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Schiff – The Fed plays all its cards

The actions of central banks in the last month or so has led to plenty of speculation as to whether they have done enough to solve the crisis or if they had gone too far and underpinned the need to buy gold. The author below believes the biggest central bank of them all, the US Federal Reserve has just shown its final hand and played all its cards. Not only have they decided to print to infinity but also they have revealed a new side to their thinking. Read on to learn if this make it even more prudent to buy gold online and seek protection in gold and silver bullion – both of which cannot be printed or multiplied.

There never really could be much doubt that the current experiment in competitive global currency debasement would end in anything less than a total war. There was always a chance one or more of the principal players would snap out of it, change course and save their citizenry from a never-ending cycle of devaluation. But developments since September 13, when the U.S. Federal Reserve finally laid all its cards on the table and went “all in” on permanent quantitative easing, indicate that the brainwashing is widely established and will be difficult to break. The vast majority of the world’s leading central bankers seem content to walk in lock step down the path of money creation as a means to economic salvation. Never mind that the path will prevent real growth and may ultimately lead off a cliff. The herd is moving. And if it can’t be turned, the only thing that one can do is attempt to get out of its way.

The details of the Fed’s new plan (which I christened Operation Screw) are not nearly as important as the philosophy it reveals. The Federal Reserve has already unleashed two huge waves of quantitative easing (purchases of either government securities or mortgage-backed securities) in order to stimulate consumer spending and ignite business activity. But the economy has not responded as hoped. GDP growth has languished below trend, the unemployment rate has stayed north of 8%, and the labor participation rate has fallen to all-time lows. In the meantime, America’s fiscal position has grown significantly worse with government debt climbing to unimaginable territory. Despite the lack of results, the conclusion at the Federal Reserve is that the programs were too small and too incremental to be effective. They have determined that something larger, and potentially permanent, would be more likely to do the trick.

However, in making its new plan public, the Fed made a startling admission. At his press conference, Ben Bernanke backed away from previous assertions that printed money would be effective in directly pushing up business activity. Instead he explained how the new stimulus would be focused directly at the housing market through purchases of mortgage backed securities. He made clear that this strategy is intended to spark a surge in home prices that will in turn pull up the broader economy.  Such a belief requires a dangerous amnesia to the events of the last decade. Despite the calamity that followed the bursting of our last housing bubble, economists feel this to be a wise strategy, proving that a poor memory is a prerequisite for the profession.

But now that the Fed is thus committed, the focus has shifted to foreign capitals. Not surprisingly, the dollar came under immediate pressure as soon as the plan was announced. In the 24 hours following the announcement, the greenback was down 2.2% against the euro, 1.6% against the Australian dollar, and 1.1% against the Canadian dollar. A week after the Fed’s move, the Mexican peso had appreciated 2.7% against the U.S. dollar. Many currency watchers noted more dollar declines would be likely if foreign central banks failed to match the Fed in their commitments to print money. On cue, the foreign bankers responded.

It is seen as gospel in our current “through the looking glass” economic world that a weak currency is something to be desired and a strong currency is something to be disdained. Weak currencies are supposed to offer advantages to exporters and are seen as an easy way to boost GDP. In reality, weak currencies simply create the illusion of growth while eroding real purchasing power. Strong currencies confer greater wealth and potency to an economy. But in today’s world, no central banker is prepared to stand idly by while his currency appreciates. As a result, foreign central banks are rolling out their own heavy artillery to combat the Fed.

Perhaps anticipating the Fed’s actions, on Sept. 6 the European Central Bank announced its own plan of unlimited buying of debt of troubled EU nations (however, the plan did come with important concessions to the German point of view). On Sept. 17, the Brazilian central bank auctioned $2.17 billion of reverse swap contracts to help push down the Brazilian real. The next day, Peru and Turkey cut rates more than expected. On Sept. 19, the Bank of Japan increased its asset purchase program from 70 trillion yen to 80 trillion and extended the program by six months. It’s clear we are seeing a central banking domino effect that is not likely to end in the foreseeable future.

Although the Fed is directing its fire towards the housing market, the needle they are actually hoping to move is not home prices, but the unemployment rate. Until that rate falls to the desired levels (some at the Fed have suggested 5.5%), then we can be fairly certain that these injections will continue. This will place permanent pressure on banks around the world to follow suit.

All of this simultaneous money creation will likely be a boon for nominal stock and real estate prices. But in real terms such gains will likely not keep pace with dollar depreciation. Inflation pushes up prices for just about everything, so stocks and real estate are not likely to prove to be exceptions.   Even bond prices can rise in the short term, but their real values are the most vulnerable to decline.   In fact, even nominal bond prices will ultimately fall, as inflation eventually sends interest rates climbing. But prices for hard assets, precious metals, commodities, and even those few remaining relatively hard currencies should be on the leading edge of the upward trend in prices.

While I believe the Fed’s plan will be a disaster for the economy, the silver lining is that it provides investors with a road map. As the policy of the Fed is to debase the currency, those holding dollar-based assets may seek alternatives in hard assets and in the currencies of the few remaining countries whose bankers have not drunken so freely from the Keynesian Kool-Aid. I encourage those looking for ways to distance their wealth from the policies of Ben Bernanke to start their search today.

Please Note: Information published here is provided to aid your thinking and investment decisions, not lead them. You should independently decide the best place for your money, and any investment decision you make is done so at your own risk. Data included here within may already be out of date.

  • David Neesan

    Well said Peter Schiff! About time his like got taken seriously on a much larger scale.