Fed Liquidity: Good as Gold

By Scott Silva

Editor,  The Gold Speculator

3-20-12

We all have experienced that sinking feeling when in difficult times; we seem to have run out of options. Sometimes our frustration gets the better of us as we lash out at anyone or anything however innocent. But kicking the dog is no solution to our problems.

Chairman Bernanke is acting beyond reason lately. He has realized what others have known for some time--his monetary stimulus has failed to jump start the economy. The Fed is now grabbing at straws, hoping that “increased visibility” into Fed forecasts, and “closer communication” with the public will somehow reverse the ebbing economic tide. The Fed chief seems at ends, ready to point the blaming finger at unsustainable fiscal spending and Congressional gridlock, and phantom “headwinds” as the culprits for the stalled economy.

But increased visibility into Fed forecast models is not helping. New economic data is inconsistent and contradictory. Much of it is biased by re-election campaign politics which mask actual data with much more optimistic numbers. Actual US unemployment for February, for instance, was 14.1% (U-6), not the 8.3% that the administration touts. Likewise, the Fed understates inflation, and forecasts optimistic inflation “central tendencies”.

The fact is, Fed monetary policy has been ineffective. Monetary policy cannot fix unchecked deficit spending, massive Federal debt and oppressive federal taxes and regulation. Rather than allow market forces to correct, the Fed is overwhelmed by the urge to take action. The Fed action is limited to maintaining its zero interest rate policy and buying more bonds. So Wall Street hangs on every word. When Bernanke does not mention QE3, as he did in his last public meeting, the markets plummet. When the Wall Street Journal reports the Fed is considering a new “sterilized” bond buying spree, the Dow jumps 200 points. This is no way to build the foundation for sustained economic recovery.

What we can rely on is more of the same from the Fed. As new uneven economic data emerges, the Fed will fall back to a third dollop of Quantitative Easing. Most bank economists have already trimmed GDP estimates for 1Q2012 down to 1.7% from 3.0% last quarter. Higher oil and gasoline prices are already slowing economic activity. Last week, consumer confidence fell below expectations. Friday, Chicago Fed president Charles Evans called for the Fed to take additional action now to “accelerate the pace of recovery”.

The EU is fully aboard the QE bandwagon. It will add another €1Trillion to combat the debt crisis. China is also easing. Election-year politics are likely to muddle things further. The president needs to show some improvement in the economy to be re-elected. So far his record has been dismal on that count. So his economic team will be pushing the Fed to buy more bonds. What this means for investors is more volatility and more QE is on the way.

QE, the Dollar and Gold

We have seen the effect QE has had on the value of the Dollar and the price of gold. QE weakens the Dollar and boosts gold prices. This is because adding to the money supply debases the currency which reduces its purchasing power. When the Dollar is weak, it takes more Dollars to buy an ounce of gold, so the price of gold in Dollars rises. That is why people over the centuries have stored their wealth in gold.

One of the primary stimulus measures implemented by the Federal Reserve over the last three years has been the injection of cash into the economy by giving money to the banks. The scale of the cash injection is unprecedented– officially, the Fed has pumped over $2.3 Trillion into the banks. The Fed also pumped more than $16 Trillion into banks in secret loans recently uncovered by Congressional audit. In 2009, the US economy was in a deep recession, with the potential, it was thought, to slip into the Second Great Depression. The Fed and many demand-side economists believed that adding liquidity during a period of deflationary recession would have a stimulative effect on the economy. With more credit from the Fed, banks would lend more, making more money available to consumers to spend and businesses to expand to meet the increased demand. Recession would then give way to broad economic expansion and prosperity, with low unemployment, rising wages and strong GDP growth.

The idea that increasing the money stock increases aggregate demand has been around for decades. In 1936, John Maynard Keynes first presented the idea in The General Theory of Employment, Interest and Money.  Keynes believed that government is more effective than the private sector at stabilizing the business cycle.  In his model, control is applied by central bank monetary policy and government fiscal policy. Keynesian theory served as the economic model during the later part of the Great Depression, World War II, and the post-war economic expansion. Japan implemented Keynesian policies in the 1990’s; the “Lost Decade” resulted. Since the financial crisis of 2007, the US, the UK and much of the EU have relied on Keynesian stimulus programs as the basis of their recovery efforts.

Quantitative Easing (QE) has weakened the currency in every case. We can see the effect QE on the Dollar.

We have seen the effects of Fed monetary policy on the US Dollar. The Dollar buys 17% less today than it did in 2009 when the Fed increased its balance sheet with bonds paid for by printing money.  The new “sterilized” bond-buying of QE3 will further debase the Dollar, shrinking its purchasing power for all who use the currency.

Many see similarities to the 1970’s in the today’s economic conditions. The US economy was failing during the Carter years. The 1970’s were characterized by “stagflation”, that debilitating mix of high inflation and slow growth. Double digit inflation, single digit growth and lack of leadership forced Carter out after a single term as president. 

Today oil prices are high, prices for food and other necessities are high, unemployment is high and the economy is limping along, barely growing. The misery index, coined in the 1970’s, has returned as a measure of popular dissatisfaction with the nation’s economic policies.

