Wednesday, March 7, 2012

Stealthy QE3

By Scott Silva
Editor,  The Gold Speculator

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.   Subscribe at our web site  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

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