|
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 Speculatorinvestment newsletter, which is based on the
principles of free markets, private property, sound money and Austrian School
economics.
|
