Dan Amoss

There’s an old saying that defines insanity as doing the same thing over and over again and expecting different results. The Federal Reserve wants to test that theory.

Fed officials have been all over the media for weeks, laying the groundwork for a third round of quantitative easing. By preparing markets for QE3, the Fed refuses to let real-world evidence get in the way of its beloved theories. QE operations haven’t worked; they’ve just promoted government spending and higher savings rates to make up for low interest rates.

The arrogance and groupthink among Federal Reserve officials won’t allow them to diagnose the following: The Fed, by its radical actions, mutates the very economy it’s trying to “boost.”

An honest review of the Fed’s record would conclude that it’s rotten. In a recent update of The Speculative Investor, Steve Saville explains why the whole concept of central banking is “rotten to the core.” He describes how central banks are providers of gambling insurance to the banking system:

“[The] central bank offers the equivalent of gambling insurance to the banking industry.

“Imagine if an insurance company made the following deal with all patrons of a casino: In exchange for a patron’s promise to gamble prudently, the insurance company promises to come to the patron’s aid if he finds himself short of money. Knowing that the insurance company was essentially acting as a financial backstop, at least a few gamblers would take more risk than they would otherwise.

“In a similar vein, knowing that the central bank will be ready, willing and able to provide support via emergence liquidity injections if things go wrong, some private banks will take more risks. Furthermore, due to the higher profits that tend to temporarily accrue to the banks that take more risk, most banks will eventually be drawn toward riskier business practices. This is why a mechanism supposedly (according to the propaganda) put in place to prevent banking crises ends up increasing the severity and frequency of banking crises.”

It’s no mystery why the US banking system had built up reckless lending and securitizing practices in the years leading up to the 2008 financial crisis: Reckless behavior paid well.

Now, instead of enabling reckless bank lending, the Fed (and other central banks) is enabling the addiction of governments to easy borrowing terms. It’s now providing gambling insurance to the biggest spending addicts in history: the US government. Suppressing interest rates near zero for years and years will transfer countless wealth from savers to the government budget.

As budget deficits continue to be measured in the trillions, we will see the size of central bank balance sheets grow too. Inflation will remain stubbornly high worldwide, despite sluggish economic activity. Central bankers may talk tough from time to time, but they will ultimately do the bidding of governments — and print.

For years, I’ve expected that at the end of all this central bank printing, we’ll see the end — not a reversal — of quantitative easing programs and a re-pegging of the US dollar to gold at much higher gold prices. A new gold standard would allow the Fed and other central banks to save face after the following sequence of events:

1. Central banks inflate their balance sheets and buy up many of the bonds governments issue to fund soaring budget deficits
2. Once the largest suppliers of scarce products realize they’re exchanging products for infinitely diluted paper money, they start demanding more and more money in exchange for sending their scarce products to the marketplace
3. Consumer prices start rising
4. Calls for monetary tightening (reduction of central bank balance sheets and interest rate hikes) grow louder
5. These central banks won’t be able to slash money supplies without crashing government bond markets and stock markets. They talk about tightening, but don’t tighten
6. As central banks lose credibility, gold launches on a final, near-vertical stage of its bull market
7. In response to inflation expectations running wild, governments and central banks draw up plans to re-peg currencies to gold in order to avoid having to drain trillions worth of cash from the banking system.

It’s almost impossible to imagine the Fed managing a “soft landing” back to its pre-quantitative easing condition. I compare QE operations to a roach motel: easy to enter and impossible to exit in a practical manner.

Say that the Fed doubles the size of its balance sheet yet again over the course of a QE3 operation, while the market’s expectation of future inflation steadily rises. The selling pressure on Treasuries would steadily grow, undermining the value of the Treasuries already sitting on the Fed’s balance sheet. On a mark-to-market basis, the equity on the Fed’s balance sheet would be negative — by several hundreds of billions of dollars.

How long will it take investors to realize this dilemma is incredibly bullish for gold? At the end of these money-printing operations, central banks won’t be able to sell assets and shrink money supplies gracefully — or at all.

Perhaps once the global paper money system is restructured, involving some sort of gold standard, sanity will return to the Fed and other central banks. Until we see more signs of sanity, hold a core position in gold, silver, and precious metal mining stocks. These asset classes will be the prime beneficiaries of future printing.


Dan Amoss,
for The Daily Reckoning

Dan Amoss

Dan Amoss, CFA, is a student of the Austrian school of economics, a discipline that he uses to identify imbalances in specific sectors of the market. He tracks aggressive accounting and other red flags that the market typically misses. Amoss is a Maryland native, a graduate of Loyola University Maryland, and earned his CFA charter in 2005. In spring 2008, he recommended Lehman Brothers puts, advising readers to hold the position as the stock fell from $45 to $12.

  • Scott

    Dan, your commentary is well placed, however naive. You righteously blame the Fed for all its failed policy, but from a purely pragmatic position as an investment guru you throw the baby out with the bathwater.

    Yes, there will be QE3 and perhaps QE4. What can we, as investors do? Well, after QE1 and QE2, the equities market soared. In particular, the resource markets soared. Why? Because you just can’t print iron ore. Or ingenuity. The NASDAQ will fair well. So will copper. There isn’t anything new under the sun. Holding paper is a very bad idea.

