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Dave Sather: Is QE2 good for you?

Nov. 2, 2010 at 6:02 a.m.


As the economy continues to struggle, the phrase "QE2" is frequently discussed by the government as its next strategy to solve our woes.

Although QE2 sounds like the name of some import car, it's just another feeble attempt to light a fire under our economy.

QE stands for Quantitative Easing and the 2 means it is now our second attempt at this game. The strategy involves the government taking our money to buy up U.S. Treasury debt in the open market.

Why would the government buy up their own debt if they issued it in the first place? When there is increased demand for existing fixed income securities it drives up the price. This is basic supply and demand. However, it is not just the price of these securities that is affected. The yield is affected, too.

The more you pay for a given fixed income security, the lower the corresponding yield that is realized over the life of that bond. As such, there is an inverse relationship between the price of fixed income securities and their yield.

This strategy therefore creates a false demand for U.S. debt and pushes interest rates down.

Why keep rates down? Low interest rates typically spur investment because it is less costly for businesses to borrow money. It also allows our spendthrift government to issue debt at low rates.

Unfortunately, there are some problems with this theory.

First, who provides the government the money to buy these securities? The money either comes from taxpayers or from our printing presses. If it comes from taxpayers, then taxes go up. If it comes from printing more money, then it devalues our currency on the world market. As our currency devalues it buys us less "stuff" from around the world.

Additionally, for this to work there has to be demand from businesses to borrow money. Demand from credit-worthy companies to borrow is non-existent. If anything, the most credit-worthy businesses are sitting on their cash as they are leery of what the future holds.

If these issues are not bad enough, is this concept fair? Depending upon whom you ask, if you are a fixed income investor, someone living off of a fixed income pension or someone relying on cost of living adjustments, you are not too pleased. Low rates equals less interest income to live off of.

If the government buys these securities and puts downward pressure on rates, it truly shortchanges anyone who invests in bonds, money markets or certificates of deposit, not to mention someone hoping for an increase to their Social Security. That seems to be many American's shortchanged by this policy of government manipulation.

Temporarily, this manipulative policy is boosting the fixed income market. However, it is not producing a thing as the government is merely shuffling money from one hand to the next. This game can only last so long.

In the long run, the net effect will be near zero returns from fixed income markets made that much worse by increases to our cost of living, higher taxes and a devaluation of our currency.

Dave Sather is a Victoria Certified Financial Planner and owner of Sather Financial Group. His column, Money Matters, publishes every other Wednesday.

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