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Or was it a distraction meant to mask the expanding limits for QE?
Published: 24-12-2013 00:00
The Federal Reserve announced last week that they intend to reduce the amount of money printing from the Quantitative Easing (QE) program beginning in January 2014. The amount to be reduced is USD 10 billion – consisting of $5 billion of Treasuries and $5 billion of mortgage bonds.
So is the Fed finally going to slow the money-printing presses? Yes and no. Let me explain.
This year will be remembered as the year where the markets were kept in suspense and left guessing whether the Fed will reduce the pace of QE. Six months since announcing increasing QE3 from $40 billion in bond purchases to $85 billion in Dec 2012, members of the Fed had been feeding the media with the possibility of tapering QE. Markets had expected the taper to happen in the September Federal Open Market Committee (FOMC) meeting but it did not.
The pent up expectation then focused on the December FOMC meeting. Tapering QE was finally announced and media headlines focused on the intention of the Fed to taper a paltry $10 billion of QE. That is still a staggering $900 billion a year - $100 billion shy of a trillion!
But tapering $10 billion of the original $85 billion QE amount was not all that the Fed chairman, Ben Bernanke, said. He also did his best to prevent a sell-off in the stock market and property market by saying “tapering is not tightening” the easy credit monetary policy that the US economy is addicted to since 2007. Not tightening QE is inflationary.
In addition, the Fed’s benchmark interest rate is likely to stay low “well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation continues to run below” the Fed’s 2 percent goal. This is a change from what the Fed announced back in Dec 2012 that they will keep rates at historic lows until the unemployment rate falls to 6.5% or inflation exceeds 2.5% a year. The US official unemployment rate has fallen from 7.7% in November 2012 to 7% in October 2013 – a drop of 0.7% in a year. Obviously, if the unemployment rate continues to fall at this rate, a 6.5% rate would be reached within a year from now. This would have warranted a hike in interest rates by the Fed based on their December 2012 decision to link the setting of interest rates to unemployment data for the first time.
However, the truth is that the US economy cannot afford a rise in interest rates. The US government needs to be able to borrow money at the current near zero interest rates to cover expenditures. With an exponentially increasing debt load, rising interest rates will only increase the burden of servicing debt.
In the words of the Fed, the purpose of QE is to “maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative”. Notice that the mortgage markets are mentioned? By maintaining downward pressure on interest rates, property buyers can continue to buy increasingly overvalued properties using the leverage of low interest rates. This will only continue the furor of speculative property buying – blowing the property asset bubble again. So the next time positive news from the property market is reported, think again if their fundamentals are sound.
If QE is needed to suppress interest rates, how can the QE spigot ever be turned off? The truth of the matter is that the US economy will continue to need the QE crutch to limp forward chained to an increasing mountain of debt. Announcing QE tapering of $10 billion but with a caveat that it is not tightening monetary policy is a sideshow to prop up the stock market and property market. While seemingly reducing money printing, the Fed has knocked down the 6.5% unemployment rate floor to allow them to do whatever it takes to keep interest rates down. And the main monetary policy tool that they have used so far to keep interest rates down so far is QE.
In addition, if their intention is to end QE by Dec 2014, the Fed would have inevitably informed all long term US Treasury holders that they will exit from supporting the bond market in the long end of the yield curve. What incentive would long term US Treasury holders have to continue holding these bonds at such minuscule bond yields? In an environment starved of good investment yields, it is likely to trigger a sell-off in the long term US Treasury bonds as investors seek higher yields in other assets. This would make the yields on these bonds climb higher and thus require the US government to pay more when issuing new debt.
Whichever way you look at this, there is no positive outcome. While the media is trumpeting tapering of QE is due to economic recovery, the truth is that we will see even more money printing ahead given the elephant in the room, the mountain of debt, is conveniently ignored.
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