Fed Says QE3 Is Possible

Last modified on September 28th, 2013

In times like this, I hate being right.

I met with a few financial people Friday afternoon at their offices in Abbotsford. As I was leaving, I casually asked everyone who worked there what they thought about the recent run of gold. Surprisingly (or not surprisingly, depending on how up to date you are with what’s going on), they didn’t seem to think it meant anything, and that the US economy was going to recover shortly. I then made a comment that I wouldn’t be surprised if the US did another round of Quantitative Easing (QE3 I dubbed it), but they simply laughed that comment off.

Not more than 48 hours after I was there, Ben Bernanke goes on 60 Minutes and says that another round of quantitative easing is definitely possible. That guy seems to be determined to destroy the US dollar at all costs.

One of the side effects of Quantitative Easing is that it forces the value of the dollar down, essentially making exports cheaper (while at the same time eroding the savings of all of its citizens). While the prime goal of QE (at least from the Fed’s perspective) is to inject liquidity into the system, at its core it’s definitely a form of currency manipulation. Why that’s important is because the United States keeps whining about how China is manipulating the Yuan, but the United States is no better.

Gold And Silver

Gold and silver have always been a hedge against currency manipulation. That’s why at various times in the history of the world the storage and ownership of gold has been made illegal by various corrupt governments (since it’s hard to manipulate a currency when people own a different form of it that can’t easily be devalued). As the US and other countries continue to debase their currencies by printing more money, the value of gold and silver (relative to these currencies) has been slowly creeping up over the last few years, with gold hitting a high of around $1,420 USD the other day, and silver (after Helicopter Ben Bernanke made his speech on TV), trading at a 30-year high of nearly $30 USD/oz.

I currently have around 20% of my retirement portfolio in precious metal stocks. Back in the day when I had a financial advisor (I don’t anymore) I asked them to add some to my portfolio, even though it wasn’t their recommendation at the time. While the rest of the items in my portfolio went up slightly, the precious metals were the real winners last year with gains of around 25%.

While precious metals have made big gains this last year, I think the best is yet to come based on what’s going on in the world. Ireland is in the process of receiving a big bailout, and rumour has it Spain isn’t that far behind. Prices in the US are going to be heading north over the next year, thanks to the massive expansion of the money supply by QE1 and QE2. If Bernanke does another round of QE, it’s only going to further erode the purchasing power of the US dollar, and cause more people to head towards the safety of precious metals.

In fact, since I was in Vancouver on the weekend and have always wanted to own some physical silver, I picked up some 99.99% silver coins (made by the Canadian Mint) from J & M Coin and Jewellery. Several of the investment grade coins they have on their website were already sold out by the time I got there, and many people were in the store purchasing 10oz bars of silver. My friend Duncan went to a bullion place out in Richmond around the same time, and not only were they completely sold out of silver coins, but Duncan purchased the last of the silver bars they had. So, not only are prices high, but precious metal stock is definitely low, at least in the Vancouver area.

How High Can They Go?

Despite being at a high of roughly $1,420, gold still has quite a long way to go before it reaches its all-time high. In terms of inflation adjusted values, gold once hit approximately $5,000/oz. Given that I think we’re in the midst of a global debt crisis, hitting that previous high is definitely a possibility. At that price, it’s possible for silver to hit $100/oz or higher as well (which is nearly 3.5x the price where it’s currently at).

Whether or not we see those prices really depends on what happens next year with global currencies, particular the US dollar. But if Ben Bernanke’s hints are any indication, it’s likely we’ll see another round of Quanitative Easing next year sometime.

6 responses to “Fed Says QE3 Is Possible”

  1. Duncan says:

    Great post. It amazes me that Bernanke still has a job, given how wrong he’s been on everything to date!
    The democrats and republicans are so busy playing politics, they don’t even consider the serious issues facing their country. They can’t even pass simple bills any longer without deadlocking. A total gong show.

    Basically, the sun is setting on the US and the once great nation is in the final stages of decline. It’s sad really, considering how much the world depends on many of their essential services like the CDC etc.
    Their largest expense is still military spending. They can’t afford it any longer. My guess is at within the year, we’ll see massive pullouts of US forces around the world.

    Bernanke will do everything he can to delay this(without cutting Gov’t spending). He’ll continue to inject more and more money into the system, with QE3, QE4 and so on until it becomes blatantly obvious to even the most ignorant of people that he’s destroying their currency and it’s not helping the economy.
    The former Soviet Union and Germany tried to inflate their way out of their problems. History has shown that it didn’t work then, so why should now be any different?

    Personally, I believe Bernanke is a straw man. The public mandate of the Fed is to maintain stable prices and employment. I call BS. Their real reason is to ensure that the government always get the money they require. In that regard, Bernanke’s very effective!

