Federal Reserve Chairman Bernanke has openly admitted that he is printing money through quantitative easing based on his statements in the March 17th FOMC meeting.
… To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.
This had the immediate effect in gold and the US Dollar as we can see from the charts.
The tools that the Federal Reserve normally uses to deal with recessions are not working. They have now admitted of enacting a policy of quantitative easing and have taken steps to put more toxic assets onto their balance sheets, as well as propping up the treasury market by supplying bids to guarantee that the auctions do not fail. With this announcement, we must be especially vigilant at the long end of the yield curve. Bernanke’s announcement has added artificial demand to the long-term bond market. Bond yields must maintain a steep curve in order give banks guaranteed profit to repair their balance sheets by way of borrowing short, lending long. In addition, people with mortgages they can’t afford are being given an out by way of refinancing their loans to more affordable rates.
Overseas investors of US Treasuries now have a guaranteed exit from their holdings. This is government intervention in the free market, and the consequences of these actions will be painful to bear in the form of sharp, rising interest rates to combat looming inflation that will become prevalent once the emerging nations start up their economies.
For gold investors, this is a “positive development”, but for American citizens, this is a bona fide nightmare. Although, inflation has not affected Americans yet, this guarantees that the purchasing power of the dollar will decrease. When nations pull themselves out of the global economic crisis, there will be a demand for resources, which will drive up the price of the goods and services that run the economy.
On a technical basis, the chart of the Dow Industrial Average has moved above the 50-day moving average and has stayed above 50 on the RSI for over a week, both bullish signs. However, looking at the tepid volume, along with the divergence of the 12 and 26-day EMA of MACD, caution should be taken before one thinks that the worse is over. This bear market bounce has been overdue for a long time, and is based on speculation of “less worse” news rather than actual profits and substance.
While it may be true that Citigroup is profitable through the first two months their profits have stemmed from billions of bailout money to offset their write-downs. In addition, due to accounting rules of mark-to-market, the securities that they have to write-down must be reflected at the end of the quarter, meaning they haven’t factored in any losses into their earnings. But as announced, under pressure, FASB has relaxed their rules on mark-to-market, so the banks can return to valuing their securities at whatever price they think it merits.
Investors waiting for the rally and thinking that this is the bottom will find themselves burned as a second round of deleveraging is in the works. We could see a repeat of the start of the bear market in October of 2007 when world markets tumbled as a result of the subprime crisis. Looming resets in Option ARM mortgages threaten to sidetrack any rally and could sink the US economy further into depression.
I end with the following cartoon which accurately depicts the situation of the US dollar. While we may laugh now, China and Russia are serious about challenging the reserve status of the US dollar as the G-20 met last weekend to discuss the economic crisis. Although, any attempt at a currency basket alternative will take a long time to successfully craft, the US had best tread carefully to not upset our creditors and risk losing this special privilege which has been seriously abused.
