Understanding QE2: The Fed’s Quantitative Easement Plan and the Global Economy

Most of us are probably familiar with the recent talk regarding the Federal Reserve Bank’s latest move to jump start the ailing U.S. economy, dubbed QE2 by the press. Many political blogs reduce the plan to the simple act of printing more currency, which touches off emotional responses from all quarters, while other pundits bemoan the politicization of economic processes, despite the fact that said  processes have been politicized since classical times. While all of the chatter surrounding the policy is interesting, it doesn’t much help us understand how exactly QE2 might affect the global economy as it slowly recovers.

So, QE2—that is, the Fed’s move to purchase large quantities of bonds with new money—has been implemented to supplement the already low interest rates and economic stimulus package of last year. This round of quantitative easing should reach USD$900 billion by the middle of 2011, and hopefully, if all goes right, the extra money injected into the economy will stimulate lending and spending on the part of U.S. banks and consumers. This could work well for the domestic economy of the United States, but how will it affect other economies around the world?

Interestingly, when The Fed floods the U.S. economy with more money, it will also create extra liquidity in the global economy. How? Well, the weaker U.S. dollar, being a reserve currency, will drive other currencies to become stronger. The stronger currency can negatively affect the host country’s exporters, many of which export to the United States. Take Germany, for example, whose exporters send high-tech goods to the U.S. They could follow in the same fate of Japanese exporters in 2009; Honda posted their first loss in fifteen years in 2009, most likely due to unfavorable exchange rates between the weak U.S. dollar and the strong yen. Likely, that same loss could affect German and other European exporters as the dollar weakens even more after QE2.

Furthermore, the weak U.S. dollar could create a greater debt problem for the U.S., which would hurt its ability to get loans from other countries. If a country loans money to or invests in the United States, wouldn’t it be more hesitant to make that move if it knew that it could be repaid with a weaker currency in the future? Remember when China began shifting toward euro-based investments in 2004? Well, the USDEURO was $1.29 in November of 2009 and now in December of 2010 it is $1.33. If this plummets further, investors in U.S. assets might turn elsewhere. Think of the mini-crisis that resulted from Greece’s recent junked bonds and the panic that spread through markets across the world. Of course, the situation in Greece was far different and on a smaller scale, but it is a good warning flag of
the dangers to come.

Author: Anna Miller, who writes on the topics of online degrees. She welcomes your comments at her email Id: anna22.miller@gmail.com.

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