  2. Chris says:

    It is the Treasury’s responsibility to fund the deficit through bond auctions, not the Fed’s.

    I disagree that the QE program is going to cause runaway inflation. QE2 was a mere $600 billion of UST purchases, mostly long-dated maturities. This sounds like a lot of money but the US bond market is fucking huge, equities are a fraction of the size. In terms of effect on the economy and of effect on the dollar, the effect is minimal.

    Artificially inflating demand for long-dated treasuries pushes up the prices on the bonds and thus lowers yields. The lower yields make the bonds less attractive to investors and pushes them instead into risk assets (like equities).

    When the Fed creates $600 billion to purchase bonds, this is not like firing up the printing press and disbursing money into the economy at large. This is not going to put more money in your pocket and my pocket, and drive up the prices of the things we buy. We won’t see a dollar of it. This is just a matter of adding some more temporary liquidity into the system to free up some cash invested in risk-free treasuries, and to put it in the hands of investors and American companies. When the economy improves sufficiently, they will sell the bonds back to the market and the $600 billion will disappear.

    US inflation is very low right now, just above 1% I believe, and the risk is much higher that the real economy could sink into deflation. This is why they want to try to increase inflation. An inflation rate of 2-3% is considered optimal for employment levels I believe.

    As to the rally in gold, we all know gold rallies when the outlook of major economies is weak. In the event that great economic numbers keep coming out like they have been recently, I think it is well within the realm of possibility that the US economy continues to recover. The US has faced much greater headwinds than this. Stagflation? World wars? They are a very resourceful and industrious people and they have built the world’s largest economy, lifting millions of people into the middle class and out of poverty. No small feat and I think it is too early to rule them out.

    Of course reasonable people can disagree… just my views… 🙂

  3. Duane Storey says:

    Hey Chris,

    1) Yes, the treasury issues new bonds to cover the deficit, but often the Federal reserve buys them via QE.
    2) QE ends up expanding the money supply in the form of credit. This is a real form of expansion. QE1 essentially doubled the entire US money supply, and evidenced by the M3 numbers (which aren’t published publically anymore). This is what it looks like when you do that.
    3) True, there’s no physical printing press. Instead, it’s simply a few buttons that are pressed that creates money that can be used to buy US treasuries. But the end result is similar.
    4) It’s not just the bonds that are affected – if that was the case, there wouldn’t be much point for QE. By buying large amounts of US treasuries, they are effectively lowering the interest rates by a small amount. Due to the fractional reserve banking system, this causes a multiple of additional credit to be created, which basically expands the money supply as that credit is utilized. We haven’t seen a lot of inflation yet, because a lot of that money is still waiting to be loaned out. But as it trickles out, my belief is that you’ll definitely start seeing more price increases.
    5) Bernanke himself has said the only way to counter the inflation (if it occurs) will be to raise interest rates, and he is prepared to do so.
    6) I would love to see the US recover, but they are in a different position than they have ever been. 70% of their economy is based on consumption, and only 30% on manufacturing. That’s why they have such large trade deficits – they aren’t making much stuff anymore. The appointment of Ron Paul I think might help put some reins on the Federal reserve and start them down a course of sound fiscal policy.

    But thanks for your comments.

  4. Chris says:

    2) It is a real form of expansion. My point is that the destination of the money is important if you are going to assess its inflationary impact. This money is going to the primary dealers (Goldman Sachs etc) who held the bonds. Money created and paid to Goldman Sachs is likely to drive up the prices (i.e. create inflation) of high class hookers and Hamptons real estate but not much else. If $600 billion were paid out directly to consumers, you would see incredibly high increases in consumer inflation — but it wasn’t.
    3) See (2)
    4) I would agree with this, with the caveat that nobody is going to be lending much money until the economy recovers anyway. People and businesses who aren’t generating income cannot often afford to borrow or simply don’t qualify under tightened credit underwriting standards.
    5) The Fed raises interest rates to cool down inflation, and lowers them to generate inflation. This is par for the course. When the economy improves, he will increase rates. If it does not improve, he will continue trying to push down rates.
    6) Most economies work very hard to get to the point where they can be driven largely on consumption and domestic spending rather than exports etc. The US is a service economy…

  5. Chris says:

    The dirty secret of QE is that a lot of that money isn’t even staying in the US. This is another reason it is not generating any inflation. Once the money gets to Goldman Sachs, it then heads over to China seeking a higher yield. This is why many central bankers have been complaining about “destabilizing inflows” of money. The emerging markets are all seeing crazy inflation but in the US, <1.5%.

  6. Chris says:

    Also, sorry, one last point, that M3 money graph, notice that the shape of it was already parabolic prior to 2001. I think the money supply has basically increased right on track with historical levels except that the period from 2001-2007 did not see much expansion, although it’s caught up now.

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