Stimulus and Gold Bullion

We’re regularly confronted by news on whether the Fed will start tapering their stimulus efforts or not. This has been covered a lot in the media lately, but the discussions have actually been appearing from time to time ever since the wake of the financial crisis of 2008.

The FOMC meeting notes shows someone raising concern or simply mentioning the longevity or effectiveness of central bank stimulus efforts and the markets react negatively.

But how serious are these discussions and how effective is the stimulus in controlling interest rates and inflation?

First things first. Discussing tapering is not the same thing as actually doing it. Somehow acting on these comments, or discussions never seems to materialize. The reason why is very simple. It’s going to be close to impossible for the Fed to extract themselves from the market without causing unprecedented turmoil.

After a 20 year bond bull market we are starting to see cracks appear. The only reason why the U.S. government have been able to issue this much debt is due to artificially low interest rates – only made possible by the Fed. Interest rates are actually the lowest they have been in over 200 years – and if they were near their average, since the 1970’s, the 10 year rate would be closer to 7%, in contrast to todays 2.63%.

With a 7% interest rate the U.S. would have difficulties servicing its debt, as 30-50% of revenues would be required, according to some estimations. This is very close to the situation Japan is in today, but with one crucial difference – debt service levels as a percentage of tax revenues in Japan are already at 50% with interest rates at all times lows – an even more explosive situation.

So if the Fed were to start extracting capital from the system interest rates would inevitably go up. Not only because of the Fed selling bonds – there would furthermore be a confidence crisis of significant proportions as everyone would scramble to get out of the market at the same time.

The recent spike in the 10 year Treasury yield shows how quickly things can change. The Fed only came out discussing ending QE sometime in 2014 and as a result rates made an unusually large move – as illustrated by the graph below.


Source: Yahoo Finance

Even if this should prove to be temporary it’s still an indication on what’s to come. This is not a situation that the Fed can handle since they ultimately don’t control long term interest rates.

Sure the Fed can continue suppressing interest rates, which is what they most likely will be doing, since the only other option is to default and restructure debt. Even so, in the long run it will be impossible to keep interest rates this low as it will lead to unprecedented inflation.

We’re already heading into the danger zone since asset price inflation is increasing – albeit not yet on a broad scale. So far, primarily equities and real estate have seen an influx of capital.

Gold and silver bullion are already closing in on levels where simple supply-demand dynamics point to rising prices. The fundamentals also still apply. We’ve yet to see the parabolic moves of the last gold and silver bull market of the 1970’s. But with excess liquidity floating out into the system on a broad scale and a potential unraveling in the bond markets the prerequisites for gold and silver to reach all time highs look very likely.


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