The Government and Gold - Understanding the Two G's.

I have often heard a phrase saying "Time is the best healer". But is it really so? I have no clue but it seems that the policy mindset firmly believes in buying time in order to solve the economic malaise facing their economies. In a bid to buy more time the Fed chairman pumped in another round of steroids to help the ailing economy recover.

Bernanke is hoping that homes, capital equipment, and employees now considered unnecessary will somehow gain value if there are simply more dollars chasing them. It is questionable why all this pumping should revive the economy given that the zero-interest-rate policy and the over $2 trillion in monetary pumping since 2008 haven`t been successful. We suggest that by introducing further massive monetary pumping Bernanke is running the risk of severely damaging the US economy. Consequently, this raises the likelihood that the US could remain in a depressed economic state for a prolonged period of time.

There are a few misconceptions that need to be cleared and few points that need to be reiterated.

Was it really done to help the economy or is there a hidden agenda to it?

Reading the policy mindset, QE3 was inevitable. However, as afar as the timing goes, the presidential elections in the U.S could have been the prime driver behind this. Earlier we had seen that the Fed would wait until signs of deflation scare before switching on its money printing spree. Reading between the lines; it`s a remarkable change in strategy i.e. without any immediate need going by the drivers the FED watches. It really looks like been undertaken to boost obama’s chances of a reelection bringing in the recency effect.

Obama has been urging voters to give him more time to prove himself. But what he has been doing is just buying more time with the help of Bernanke and aggravating the problem. It would have been beneficial if he had taken stringent measures though politically unviable would have gone a long way to prove his credentials. Obamanomics has failed completely to what people were seeing as a hope of change for betterment.

Chart: Expected Inflation Expectations

Data Source: Bloomberg

The above chart shows the spread between the yields on standard 10-year T-Notes and 10-year inflation-protected Treasury Notes. It is a good proxy to depict the inflationary expectations measured by the markets in a particular economy; U.S in this case. If you observe in the above charts the circle marks the points where earlier rounds of QEs were unannounced. The inflationary expectations at that point in time were much lower to provide Fed with a justification for monetary easing. But this time around inflation expectations were already at multi year highs which is a big change in strategy and extremely disastrous over the long term.

The root of the problem is unwavering commitment to bad economic theory, so that when the economy doesn`t respond as expected to a certain dosage a higher dosage is automatically considered appropriate. This program emarked on buying mortgage secrutities and no treasury securities was primarily to keep Romney’s allegations of Fed funding the deficit at bay. Post the elections there could be another round of QE or atleast a modified QE that includes treasury purchases as well.

Mr. Romney, your allegations are correct.

Growth in government is enabled because a government with a captive central bank will never run short of money, irrespective of how big its deficits become and how far into debt it goes.

One or the primary objective of the Fed has been to help government to deficit spend. The below given chart provides an evidence of the spending spree undertaken by the U.S federal government. If you carefully observe, the initial years show a flattish line meaning no growth in spending upto 1913 i.e. until the Federal Reserve came into existence. Post that there has been continuous growth in government spending which was possible only with the help of an agency like Federal Reserve. Prior to the Fed, spending was just 3% of GDP. Currently, US federal government spending equates to about 24% of GDP.

Chart: U.S Government spending (% of GDP)

Would a change in government i.e. a Republican victory in this year`s US Presidential election reverse the upward trend in the size of the federal government?

Looks extremely unlikely. Historically, government spending has increased by more during Republican administrations then compared to the Democratic ones. Romney like previous republican candidates who have assumed power is making promises of reducing the size of governments. It’s not happened in past to make us believe it will happen this time either. Republicans are generally in favour of boosting the amount of money spent on the military. An increase in military spending is always politically viable to accomplish and is the most unproductive of all spending.

So, a Romney victory in November would probably change the composition of the federal budget, but its looks extremely unlikely that it would result in curbing government spending. Regardless of who wins in November, it`s a good bet that the US federal government will be a bigger part of the economy four years from now than it is today. And as always, the government growth will be enabled by the Federal Reserve.

The reason no viable solution is being offered is that we have no viable solution. America and much of the rest of the world has effectively mortgaged their future and we have finally come close to the day of reckoning. Until then, gold will likely continue to increase in its value against the monetary debasement undertaken by governments across the globe.