The following editorial was published in Price Perceptions issue #1467A on October 13, 2012

Kinks in Monetary Transmission System...

Since the early Nineties, the Federal Reserve has promoted a policy of extremely easy money. This led to major bubbles in the stock market and housing industry. It also contributed to a series of minor bubbles in selected commodities. Following the 2008 crash, the Fed has taken unprecedented steps with unknown risks in an effort to re-inflate the economy.

Although their efforts have rejuvenated the stock market and propelled some commodity markets, economic growth has failed to recover as expected. Their recent commitment to print money as long as it takes and hold interest rates near zero for at least the next two years has led to widespread controversy. Dislocations in financial markets as well as the US economy have become evident.

It appears the Fed may be losing control of the monetary transmission mechanism... Consumers are not taking on more debt as expected, even though interest rates are at record lows... Businesses and corporations are hoarding mountains of cash rather than spending it on new plants and equipment... The “wealth effect” of a rising stock market has failed to result in a consumer spending surge... The monetary base is contracting, rather than expanding.

What’s happening? Why aren’t the Fed’s unprecedented measures working? Does anyone have confidence in his or her economic future?

In some past similar situations, central banks began to print money to maintain economic growth. When growth slowed, they just printed more and the economy recovered. However, in time, bubbles began to appear and distort economic progress. When the central bank pulled away from easy money policies, the bubble burst and recession ensued. To end the recession, monetary expansion was reinitiated, but economic growth failed to respond as strongly as before. In some cases, money printing expanded as never before in a desperate effort to maintain growth. Although authorities realized accelerated monetary expansion was destructive, they feared stopping it would be even more destructive. In some cases, monetary expansion eventually led to chaos and a completely new monetary system.

While it is unknown where the current monetary expansion policy will eventually take markets and the economy, it is important to realize many months and years were required in past episodes before resolution was known. Until then, commodity traders should place more reliance on technical indicators and less on traditional fundamental developments. Accepting quick losses and taking early profits appears to be the best approach until more is known about the current monetary and economic environment.

Bill Gary
CIS, Inc.


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