December 7, 2022

Gold Soars As The Fed Explicitly Promises To Debase The U.S. Dollar

Federal Reserve Chairman Bernanke hit the panic button today by announcing a specific inflation target, vowing to keep rates at zero until at least 2014 and pledging to offer additional monetary stimulus. The Fed also noted, as it has in the past, that the economy still faces “significant downside risks”.

These actions by the Fed come nearly four years after the financial crisis began in 2008.  During that time, the Fed has ballooned its balance sheet to almost $3 trillion, driven real interest rates to negative 1.2% and encouraged lending by flooding the banking system with reserves.  The Fed’s monetary easing was supplemented by trillions of dollars in U.S. deficit financed spending  aimed at restoring economic growth and gluing back together the shattered real estate bubble.

Despite these unprecedented and controversial actions, the economy refuses to rebound.  Collapsing home prices, declining real incomes and an “official” unemployment rate of 8.5% are deflationary and this is what has panicked Bernanke more than anything else.  Deflation is the mortal enemy of a credit fueled, debt burdened economy.  Today’s actions by the Fed show that Bernanke will do whatever is necessary to prevent a deflationary collapse.  Of course, the markets already knew this.

GOLD 01/25/2012 17:15 1710.80 1711.80 +44.40 +2.66% 1648.20 1714.00
SILVER 01/25/2012 17:15 33.27 33.37 +1.22 +3.81% 31.46 33.53

The real reason behind the explosive move up in gold and silver was the historic change in Fed policy with the announcement of an explicitly targeted inflation rate of 2%.   Although the Federal Reserve has been debasing the value of the currency ever since its creation, for the first time ever, currency debasement and financial repression has now become an officially stated policy goal.

 

Gold Explodes - courtesy kitco.com

 

The concept of explicit inflation targeting is dangerous and reckless, which is why it has never been done before.  If the Fed decides that we need 2% inflation today, does the rate go higher later?  How will the Fed know exactly when and exactly how to stop creating inflation?  This is the same Fed run by the same Ben Bernanke who could not identify the biggest credit fueled real estate bubble in history.

Will debt-deleveraging overpower the Fed’s ability to create inflation?   Bloomberg’s Michael Kinsley persuasively tells us, Please Remain Worried About Rising Inflation.

About two years ago I wrote an article saying that despite the lack of evidence, and despite the near-universal belief among economists that it was not a problem, I was worried about inflation. My reason was that I couldn’t see how the government could pay off the massive debt it was running up except by inflating at least part of it away.

For this, I was widely ridiculed, and I’d like to take this opportunity to claim vindication. That is, I’d like to — but I can’t. Inflation (CPI) has been creeping up the past couple of years – – from less than 2 percent to more than 3 percent — but that’s still pretty low. Nevertheless, I double down: Barring a miracle, there will be a fierce storm of inflation sometime in the next few years and it will wipe out a big chunk of the national debt, along with the debts of individual citizens, and the savings of others.

One reason I say this is that the arguments on the other side have shifted. It used to be, “It’s not gonna happen — so don’t worry about it.” Now it’s, “You know, a moderate dose of inflation would be no bad thing. So don’t worry about it.” Kenneth Rogoff, an economics professor at Harvard University, is the leading spokesman for this view. He wrote in August that he would like “a sustained burst of moderate inflation, say, 4 percent to 6 percent for several years.” Five years of 5 percent inflation would reduce the value of debts by 27 percent —

It has been four years now, and things are starting to look up a bit. Time to raise taxes or cut spending? Time to stop borrowing? No, not yet (says Krugman). So, when? After eight years? Twelve? Soon you’ll be bumping into the next recession. Or do the annual deficit and the national debt simply not matter? If that’s the case, why do we pay taxes at all?

Although Kinsley cites the example of how “moderate”  inflation of 5% for 5 years would reduce the value of debt by 27%, the obvious corollary would be a decline in the value of the dollar by the same amount.  The U.S. dollar can no longer even pretend to be a store of value, given the new Fed policy of targeted inflation.

The old adage “don’t fight the Fed” is true – and the Fed has just given an all out buy signal on gold.