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By Ronald-Peter Stoferle, Incrementum AG Liechtenstein

July 11 (King World News) - Gold’s Rise & A Stunning Decision To Reverse Policy On QE

Market participants are currently watching the Federal Reserve's repeated attempts to exit its unconventional monetary policy with eagle eyes. Over the past five years, two such attempts have failed already. At the end of both QE1 and QE2, massive dislocations in financial markets ensued almost immediately. In the current third attempt at an exit, the Federal Reserve is attempting a 'softer exit' from its money printing....

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The most arguably amusing comparison in this context was provided by FOMC member Richard Fisher in January 2014: he pointed to the fact that under the influence of alcohol, things tend to look more alluring than they really are and offered by way of comparison that QE had a similar effect on investors. Due to artificially low interest rates, they see risk assets through “beer goggles.”

Fed balance sheet vs. expectations

    Source: Federal Reserve St. Louis, Incrementum AG

We believe that so-called 'tapering', i.e., the slow exit from 'QE', will once again have a significant impact on capital markets. Should the attempt be made to actually reduce the amount of money created hitherto as well, a severe recession would undoubtedly ensue. The exit debate is in our opinion merely verbal hygiene. For a system that – as a result of the rapidly declining marginal utility of every additional monetary unit that is created – requires a steady increase in monetary stimulus, the 'tapering' currently underway definitely amounts to 'tightening'.

The knee-jerk reaction to a fading of the effects of short term stimulative monetary policy is once again going to be the application of even stronger 'monetary ecstasy' in the future. We believe, contrary to the majority of market participants, that 'QE' is not simply going to be stopped, but will probably be continued in the long run, or be replaced by other, possibly stronger monetary drugs, such as negative interest rates. The ECB already successfully demonstrated this option in June. Central banks are facing the difficult choice between further artificial bubble blowing, and a painful economic adjustment. Based on recent history, we believe that when in doubt, the former method will clearly be preferred.

The decisive factor affecting financial markets thus remains (unfortunately) the anticipation of central bank actions. In order to stimulate the economy from the demand side, the Fed is once again – just as in the last US business cycle – betting on the so-called “wealth effect”. It is not least this phenomenon that worsens the dependence of a consumption-oriented economy on ever more expansive monetary policy. Should the market values of once again artificially inflated financial assets decline, consumer demand is apt to decrease all the more, raising the danger of recession. The incentive to counteract this with even more expansive monetary policy is hence quite pronounced. The extremely tight correlation between the growth of the Federal Reserve's balance sheet and the trend of the S&P 500 can be discerned in the next chart.

Balance sheet Federal Reserve vs. S&P 500

    Source: Federal Reserve St. Louis, Incrementum AG

Due to monetary excess and the global devaluation competition of recent years, we expect that the exchange rate between gold and paper will continue to rise.1

1 If one – similar to us – views gold as a monetary asset and not as a commodity, one must speak of gold's exchange rate so as to be consistent.

© 2014 by King World News®. All Rights Reserved. This material may not be published, broadcast, rewritten, or redistributed.  However, linking directly to the blog page is permitted and encouraged.

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