Financial markets were consumed this week with talk of quantitative easing – the prospect that the Federal Reserve will buy assets to pump liquidity into the economy and stimulate economic recovery. Also called monetary stimulus, QE is often thought of as "priming the pump."
Once the money is injected, the theory goes, it will drive more lending and more spending, and thus, more economic activity.
Statements by the Federal Reserve suggest that chairman Benjamin Bernanke will soon announce another round of QE. Over the summer, Bernanke said that the Fed would use returns from its portfolio of mortgage-backed assets to purchase more debt, not growing its balance sheet but effectively keeping it stable.
Now, however, both Bernanke and the presidents of the regional Federal Reserve Banks are suggesting that a greater commitment will be needed.
Yesterday Charles Evans, the Chicago Federal Reserve Bank president, told the Wall Street Journal that the economy needs "much more [monetary] accommodation than we've put in place."
The Federal Reserve has a mandate to both control inflation and maintain full employment – but historically, when it must choose, the bank will almost always spring for the employment side of the equation. The political pressure to increase the money supply to try to stimulate growth is generally too powerful to resist.
"The consensus is starting to form around more asset purchases," Michael Feroli, the chief U.S. economist at JPMorgan Chase, told Bloomberg/BusinessWeek. "Bernanke doesn’t mind that there's open public debate, but when the majority does come to a view, he wants the public and the markets to understand what that view is so that the public and the markets can price that in."
So if the Fed does spring for further QE, what will be the likely outcomes?
Stock index futures will likely surge, at least in the shorter term. The prospect of a falling dollar may drive some investors out of fixed-income assets like Treasury notes and U.S. corporate bonds, and some of those investors will turn to back to the stock markets.
If QE achieves its stated goal and pushes the economy back towards full employment, the U.S. could also see a spike in consumption and a return to a healthier economic state.
A liquidity injection will almost undoubtedly cause a spike in the precious metals sector: gold futures, silver futures and platinum futures. While commodity futures brokers and traders have been busily pricing in the effect of possible QE since the possibility first surfaced, confirmation of another round of monetary stimulus will definitely boost all three commodities. That could set some eye-popping all-time records for gold prices and some pretty astonishing figures for silver.
Crude oil futures are a more complicated entity, since the vast majority of the world's oil trade is dollar-denominated. However, it seems likely that crude oil futures, along with contracts on a slew of other commodities, will rise somewhat in response to both a falling dollar and the potential for renewed economic growth.
Projections about QE are also complicated by political considerations – while some economists on the left regard more stimulus as essential, others on the right see it as potentially disastrous. Both, however, would be likely to agree that more quantitative easing means high commodity prices.
"Gold needs fears of inflation to sustain its rise. Bonds need fear of deflation. And equities need a nice middle ground," said James Mackintosh of the Financial Times on Thursday. "It is possible to bet on both short-term deflation and long-term inflation, making gold and bond prices compatible. This cannot be reconciled with strong equities, though. Something has to give. For now, that something is the dollar. Even that could change if expectations of Fed action in November prove misplaced, though."
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