WealthCycles: Overt Currency Printing - Round 3

The Federal Reserve holds eight regularly scheduled meetings annually, and other emergency meetings as needed. These meetings are where the carefully crafted Fedspeak message is painstakingly explained for us rubes. We believe that there is a clear difference between overt printing of currency and the stealth inflation we have seen in the interim.

In the January meeting, we learned that the Federal Reserve wanted to set expectations for interest rates to remain near zero for at least another year beyond the earlier projection, to 2014. Setting this expectation encourages further misallocation of resources that would have otherwise been invested in more productive development of our economy. WealthCycles previously detailed the zero interest rate policy (ZIRP) inthis feature. Moreover, the policy allows the precarious currency system to remain functional. Imagine if the United States actually had to pay real rates of interest on its massive national debt? We would simply not have the tax revenues to do so. Extreme low interest rates are the only thing holding back the U.S. and financial institutions globally from bankruptcy today.

This type of policy leads investors to the logical conclusion that, to ensure rates do stay low, the Fed will buy assets that are losing fundamental value, such as Treasuries and mortgages. This type of sideways communication is different than overt (announced) purchases, and has mitigated effects comparatively.

From the point of view of the Fed, in order to combat the natural deflation of credit and currency outstanding after the prior unnatural expansion leading up to 2007, further currency creation had to take place. So, the Fed simply tripled the monetary base!

Today this excess currency lies in wait, temporarily held by the banks, and as a result, price inflation has been subdued, for now. When the banks choose to loan the new currency, remember that they will be able to loan 10 times that quantity—leading to massive expansion of the currency supply.  

According to research conducted by the Fed itself, left to its own devices, housing prices would have another significant leg lower before even deflating to the long-term average price level. This conclusion matches the fact that more than 3 million homes have not even entered the housing market, held deliberately in legal-limbo in order to take the associated debt write-downs at the opportune moment. This is important, as bank balance sheets are precarious at best, as we detailed here. As foreclosed or short-sale houses are added to the existing stock of homes, the increased supply further pushes prices lower, a self-reinforcing cycle. As mortgages are the backbone of bank assets, this type of deflation undermines the very structure the Fed must keep intact in order to survive. Below are quotes from when Bernanke was considering his solution to the last deflation to threaten the currency monopoly, the Great Depression, claiming that the Fed will not let the mistake happen again:

In the first round of recent overt printing, dubbed QE 1, the Fed “bought” mainly mortgages. Therefore a precedent has been set. The motive laid out above is nothing short of an imperative.

So what’s the point?

In conclusion, at either the March 13 or April 24 meeting, the Fed may focus on buying mortgages yet again.

The largest bond fund, Pimco’s Total Return Fund, had $244 billion under management, and has just increased allocation to over one half of total assets held in mortgages in early January. This is a giant bet that the Fed will at least set the expectation of monetizing (buying with no currency) these types of assets, relieving Pimco from “holding the bag.” The Federal Reserve and government geniuses plan the timing of overt currency printing to coincide with the election cycle, falsely giving an air of improvement in the economy.

Exchanging dollars and other currencies for gold and silver should be at the very top of the priority list, prior to the “devaluation [which] itself can be beneficial.”

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