WHERE WILL QE3 TAKE US ? / CASEY DAILY DISPATCH

Sep 17, 2012

Where Will QE3 Take Us?


By Bud Conrad, Chief Economist




As you've undoubtedly heard, the Fed announced a new quantitative easing (QE) program on September 13, 2012. It will purchase $40 billion of agency and mortgage-backed securities (MBS) per month until the labor market improves. This amounts to a substantial $480 billion per year, and there is no specific limit on how long the program will last.
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To get a picture of what that continuing policy might look like, I extended the balance sheet of the Fed's assets at that $480B per year out to 2015, keeping all other items unchanged. The Fed said it would be rolling over existing debt as it matures and actually buying $85 billion of assets per month. The crosshatched triangle shows the accumulated growth of the MBS from such a program. By 2015, the Fed balance sheet would grow to $4 trillion, from under $3 trillion today.
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(Click on image to enlarge)


This is a huge rise, and the market reactions were big, as would be logical: On the first day, gold was up $40, Dow stocks up 200 points, crude up $1, and the dollar weaker with the euro rising.
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Further, the Fed promised to keep its overnight rate at close to zero for an additional year, through 2015. This is consistent with the big MBS purchases of QE3 above, as it will need to keep adding liquidity to force rates to this low level. Just looking at the length of its promise shows how powerful the distortion can be, and how this unprecedented period will challenge the Fed's very ability to keep its promise.

(Click on image to enlarge)


Some say the Fed panicked. I say it is business as usual. It is required to keep rates low to avoid the government going bust, which would happen if it had to pay too much interest on its debt. The Fed has essentially promised to destroy the dollar to keep supporting the banks and to keep the government alive, with debts that the political parties have no way of coming to an agreement on how to fix. The Fed has clearly told us what to expect.
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The trajectory is unsustainable. I believe that during the promised time frame to 2015, there will be a new downgrade of US debt, that the Fed will print at least as much as indicated above, and that confidence in the dollar will erode even more. It has happened to many countries before.


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The only safe haven is the real money: gold. Not only do the Fed's actions imply that its price is going a lot higher, but gold is the one asset that can financially protect you from inevitable government intervention that will weaken the dollar and dollar-denominated investments.




While QE3 bodes well for gold, a little-known anomaly in the metals market is presenting an even better opportunity for investors.