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You'll Pay the Price for QE2

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On a day like yesterday, everything seemed perfect. As long as you had your money invested in something, you probably saw it go up. Stocks soared, as the Dow and S&P 500 set new two-year highs. Seeing a sea of green on your portfolio screen is always a nice feeling. You might even conclude from a day of great returns that the Federal Reserve's latest round of quantitative easing is already a huge success.

But as happy as they make investors, skyrocketing asset prices come with costs -- both short-term and long-term ones. If you're not careful, you'll end up paying in two different yet equally painful ways.

The immediate cost
Booming markets make investors happy. But for the things you have to buy, rising prices are not your friend. That may not be such a big problem with headline-making movers like gold, but with some commodities, you definitely feel the pinch.

The most obvious example is oil. The price of crude oil, gasoline, and heating oil all hit six-month highs yesterday, as oil prices jumped above $85 per barrel. That's great news for Chevron, ConocoPhillips (NYSE: COP  ) , and BP (NYSE: BP  ) , all of which did even better than the broad market yesterday.

But for consumers, higher oil company profits mean less money in your pocket. You may not have noticed much pump pain yet, since gasoline prices tend to drop off in the fall as demand from summer travel goes away. But if you use heating oil to heat your home, then the recent $0.40 spike translates to hundreds of extra dollars over the course of the coming heating season.

Companies have also started passing on price increases for other products. Kraft Foods (NYSE: KFT  ) and Starbucks (Nasdaq: SBUX  ) hiked coffee prices earlier this year, which rose to new highs for the year yesterday. Jones Apparel Group (NYSE: JNY  ) and Hanesbrands (NYSE: HBI  ) are planning to raise prices on their products to offset higher costs of cotton. Even McDonald's (NYSE: MCD  ) is looking at raising menu prices next year in order to offset higher costs of meat and sugar.

Trends toward higher prices among commodities were already firmly in place before the Fed acted. But based on yesterday's price action, it's clear that the Fed's move has renewed the push toward rising commodity prices.

The longer-term cost
Those immediate costs may seem trivial compared to rising portfolio values. But QE2 may also have a much more long-lasting impact that hurts investors in the long run.

Rising markets always look good as long as they keep going up. During the tech stock bubble, people came up with innovative new ways to justify valuations on companies with neither earnings nor sales. Similarly, when housing prices were approaching their peak, people made home-buying decisions as if prices would keep rising forever.

It's only after prices reverse that people look closely at whether those gains were real or artificial. In this case, the Fed's move is clearly artificial; if the system were working naturally, then QE2 wouldn't have been necessary.

Gains like yesterday's have a huge psychological impact. They scare investors off the sidelines by showing them the big profits they'll miss if they don't put their money to work. Yet by buying after the big price run-up, they're then at the most risk of suffering future losses -- ones that could convince them once and for all that the stock market is a rigged game.

Stop the madness
Government intervention in the investment arena seems to be increasingly commonplace. Although some will argue that such measures are necessary to ensure economic growth, the institutional damage it does to investing erodes confidence in the very system they're meant to protect. In the end, you'll pay the price for QE2, and unless you're very careful, it could end up taking back all of yesterday's gains and more.

Some stocks will do well no matter what the Fed does. Click here to get The Motley Fool's free report, 5 Stocks the Motley Fool Owns ... and You Should, Too.

Fool contributor Dan Caplinger only picks up the tab for his friends. He doesn't own shares of the companies mentioned in this article. Starbucks is a Motley Fool Stock Advisor pick. Chevron is a Motley Fool Income Investor recommendation. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy never stops looking for the best way to play.

Read/Post Comments (14) | Recommend This Article (34)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 05, 2010, at 2:31 PM, elkojohn wrote:

    I agree.

    With the Fed day-trading the markets,

    I have had to become a swing trader.

    I don't know if all these tricks will keep the

    market up until the junk in the financial system

    is cleared out,

    or the housing market returns to normal,

    or the middle class starts spending again like a

    drunken sailor (no offense intended) --

    but if it doesn't work, LOOK OUT BELOW !!

  • Report this Comment On November 05, 2010, at 2:31 PM, rd80 wrote:

    I believe the inflation scenario is even worse than what you present. Since most of the pressure is showing up in energy and food commodities, many of the price hikes we're seeing/about to see won't show up in the gov't core inflation numbers.

    That means, at least for a while, we're going to see these higher prices while the gov't is busy telling us there is no inflation and the Fed continues its attempts to pump more inflation into the markets.

  • Report this Comment On November 05, 2010, at 6:29 PM, modeltim wrote:

    QE2 is a reflection of the utter corruption in the financial system. Banks are being given more funny money to play with so that they can make out like bandits on the spread and give them more time to hide and move around their rotten real estate "assets". Production capacity sits idle and nothing is being done to address lack of demand due to high unemployment. A classic house of cards and very dangerous.

