Calling the Fed’s Bluff
The US Federal Reserve revealed from their December meeting that several of their voting members would opt to end their extensive bond purchasing program, known as Quantitative Easing, by the end of 2013. It was back in November of 2008 when the US Fed initiated this monetary stimulus effort, and just for reference the price of gold closed that month at 811.30 USD/oz. It’s no secret the price of gold has moved up significantly in response to the US central bank’s issuance of cheap credit at the cost of their dollar, but the question then becomes what happens to the price of gold when the Fed takes the punch bowl away?
Well, that is a scenario that I do not think we need to worry about just yet.
There is no set in stone timeline for when this stimulus program will end, but it is up to the Federal Reserve’s Policy setting committee. The structure of the Fed’s policy setting committee (known as the Federal Open Market Committee, or FOMC) has it so that the majority rules. Of the twelve voting members, there are seven Federal Reserve board governors, including chairman Bernanke, which traditionally vote in unison. The remaining five positions rotate between the 12 Federal Reserve District Bank presidents, and that is there there can be dissent from the consensus. This structure, however, ensures the governors have their majority in all decision making.
The renowned Bond Fund investor Bill Gross of PIMCO stated on CNBC following the release of the FOMC December minutes that it’s too early to put an end date on this monetary policy experiment. The incoming voting members of the FOMC are more dovish and will support a more accommodative policy going into 2013. For this reason alone, it’s too soon to anticipate these bond purchases will be wound down.
In fact, James Bullard, the St. Louis Fed’s district president promptly told media following the release of the December minutes that it will take a significant improvement in the economy to end the program instead of setting some tentative date. This was his effort to make clear that the Fed’s expectation is for the economy to improve by the end of this year, such that they will no longer need to supply such a supportive policy; moreover, cutting back bond purchases is very conditional on an improvement in output and labour markets.
In an introductory course to macroeconomics we learn how central banks may utilize the media to affect consumer and business confidence. If business’s all truly believe that the economy will improve by the end of 2013 maybe that will prompt them to go out and hire more employee’s and increase capital expenditure and investment. But then, how much of the Fed’s forecast for the improvement in the economy is based on the fact that business and consumers will react in this way?
My view is that the US economy will continue to advance at a mediocre pace in 2013. Friday’s job’s report helped illustrate that the labour market is only moving in accordance as job creation remains quite weak and only slightly outpaces the growth of their labour force.
The US Federal Reserve will have no choice but to continue their experiment known as Quantitative Easing due to how reliant this fragile American economy truly is. With a stalemate in Washington that only looks to get worse, the next bump in the road will be negotiations on the budget ceiling and the imposition of spending cuts that the federal government keeps delaying. This will lead to very cautious levels of investment and consumption akin to 2012. With a market potentially expecting an end to this program by 2013 year-end, any extension will be very bullish for gold.