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- Economy Economy Behind almost every major market trend is some underlying economic factor. From rising GDP growth rates to declining unemployment or the threat of inflation in Europe, economic trends are a major determinant of what happens to American companies and their stock prices. Along with corporate earnings, economic reports are the most watched regularly scheduled pieces of news. Almost every week there is an economic report that can help investors estimate what the future of the economy holds. This section will educate you about several basic, yet crucial economic concepts and will tell you the economic information that's most important to you as an investor.
Fiscal Policy The economy can be impacted by the U.S. government through two major types of economic policy. The first type is called fiscal policy, which is economic policy instigated by the President or by Congress. The fundamental tools at the disposal of these branches of government are taxation law and government spending. By changing tax laws, the government can effectively modify the amount of disposable income available to its taxpayers. For example, if taxes were to increase, consumers would have less disposable income and in turn would have less money to spend on goods and services. This difference in disposable income would go to the government instead of going to consumers, who would pass the money onto companies. Or, the government could choose to increase government spending by directly purchasing goods and services from private companies. This would increase the flow of money through the economy and would eventually increase the disposable income available to consumers. Unfortunately, this process takes time, as the money needs to wind its way through the economy, creating a significant lag between the implementation of fiscal policy and its effect on the economy.
Monetary Policy The second way the government can impact the economy is through monetary policy. Monetary policy is instigated by the central bank of a nation (the Federal Reserve in the U.S.) to control the supply of money within the economy. By impacting the effective cost of money, the Federal Reserve can affect the amount of money that is spent by consumers and businesses ( The Federal Reserve and Monetary Policy).
International Economics While most investors are concerned with the state of affairs in the U.S., it is also important to keep an eye on what is going on around the world. More and more it seems that the global economy is taking shape with circumstances in many parts of the world having a large impact on things at home. Moreover, many money managers suggest that a portion of an individual's investments should be made overseas in order to diversify against a downturn in the U.S.
From an economic perspective, currency valuations are probably the most important factor to be concerned about. Depending on the state of various economies, the relative value of a dollar (or a yen, Euro, etc.) can fluctuate compared to other currencies. You will often hear about a "strong dollar" or a "weak dollar." A strong dollar is when the U.S. dollar can be converted into a historically high quantity of other currencies. A weak dollar means that the U.S. dollar cannot buy very much of another currency. These factors have an impact on imports and exports because goods and services from a foreign nation are usually purchased in the currency of the producing nation. For example, if the dollar were strong, one would expect imports to be high and exports to be low because the dollar will buy a lot in a different country while it is expensive to purchase dollars with outside currencies. Alternatively, with a weak dollar you would expect high exports and low imports. For investors who choose to invest in foreign securities, there are additional risks to be concerned about. In addition to worrying about the performance of the company and its stock, foreign investors need to be concerned about currency risk. Currency risk is the risk of an investment losing value because of changes in the value of the foreign currency. For example, if you invest $1000 in a European company when there is a one-to-one exchange rate between the Euro and the dollar, you would have made a 1000 Euro investment. Assume the investment increases by 5% to 1050 and you choose to sell. If the exchange rate is now $0.85 per Euro (a strong dollar), your 1050 Euros will get you $892.50. So, even though your investment returned 5%, you actually lost money on the investment because of a change in the currency. Of course, the opposite can be true as well; if the dollar weakens during the period of investment, the return on investment increases.
ther major concern for U.S. investors is the amount of goods and services the country exports to other countries. The U.S. is a major exporter of products to countries around the globe, so U.S. companies and the U.S. economy are often dependent upon foreigners being able to purchase American goods and services. When other economies struggle, decreasing the disposable incomes and capital expenditures of those countries, the effects are often felt at home. In some cases, such as the Japanese collapse during the 1990s, the U.S. government can step in and boost up the foreign economy with investments or credit.
The European Central Bank is analogous to the Federal Reserve Bank of the United States. Therefore, the ECB attempts to maintain price stability for the currency of the European Union, the Euro. The central banks of the member nations of the EU are all part of the larger ECB system. Like the Fed, the ECB influences interest rates by controlling the rate at which member banks may borrow from the ECB.
Money 2016