Here's How Quantitative Easing In Europe Could Affect U.S. Businesses

This article was written by Michael M. and is the opinion of the author.

We have all heard the news of the European Central Bank's first-ever attempt at economic stimulation through quantitative easing (QE). But what does this mean for U.S. businesses?

What are the things you should be aware of in order to avoid any potential pitfalls? The most important considerations are short-term effects; these include changes to inflation domestically, impacts to U.S. exports, fluctuations in borrowing costs globally, and the potential for asset bubbles. There are also some important long-term effects that businesses should look to as they try to strategically position themselves for the long run.

Short-Term Effects

The U.S. Imports Lower Inflation

The first main impact of the ECB's QE efforts will be lower inflation in the U.S. As the ECB buys over a trillion euros of bonds, those investors will be flush with cash and will be forced to invest that money elsewhere. The goal is that some of that money will be invested in ways that will stimulate the European economy; doubtlessly, some of that money will be reinvested in similar assets in the U.S., where yields are not as low. This pushes up demand for—and, thus, the value of—the dollar, limiting inflation of the USD.

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This comes just as the Federal Reserve is trying to push domestic inflation closer to its target of 2 percent. Inflation has been below 2 percent for the last 31 months, and prices on consumer goods imported into the U.S. dropped 1.7 percent in January from a year ago. Inflation, or rather deflation, is a large part of why the ECB needed to take what, for it, is a bold move.

The problem with deflation is that consumers increasingly decide to forgo consumption of goods and services because the price will be cheaper in the future; this dampens demand and lowers economic activity. A low, modest amount of inflation can be very healthy for an economy, and the U.S. is effectively importing lower inflationary pressures from Europe.

U.S. Businesses Will Lose (Some) Exports

A stronger dollar and, consequently, a weaker euro makes U.S. goods comparatively more expensive, both in Europe and globally, and European goods less expensive. This will put a downward force on U.S. exports. The question is how impactful will that be. According to a January 24 Wall Street Journal article, "Fed officials say they aren't too worried about the effects of a stronger dollar on broader economic growth, at least for now."

Exports account for only 13 percent of the U.S. economy, meaning that a modestly stronger dollar will likely not be an economic death knell. U.S. companies will need to look at how much of their business comes from overseas and how much international competitors with newly lower prices will be a concern for them. Furthermore, if your customers are largely domestic, but their customers are largely international, this could be an area to watch.

Global Borrowing Costs Will Be Lowered

Just as the U.S. will be effectively importing lower inflationary pressures, so too will it be importing lower interest rates. As current European bond holders are given cash in exchange for those bonds, they will be essentially forced—by the market, by their investment theses, by their investors—to reinvest that money.

Some of it will find its way to American capital markets where it will increase demand for fixed income assets, lowering yield. (Price and yield on a bond are inversely related; as price on a bond goes up, the yield on that bond goes down, and vice versa.)

This will have the ultimate effect of lowering borrowing costs, which the Fed may welcome. They have already indicated that they are willing to delay increases in interest rates to June or later and have proven very patient on the issue generally.

Lower Global Borrowing Costs Increase the Potential for Asset Bubbles

If you recall the housing bubble that reached its height around 2006, you will remember that there were two main causes: cheap interest and exotic mortgage options. As borrowing costs are lowered due to the importing of capital seeking better returns, this could drive some money towards asset classes with better returns.

This, in turn, would drive up demand and prices for alternative asset classes, resulting in a short-term increase in return within the asset class and causing more people to want to invest in the asset. When this cycle continues beyond what is supported by fundamental economics, an asset bubble is begun.

Businesses should be weary of putting their money in any asset or asset class that might be fundamentally overpriced, overinflated, or overhyped.

Long-Term Effects

Improving European Economy

It has been said that Mario Draghi, President of the ECB, may just be very good at timing. There are some indications that the European economy was readying to pick up before the QE announcement. The ECB's bank lending survey shows that companies are more willing to borrow money for investing and that banks are more willing to lend it to them.

Forward looking indicators such as the ZEW and the IFO are currently pointing towards an improved economic future. The combined effect of a naturally resurging European economy, quantitative easing, and lower oil prices are likely to increase overall European demand for U.S. exports in the long run. One big question is how long it will take for this effect to play out.

Taking Pressure off Needed Structural Reform

In contrast to this long-term picture of an improving Europe, others are concerned that QE will not have the full impact that is hoped for. The concern is that QE will take away pressure from European governments to make the structural reforms, particularly to their labor markets, that are necessary to deal with stagnant growth.

"We have seen QE in the U.S. and Japan, but the key is structured reform. Without that, it may not work, and I see little sign [of structural reform] in key countries like France and Italy," Sir Martin Sorrell, CEO of WPP, said in a recent quote to the Wall Street Journal.

What Does That Mean for the Future?

Without these needed structural reforms, the European economy could easily find its way back into trouble in the future. This reality has caused Germany's two members of the ECB council to voice opposition to the current QE bond buying. Germany's Chancellor, Angela Merkel, said in a recent speech in Davos, "Now is the time to get our houses in order."

Germany is concerned that, by being more fiscally conservative than neighboring Eurozone countries, it might wind up bearing more than its share of the risk.

The long-term concern here for U.S. businesses is that if QE1 is not as effective as Draghi and the ECB hope that it will be, if structural reform is not accomplished, if future rounds of quantitative easing are required to stimulate the European economy, if sovereign default risk goes up, will stronger and more prosperous countries like Germany be as willing to continue with more of the same, in which case Europe may continue to have anemic growth for some time.

Either way, U.S. businesses, whether they interact with Europe directly or not, would be wise to keep an eye on the European economy, because, in the long run, success there will mean success here, and stagnant growth there will mean hard times for us at home.

Image credit: JIP, Wikimedia