The Fed is certainly not going to sell assets because they are currently the major purchasers of the asset markets they participate in, i.e. Treasuries, agency debt and mortgage backed securities. The Fed being the major holder and purchaser of particular assets has led the Fed to mark their assets to prices which they would pay, not necessarily the price of an outside buyer, and should the Fed become a major seller of these assets the need for mark downs versus current valuations is highly likely. In this circumstance, the Fed will again come face to face with their tiny capital base as they are unable to absorb losses of even 1% on their current asset markings without going insolvent.
Without QE3, interest rates can be expected to rise, and this should influence the Fed to step in and try restrain yields. Even though money printing has continued since the end of QE2, this is insufficient to maintain the Fed?s bubble. If interest rates rise substantively, this will put major pressure on sovereign, state and household solvency and could lead to near future bankruptcies across the board. The Fed will not stand idle and will come in to try paper over the markets problems in an illusory rescue attempt.
Bill Gross, manager of the world?s largest bond hedge fund, says bond yields should rise after the Fed ends QE2. Who is going to buy those treasures when a trillion dollars of purchasing power exits the market, he asks? (see video interview) With the Fed?s intent to restrain bond yields from rising, another money printing program is the only solution in their tool kit.
Whether preemptive or responsive, the Fed?s reaction this time around will likely be much faster than in previous episodes. The Fed is much more equipped now, after having several new powers resolved by congress and experiencing the 2008 chapter of the crisis, and are now unlikely to be as timid and lagging going forward.
Another way of seeing the inevitability of QE3 is realizing that the Fed has two mandates, price stability and low unemployment. The Fed has convinced themselves that inflation is not a problem so the only responsibility left for them is to ensure a high level of employment. The only measure the Fed has to even attempt to influence this is to print money, and yesterday's Fed statement indicated that they are concerned about the level of unemployment, meaning they're getting ready for a new money printing program to try and address this.
All of the above points to good times ahead for gold and silver as the money printing spigot is more easily turned on rather than addressing the core issues.
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