Can the Fed reverse the cycle causing the rise in precious metals markets?
'It's not an abstract fear. The Fed caused high inflation in the 1970s and participated in a weak-dollar policy in the 2000s that made gold a vital investment for capital preservation. And the Fed has repeatedly warned of a Japan-style deflation over the last decade, itself buying bonds in huge quantities and now forcing more capital into dead-end government bonds by assuring near-zero interest rates into 2013.
Reinforcing investor fears, the Fed has caused extraordinarily wide and harmful swings in interest rates, the value of the dollar, gasoline prices and inflation in recent decades. This makes precautionary investments like gold, bonds and foreign diversification more profitable than investing the old fashioned way in small, growing businesses.
The result: Growth has stagnated. With gold prices flying through the roof, interest rates at near-zero and 10-year bond yields at only 2%, too much capital has been diverted into protecting investors from monetary-policy extremes.
The Fed takes the view that gold prices have limited meaning and that low bond yields are desirable as stimulus, not a market-based indicator of slow growth and high risks to the financial system. This leaves the financial world in suspense over whether the Fed will buy back more of the national debt or even new types of assets as some are urging. The uncertainty is great for the Fed-watching community and Wall Street, which profits by buying bonds in advance of Fed purchases. But the suspense hurts growth and jobs.
To break this cycle, the Fed needs to rebuild a monetary system in which the dollar is a strong and stable store of value and capital is allocated based on interest rates and market forces rather than the rationing of regulatory capital. Gold prices would be lower and bond yields higher in anticipation of a growing economy and a safer financial system.
Unless the Fed breaks the cycle, many of the arguments for buying gold and bonds still pertain. The Fed owes $2.8 trillion in liabilities, undercutting confidence in the dollar and the financial system. It is willing to promise zero interest rates for years but not willing to criticize the declining value of the dollar, one of the most important metrics of central banking.''