Chairman Bernanke’s Fed policies are similar to Fed policies in the 1970’s. In both periods, the Fed responded to recession by expanding the money supply, although the scale of monetary expansion in the recent case is unprecedented. Under Fed Chairman Burns, monthly money growth, which had averaged 3.2 percent in the first quarter of 1971, jumped to 11 percent in the same period of 1972. The money supply grew 25 percent faster in 1972 compared to 1971. Money supply growth under Chairman Bernanke has been nothing short of remarkable.

Debasement of the Dollar has made many eager to shift out of Dollar denominated assets into hard, commoditized assets precisely because dollars are losing value. We have seen this trend in history. Gold prices tripled in 1980-1981; gold has double in price since 2009. Prior Fed QE policy has boosted the price of gold, and QE3 at $1Trillion will likely push gold above $2000/oz.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio has outperformed the DJIA and the S&P 500 by more than 3:1 over the last several years. Follow @TheGoldSpec  Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Stealthy QE3

By Scott Silva

Editor,  The Gold Speculator   Follow @TheGoldSpec
www.thegoldspeculatorllc.com

3-7-12

Today, there are new reports that the Federal Reserve is planning to inject more cash into the ailing economy though another round of Quantitative Easing (QE3). You have read in these pages before that More QE is on the Way (1-23-12, The Gold Speculator).  The new bond-buying program would be “sterilized” by coincident selling of short-term instruments in an effort to control increased inflation that would result from the addition of another $1 Trillion or so to the money supply. This approach is not new; the ECB has used large, “sterilized” bond purchases over the last year in its attempt to stimulate the Eurozone economy and provide bailout funds to ailing European banks.

The Fed bond-buying program would be the third attempt to jumpstart the US economy through aggressive monetary policy. The previous cash injections added $2.3 Trillion to the Fed’s balance sheet. The results of Fed stimulus efforts have been underwhelming. US unemployment has actually increased since QE1 was implemented in 2009 and the larger QE2 in 2010.  Today, the US Labor Department, Bureau of Labor Statistics reports US unemployment at 15.1% (U-6), up from 14.1% in January 2009. And GDP continues to limp along at 1% to 3% since QE2 went into effect.

Milton Friedman instructs us that “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” (The Counter-Revolution in Monetary Theory, 1970). The Fed policy of extended accommodation has increased the money supply (M2 measure) to $9.8 Trillion. M2 includes demand deposits (M1) plus small time deposits, money market funds and the like. M2 is considered money available to the transactional economy. These levels are unprecedented, and we can see supply has increased almost $1 Trillion in the last twelve months.

The Fed reports inflation is modest at 2.0%. But as anyone who buys food or fuel knows, prices for everyday goods have increased by multiples since the Fed first implemented Quantitative Easing.  The problem is the growth of the money supply greatly outstrips the growth in output, the sum of all production of goods and services. When more money chases the same amount of goods, prices rise.

We can see the rise in prices in the rise in the CRB commodity index. Higher commodity prices, particularly oil-based energy products, dampen economic activity, and slow economic growth. This is another example of Bastiat’s “unseen” effects. The Fed’s policy, in fact all government intervention, is counterproductive to true economic growth. So as more and more poor economic data emerges, it is no wonder that the Fed is now preparing to revert once again to the only tool in its “stimulus” tool bag:  additional Quantitative Easing (QE3).

With every new Dollar the Fed prints, the value of each Dollar in your wallet declines. And the price of any commodity priced in Dollars increases. We can see that dynamic play out in the CRB index, and in particular, the price of oil. Certainly there is a “war” premium priced into oil, as Iran threatens to close the Strait of Hormuz. But the more fundamental reason for high oil prices over the last few years has been the decline of the Dollar. After all, the Iranian threat to oil transportation in the Persian Gulf has only recently resurfaced.

But some say that the US does not rely on imports of Iranian oil. Well, we do feel the effect of the Iranian war premium. Oil is traded in the global market, and oil is fungible. That is, a barrel of oil from Saudi Arabia can be substituted for barrel of similar quality oil from Iran or Venezuela at the same market price. Because the US is a net importer of oil, we pay the global price. Unfortunately we are likely to be a net importer for some decades yet.

           

We can see the inverse relationship of oil (WTI) to the value of the Dollar in the chart below.

WTI has jumped from $95 bbl to over $110 bbl as the Dollar dipped from 82 to 78. Gasoline prices have jumped in turn, to over $4.00/ gal in some states. Higher energy and transportation costs eventually find their way into the prices of most consumer products, acting as a tax on the consumer. This causes many consumers to pull in their horns and puts a damper on consumer demand which slows economic activity. Higher oil and gasoline prices are additional examples of the unintended consequences of the Fed’s ultra-accommodative monetary policy.

Stealthy QE3 would pump up the stock market, particularly bank stocks. But QE3 would also mean higher prices in general. QE3 would further debase the Dollar and reduce purchasing power. QE3 means more inflation. QE3 means there is more reason to guard against inflation and artificially inflated assets. QE3 means higher gold and silver prices. To the prudent investor, QE3 means buy more gold and silver. The way to preserve wealth is to own and hold sound money.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio has outperformed the DJIA and the S&P 500 by more than 3:1 over the last several years. Follow @TheGoldSpec  Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055