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Peter Schiff's Gold Commentary

When Infinite Inflation Isn't Enough
Wednesday, November 07, 2012


If no one seems to care that the Titanic is filling with water, why not drill another hole in it? That seems to be the M.O. of the Bernanke Federal Reserve. After the announcement of QE3 (also dubbed "QE Infinity") created yet another round of media chatter about a recovery, the Fed's Open Market Committee has decided to push infinity a little bit further. The latest move involves the continuing purchase of long-term Treasuries when Operation Twist expires, thereby more than doubling QE3 to a monthly influx of $85 billion in phony money starting in December. I call it "QE3 Plus" - now with more inflation!

Inflation By Any Other Name

In case you've lost track of all the different ways the Fed has connived to distort the economy, here's a refresher on Operation Twist: the Fed sells Treasury notes with maturity dates of three years or less, and uses the cash to buy long-term Treasury bonds. This "twisting" of its portfolio is supposed to bring down long-term interest rates to make the US economy appear stronger and inflation appear lower than is actually the case.

The Fed claims Operation Twist is inflation-neutral as the size of its balance sheet remains constant. However, with QE3 Plus, the Fed won’t even pretend to balance the books, for one simple reason: in December, it runs out of short-term debt to exchange. Instead, it plans on ignoring the so-called twist, and just printing money to buy new long-term Treasuries at the same rate of $45 billion a month for the foreseeable future. I said it last year when Operation Twist was announced, and I'll continue to say it: low interests rates are part of the problem, not the solution.

Inflating Us into a Corner

Just as the Fed used its interest-rate-fixing power to make dot-coms and then housing appear to be viable long-term investments, they are now using QE3 Plus to conceal the fiscal cliff facing the US government in the near future. All they are really accomplishing is ensuring the cliff is larger and steeper than ever before.

Operation Twist extended the average maturity of the Fed’s portfolio, essentially locking in the inflation created in the wake of the '08 credit crisis. Back then, we were promised that the Fed would unwind this new cash infusion when the time was right. QE3 Plus will make this promised “soft landing” pretty much impossible to achieve, as the Fed’s portfolio will become less and less liquid the more it extends its balance sheet with long-term bonds.

We can already see the effect of the Fed’s money-printing on consumer prices. Take a look at the gas pump or the cost of a hamburger. Previously, the idea was that the Fed might try to control these prices one day by selling its portfolio of long-term bonds. While short-term paper can be easily sold or even allowed to mature even in tough economic conditions, long-term bonds will have to be sold at a steep discount, which will have devastating effects across the yield curve.

By further expanding the Fed’s long-term debt, QE3 Plus ensures that nothing the Fed can do will help control skyrocketing prices. So why bother? The more precarious its balance sheet becomes, the less likely the Fed is to even attempt a safe exit strategy. QE3 Plus lays down an even stronger incentive to continue suppressing interest rates until a mega-crisis forces their hand.

And don’t forget, when interest rates inevitably rise, the Fed will incur huge losses on its portfolio, which, thanks to a new federal law, will become a direct obligation of the US Treasury, i.e. you, the taxpayer! Meanwhile, in the intervening time, the government and private sectors will have made a bunch of additional wasteful spending.

Of course, the Fed refuses to accept this reality. Even though a painful correction is necessary, nobody in power wants it to happen while they're in the driver's seat. So Bernanke will stick with his well-rehearsed lines: the money will flow until there is "substantial improvement" in unemployment.

Does Bernanke Even Believe It?

Even Bernanke must have a hunch that there isn't going to be any "substantial improvement" in the near term. I suggested before QE3 was announced that a new round of stimulus might be Bernanke's way of securing his job, but recent speculation is that he may step down when his current term as Fed Chairman expires. Perhaps he is cleverer than I thought. He'll be leaving a brick on the accelerator of an economy careening towards a fiscal cliff, and bailing before it goes over the edge. Whoever takes his place will have to pick up the pieces and accept the blame for the crisis that Bernanke and his predecessor inflamed.

Don't Gamble Your Savings on Politics

For investors looking to find a safe haven for their money, QE3 Plus is a strong signal that the price of gold and silver are a long way from their peaks. Gold hit an eleven-month high at the beginning of October after the announcement of QE3, but the response to the Fed's latest meeting was lackluster. When the Fed officially announces its commitment to QE3 Plus in December, I wouldn't be surprised to see a much bigger rally. For that matter, many are keeping an eye on the election outcome before making a move on precious metals.

However, seasoned readers of my commentary know that short-term trends are not a good reason to invest in physical precious metals. QE3 Plus can only boost the confidence of anyone intent on the long-term protection of wealth through hard assets. No matter who takes office in January, Helicopter Ben Bernanke will continue on the path of dollar devaluation until there is a flight of confidence from the dollar.

This commentary was first published in Peter Schiff's Gold Letter, a monthly newsletter from Euro Pacific Metals. Click Here to Subscribe and be among the first to get Peter's latest gold market analysis, along with insights from other leading experts and major news stories from the precious metals markets.