  • Report this Comment On November 05, 2010, at 6:42 PM, xetn wrote:

    I think this article misses the point. QE2 is another way of saying monetary inflation (creating money out of thin air) which ultimately leads to price inflation (a loss of purchasing power). The increases in the "cost" of oil, gold and other commodities is a reflection of the loss of value of the dollar. In fact, the dollar has lost 13% of its value during the last 5 months. One of the state goals of the Fed is price stability and it has completely failed.

    Here is another way of "seeing the big picture":

  • Report this Comment On November 05, 2010, at 7:02 PM, PostScience wrote:

    Clearly the answer is to do nothing and have two decades of Japan-style malaise.

  • Report this Comment On November 05, 2010, at 7:19 PM, rfaramir wrote:

    Wow, 5 comments in a row supporting your article, though each of us seems to think you could go farther.

    Quantitative easing is legalized counterfeiting. A ripoff. It hurts every current holder of US dollars, stealing our purchasing power to give to bankers instead. It hurts everyone on a fixed income as prices rise. It hurts every saver. It hurts creditors, whose loaned out funds are paid back in lower value future dollars. It hurts the naturally wise notion of thrift, since it discourages savings, so it could be said to be a corrupter of morals (blatant stealing and getting away with it tends to do that).

    Audit the Fed, then End it!

  • Report this Comment On November 05, 2010, at 10:21 PM, tdiaczok wrote:

    Good article.

    Here's a thought.

    QE2 isn't about stimulating the economy for jobs growth. It's a bait and switch where thre FED is attempting to bail out a bankrupt (insolvent) federal govt through inflating away it's debts.

    Which ever way you look at it, QE2 is designed to crush the sleepy middle class who wrongly assume the government is there to look after the middle classes interests.

    Should be interesting when people wake up !

  • Report this Comment On November 06, 2010, at 8:34 AM, pedorrero wrote:

    Always the cheery input [not!] this all won't be over until the USA has had something resembling the Civil War (postage stamps as money, anyone?) plus the attendant erosion of civil liberties and such. Mass killings, seizing of property, concentration camps, deportation of aliens AND US citizens who "look like it." Can't happen here? All of these have (in limited ways)!

  • Report this Comment On November 06, 2010, at 9:40 AM, MachbusterTom wrote:

    Absolutely agree with all you guys and for me as an european investor this carriers also grim prospects of dollar going totaly crazy low - ?? 1.50 who knows... Anyway QE or any other distortions and crazy state action will not make people evaluate risks clearly or come back with confidence. And only confidence and our work can create jobs - NEVER THE STATE OR FED and all those interventionists...

  • Report this Comment On November 06, 2010, at 10:47 AM, Gorm wrote:

    Fully expect the US will experience NOTHING but income compression. Yes, we'll suffer the globally increased commodity costs but ONLY true economic growth and increased productivity will PERMIT US wages to increase, ie compression.

    I don't, for a minute, believe QE2 was designed to stimulate economic growth by flushing our economy with plentifully cheap money. Bernanke is no fool. He knows more of the same old stimuli will NOT work.


  • Report this Comment On November 06, 2010, at 12:33 PM, joenobody101 wrote:

    Buy stocks on margin to the maximum. That was what I was doing in the past two years. It pays. The Fed has not disappoint, it continues to debase the dollar by QE and I continue to protect my net worth by moving money (mine and my brokerage firm's) into energy stocks.

    Now is still the time to buy as the dollar is still alive and kicking but dying all the same.

  • Report this Comment On November 07, 2010, at 1:34 PM, crca99 wrote:

    Clearly, I missed something. I still don't know what QE2 is...was expecting the Queen Elizabeth 2 floating paradise.

  • Report this Comment On November 07, 2010, at 2:20 PM, deltafox2 wrote:

    The best comment was the one! Ok, since everyone's commenting QE so negatively here is a positive view of this: IF (big if there) kicking the can succeeds in buying another year or two this might help certain (many, most?) US banks to wrinkle a few things out, mark to phantasy bookkeeping on real estate comes to mind here. The price to pay for this - rfaramir has nailed this one pretty well - is a lot lower than the whole card house collapsing. Bets are on..

  • Report this Comment On November 08, 2010, at 1:29 PM, mpendragon wrote:

    This is terrible in the same way that weakening the Yuan ruined China's economy. . . except that it didn't.

    Since the government isn't going to be able to increase demand with stimulus like infrastructure improvements (and tax cuts and keeping teachers and fire fighters and police employed and aiding state safety net programs) they'll need to weaken the dollar to make the goods we produce cheaper on the domestic and international markets.

    That makes imports more expensive but we have one medicine that's bitter (debt) and one that sour (weak dollar/expensive imports). The last election has shown us that the public doesn't care to stomach any more debt (never mind that most of our budget deficit comes from the wars, the Bush tax cuts, and the reduced taxes from a depressed economy) and it's time to go back to the sour medicine.

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