By Scott Silva
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.
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