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Ask Money Talk – quantitative easing

Listener Question (from Dan):  Will the implementation of QE2 stifle the stock market as the dollar decreases in value?

Margaret Schumacher:  

First, the stock market can do very well in times of a weak dollar. There isn’t a direct correlation between the two.

As an offshoot of our weekly podcasts – and to encourage your participation – we regularly feature responses to listeners’ questions.

Here’s how Margaret Schumacher, vice president at Landaas & Company, addressed a question about the Federal Reserve Board’s use of quantitative easing (or QE2) to try to stimulate economic growth.

Click here to send us your questions about financial trends and investment strategies.

I wouldn’t worry about the weakness in the dollar affecting the stock market negatively, mainly because so many U.S. companies now sell overseas. The weak dollar especially helps big stocks in the Standard & Poor’s 500 index.

Quantitative easing (QE2) is the Federal Reserve plan to buy back long-term bonds and types of financial instruments it normally doesn’t buy. That gets more money into circulation so banks hopefully will lend more and stimulate the economy.

What is controversial about that is some analysts feel it will increase the chance of inflation. We’re continuing to try to solve our problem, which include huge deficits, with more money in circulation, more spending power. That is quite controversial and has also become quite political.

As for how the implementation of QE2 would affect the stock market, I think it helps to look at a couple of different scenarios.

  • One possibility is that the QE2 stimulus fails and the economy continues its very slow, sluggish recovery with high unemployment and many people worried about their futures. Stocks might stagnate
  • The second scenario would be the one the Fed is looking for: That QE2 does stimulate spending, and it results in growth in the economy.  This could also result in higher inflation.

As long as the economy picks up – even if it does increase inflation – the Fed has said that it can handle it and would view QE2 as a success.

The stock market is a good inflation hedge – if inflation doesn’t last long.

To read what Bob Landaas, president of Landaas & Company, thinks about QE2, please click here.

Initially, inflation gives businesses pricing power. They can raise their prices and increase corporate profits. That should be reflected in higher stock prices.

However, if inflation drags on – let’s say the Federal Reserve is not successful in capping it – that’s when stocks do not end up being a good inflation hedge. Companies can struggle to make money in an inflationary environment that drags on too long.

initially posted November 19, 2010

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