income doubled.
And if you’ve got a retirement plan—the Government would much rather tax it after it’s been inflated than at it’s current value.
This hidden tax of inflation is particularly evil with gold. If you look at gold as more of a storehouse of wealth rather than an investment, then one argument you can make is that gold has a constant value and it’s actually currency that changes in value. This is overly simplistic and not entirely accurate, but it’s not too far off from the truth.
The Fed doesn’t like people owning gold. For the basic reason that gold going up in value is a pretty good indicator that the dollar is dropping in value. So, they tax you on your gain if you ever sell your gold. As an example, if you bought gold when $600 bought one ounce of gold and now it takes $1200 to buy an ounce of gold, the Fed wants to tax you on the $600 difference.
I would argue that MOST of that $600 is due to a drop in the value of the dollar rather than an increase in the value of gold. If that’s truly the case, then the end result is that gold sellers get taxed based on how much value the dollar has lost. If the last two paragraphs didn’t make sense the first time you read them, that’s because our whole currency system is kind of nuts.
And, they went one step further with the Obamacare bill. Section 9006 says that businesses must file 1099s anytime they make a purchase of $600 or more, starting in 2012. Right now, that includes anything more than half an ounce of gold. And, if you sell your gold and can’t find proof of how much you paid for it, you get to pay tax on the whole amount…not just your gain.
So, why is the Fed doing this?
Many people have made the argument that they’re trying to destroy the country. Let’s take that argument off the table for just a second and look at some of the other reasons why they would do this.
As a sign to other countries that we’re through the worst of our financial troubles — This seems kind of ridiculous to me, but the argument here is that if we were in trouble, the Fed would have created $1 trillion or more. The fact that they ONLY created $600 Billion is somehow supposed to give our international trading partners confidence in our economy.
Encourage corporate spending and investing – By pumping money into government bonds and lowering the yields, corporate bonds, corporate investment, and stock in large & small companies will look more attractive. This still doesn’t seem to be a good enough reason to create $600 billion out of thin air. They could have encouraged corporate spending and investing by simplifying the tax code and streamlining regulation.
Foreclosure Crisis/Credit Default Swaps – Right now, several major banks have so many bad mortgages on their books that if they’d foreclose on them all and sell them at fair market prices, they would lose so much money that the FDIC would declare them bankrupt and shut their doors. Many of these major banks bought insurance on the mortgage bundles that they own. This insurance was called a “credit default swap.” These credit default swaps were issued by other major banks.
Basically, bank A would buy a bundle of bad mortgages and buy insurance from bank B to guarantee their performance. Bank B would buy a bundle of bad mortgages and buy insurance from bank A. Now none of the banks that issued the credit default swaps, or “insurance,” can afford to pay.
This injection of money by the Fed may be necessary to prevent another round of bank bankruptcies like Merrill, Lehman, and AIG. If nothing else, it’s easier for the general public to stomach than another “bailout” or “stimulus.”
The quantitative easing, along with the convenient timing of the recent suspension of foreclosures by Bank of America and others are signs to me that the Fed is running out of levers to pull to keep the banking system running in its current form.
This is the most likely reason, in my mind, for the current round of quantitative easing. Keep in mind that I’m a survival guy. I’m seeing things through the lens of having been both a stock broker and a real estate investor in the past, but I don’t have a PhD in economics and I can’t see all of the pieces. Your experiences may give you a completely different lens to look at these events through. In fact, let me know what you think about my theory, or if you have your own.
What to do?
This is the big question. One way to look at it is that quantitative easing isn’t the problem. It’s simply an outward sign of a long term financial cancer. What that means is that quantitative easing doesn’t represent a new threat. We’ve had decades of poor decision making that has brought us to the point where the Fed felt that things are bad enough to use quantitative easing.
So, whether you think it will lead to no inflation, some inflation, or hyper inflation, one of the smartest steps that you can take over the next few days and weeks is to start buying more of the foods that you currently eat than you are consuming. Buying MREs and 25 year “survival food” is good, but buying food that you will actually eat, no matter what happens is even better.
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Until next week, God bless and stay safe.