  • Stephen

    Why have a central bank at all, especially one that is privately-owned like the Federal Reserve? Why are private bankers allowed to control any nation’s money supply? They have absolutely no accountability to the public!

    The Federal Reserve needs to be ABOLISHED, just like all the world’s privately-owned central banks. Vladimir Lenin said that “Creating a central bank was 90% of communizing a country.” Well, we’re there.

  • http://GenerationBitcoin.com Tuxavant

    No need to actively end the fed. Just start using/accepting Bitcoin instead. Bitcoin is the worlds first decentralized peer-to-peer payment system with deflationary properties, allows for secure off-line storage of wealth, enhances financial privacy, transactions are irreversible and non-stoppable over any geo-political boundary in literally any amount.

  • nuts to U

    It is always fun for children to pretend they can tell the future.
    My guess is you crystal ball is as full of crap as you are, sonny!

  • Starving Steve

    A few reasons why houses — not in retirement areas but houses in most places — could become cheaper than ever:

    1.) Interest rates, now at zero, have no-where to go but up, albeit slowly, but up nevertheless;

    2.) Banks, after the Great Recession, have little interest in making loans unless the borrower has 1/3 or 1/2

    3.) Buyers have big eyes, fancy talk, and big debts — but little else;

    4.) The baby-boomers ( those born 1947- 1959 ) have to sell their homes now, not buy them;

    5.) Household sizes ( household populations) are increasing, so there is little demographic pressure on housing demand;

    6.) Jobs are scarce, and wages are frozen, even decreasing — not quite the economics to create a rising housing market;

    7.) Rising utility bills, especially electric rates, will make it impossible to live in homes, especially large homes;

    8.) Facing their retirement years, the baby-boom generation is broke and has nothing to invest in new homes.


  • Rusty Fish

    Still, situational needs outweighs reality. When Adolf powered up his machinery, he was 15% insane, balance 85% went to market trend. I think so???

  • Randy Monsen

    Well, I would be THRILLED to see your steps toward a gold-pegged dollar work out as you suggest. However, your framework does not take into account how violent this process would be in reality. In the 1930’s Americans still had some level of civilized behavior. Today, gangs of unionized thugs burn down plants to get what they think they “deserve”, and with legal IMPUNITY! No government can suddenly reneg on its social security and Medicare promises and expect there not to be riots in every city, and terror acts against every federal agency and banking institution. Look at the teachers’ union in Chicago today! A 16% raise is not enough! And they’re already the highest-paid “teachers” in the nation! These people and their AFL-CIO union thug brothers will burn this country down, if the federal government stops paying them outrageously for their shoddy contributions. It will be violent, and may result in American armed forces firing on Americans. There may be UN blue hats called in to kill Americans. Don’t suppose your nice, clean transition to a gold-based dollar will not turn out to be the most violent event in the history of America.

  • Rusty Fish

    Maybe we need blood screening and immunisation dose against the deadly worldly spreading insanity virus. That carries no lesser degree than its peer, the HIV.

  • Eric

    Control is the ultimate outcome. Those in control will never cede it without, at minimum, an attempt at its preservation. (basic human nature, even physics on an obscure level: an object in motion, etc..etc..)The idea of a gold pegged currency is a logical twist in this ever developing quagmire. Two basic emotions influence markets and investors: Fear and Greed. In this aspect, given the apt description of what could, and probably will transpire(Nice example Dan). A gold pegged currency transfer to deflate a bloated currency in my opinion is a logical conclusion. At some point, the excess cash will and must be drawn out of the system (inflation). With the current amount of currency in circulation (esp a reserve currency), exactly what do you think will accomplish that? Unless you truly are willing and able to literally push a wheel barrow full of currency to purchase bread….Watch two things: Tech and housing, Tech is sitting on mountains of cash, and housing still has at least another third in pricing to come down…both of these sectors traditionally have and probably will continue to lead a “recovery”. In the meantime, bet smart, hedge, read,watch and listen. Something we all fail to do occasionally and sometimes neglect to appreciate. The rest is all white noise….unless you honestly believe they want to loose control of the most productive nation of sheep on earth…one of the few nations with a populace that is exquisitely armed to the teeth.

  • http://twitter.com/bgamall Boycott the Lenders

    Actually, there is a shortage of quality treasuries in the world. The bankers want more quality treasuries. America is cutting the deficit and this must make the bankers nervous. We are looking at deflation, not inflation.

Recent Articles

The Euro Isn’t Dead

Peter Schiff

Peter Schiff reports on the broken spell of confidence surrounding the dollar, and how it may also reverse the fortunes of other beaten down currencies...

Gold Miners, RIP…

Bill Bonner

Bill Bonner explains why you can count on central banks to exaggerate the commodities cycle with more cheap credit...

Five Stories You Should Read This Week

Amanda Stiltner

“Supersoldiers” of future warfare…A switch that turns off ageing? Plus, a little robotic bug that defies physics, testing your viral history with a single drop of blood, and can plants react to stress?