With the recession officially over and the economic recovery officially weak, the Fed has now introduced what has become known as QE2 or, the second round of quantitative easing (not to be confused with QE2, the ocean liner). What lies ahead is an interesting balancing act for the Federal Reserve as they inject enough new cash into the system to stimulate the economy but not so much to debase our currency. By definition, inflation is "more money chasing after the same number of goods" and with regard to inflation, an 80 year-old individual has seen prices increase by over 1,000% in their lifetime.[1] For those of you who are more visual thinkers, let me put it in terms that are right-brain oriented: The ship Titanic cost roughly $7.5 million to make while the movie Titanic, on the other hand, cost approximately $200 million to make, with both the ship and the movie taking about three years to complete. Both of these creations brought with them their own unique risks--and both, well documented.
Over the past few decades, new financial instruments were created, which in turn created new financial risks. The culmination of these risks, which started gradually, was a harrowing collapse. The risk taken is now obvious. It would be a stretch to think, "We'll never do that again!" because the next crises will certainly rear its head; however, if history is our guide, it will simply be dressed differently.
In 1913 it was asked of Benjamin Graham, the father of quantitative analysis, "Can you foresee the coming of a bear market?" His response, "Yes, there are three things: 1. Excessive optimism, 2. The erosion of the fundamental foundation of the underlying securities and, 3. Excessive margin debt."
Margin debt. Option ARMS and 0% down--it all seemed like a good idea at the time.
Now that the Fed is attempting to repair our overzealous behavior and return the economy to a degree of sanity, one must ask, "Will the Fed overreact?" By providing tax credits for first time home buyers and "cash for clunkers" were they aware of the unintended consequences? It certainly helped in the short term but it was not without its setbacks.
The money supply in the United States was expanded by 114% in 2009; the largest increase in our money supply since 1960 when it was increased by 16%.[2] If the teachers of economics are correct, and inflation is defined as more money chasing after the same number of goods, then there is a likelihood of facing a degree of inflation in the future after they have finished fighting the current demon of deflation.
The only question I have is "How much is enough, and how much is too much?"
The famous tightrope walker, Karl Wallenda, once performed a feat of pushing a wheelbarrow across a tightrope and safely making it to the other side. When the applause of the crowd subsided, he yelled down, "How many of you think I can do it again?" and the crowd applauded enthusiastically. He then asked, "Who wants to ride in the wheelbarrow?" The crowd went silent.
I certainly hope the Fed can achieve with QE2 its quest of an improved economy, I'm just a little nervous of what the end result may be if they push too hard.
