For Gold Investors the Best of All Possible Worlds

We have long expected further monetary easing by the US central bank but this past Thursday's news from the Fed was more than most gold investors could have imagined or hoped for. In reaction to persistent recession-like conditions and continued high unemployment in the US economy, the Fed is now embarking on even more reflationary – and ultimately inflationary – monetary policies.

In a statement following Thursday's Federal Open Market Committee (FOMC) meeting, the Fed said, "If the outlook for the labor market does not improve substantially, the committee will continue its purchase of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in the context of price stability."

More specifically, the Fed said it will buy $40 billion of mortgage-related debt each and every month until the outlook for employment improves significantly. At the same time, the Fed will continue its "Operation Twist" program in which it sells short-term securities and buys longer-term Treasury debt. And, in addition, the Fed stated it is unlikely to raise interest rates from their current near-zero levels at least until mid-2015.

The Fed's newly adopted quantitative easing, unlike QE1 and QE2, is open-ended and unlimited. It will continue until there is evidence of healthy employment market conditions – which could be years away. And, it may include other policy tools that remain undefined.

All of this is meant to lower mortgage interest rates, stimulate the housing and construction sector, raise prices of existing homes, keep Wall Street's bull market in tact, and thereby reinvigorate the economy.

So far, gold and silver have been the main beneficiaries, rising in the week before the FOMC meeting in anticipation of more stimulative monetary policies, and then, after the announcement, reacting to the even-more aggressive monetary stimulus than even the most liberal observers had expected.

But will these unprecedented Fed policies juice the economy, create jobs and lower unemployment anytime soon? I think not. The real problem is not too little monetary creation . . . or too high interest rates . . . but the unprecedented levels of household and public-sector debt . . . along with extreme anxiety, uncertainty, and fear arising from Washington's inability to formulate appropriate fiscal policies.

Even with all this newly created liquidity available for bank lending or sloshing around the financial and commodity markets, lending is not picking up because too many households and businesses are simply considered poor credit risks.

US Treasury debt has already reached such high levels (in proportion to nominal GDP) that last summer the Standard & Poor's credit-rating agency lowered America's credit-worthiness . . . and recently another credit-rating agency, Moody's, has warned it too will lower our rating if America continues running Federal budget deficits without any long-term measures in place to bring down the nation's indebtedness.

Instead of dealing pro-actively to put our house in order, America faces the so-called "fiscal cliff" with extreme and automatic Federal spending cuts and tax increases set to take affect at yearend – unless Congress and the Administration can come to some compromise, something that they have not been able to accomplish in recent years.

Many of the Fed's critics claim that its recent and prospective monetary policies will be ineffective and inflationary. I believe these policies will be effective – eventually – simply because they are inflationary and I believe that Fed Chairman Bernanke knows this as well as, if not better than, his critics.

Through inflation – which is simply the devaluation or debasement of the US dollar brought about by excessive growth in the supply of dollars – the Fed will bring the country's debt-to-GDP ratio back down to manageable levels, levels at which the economy will be able to once again function properly.

But America's current economic predicament was years, if not decades, in the making – and it will be years before we can once again enjoy a healthy economy with adequate employment growth and rising prosperity.

In the meantime, we can expect continued accommodative monetary policies from the Fed – with gold prices rising to record heights far above recent levels.

About the Author
Jeffrey Nichols

Jeffrey Nichols, managing director of American Precious Metals Advisors and senior economic advisor to Rosland Capital, has been a precious metals economist for over 25 years.

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