Did the Federal Reserve Just Admit That QE Doesn’t work?

Did the US Federal Reserve just admit that their long running policy of QE doesn’t work? We don’t know, but it sure seems like it.

Whenever you want a quick interpretation of what the Federal Reserve actually said or meant in one of its meetings, turn to Fed mouthpiece at the Wall Street Journal, John Hilsenrath. The following introduction says it all about the Fed’s current indecision:

Federal Reserve officials had a wide-ranging discussion about the outlook for monetary policy at their Oct. 29-30 policy meeting. The bottom line was that they stuck to the view that they might begin winding down their $85 billion-per-month bond-buying program in the “coming months” but are looking for ways to reinforce their plans to keep short-term interest rates low for a long-time after the program ends.

They struggled to build a consensus on how they would respond to a variety of different scenarios. One example: What to do if the economy didn’t improve as expected and the costs of continuing bond-buying outweighed the benefits? Another example: How to convince the public that even after bond buying ends, short-term interest rates will remain low.

It seems like it’s dawning on the Fed that QE isn’t really working its way through to the real economy. So they’re beginning to think about tapering their purchases while coming up with other ways to keep interest rates low.

What other ways are they thinking of? There aren’t many that we could see. Apparently one option is to cut the rate of interest paid on excess reserves from the current 0.25%. Right now, banks hold massive amounts of excess reserves (a direct response to QE) on which the Fed pays interest.

The thinking is that by cutting this interest rate, it will encourage banks to lend. Maybe it will, but to do so banks will have to start setting up mobile lending shops or dragging people into branches to give them a loan. Banks lend to people or corporations who request a loan. Banks don’t usually hold people at gunpoint and force them to sign up.

But even the Fed sounded lukewarm on that option, stating that:

Most participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage, although the benefits of such a step were generally seen as likely to be small except possibly as a signal of policy intentions.

So, in summary, the Fed wants to taper in the coming months…but it’s data dependent so may or may not happen in the coming months…and when it does they’ll replace it with something else…that they’re not quite sure of yet.

Just so you’re clear, here’s a final comment from the Fed minutes:

Participants broadly endorsed making the Committee’s communications as simple, clear, and consistent as possible, and discussed ways of doing so.

What is clear is that the hedge funds are having a ball with the gold price. It was down another US$30+ overnight. Like every other major market, we believe gold is subject to manipulation. But sometimes you just have to look at the facts and realise that ‘the nefarious banking cartel’ is not behind every down move.

Right now, evidence suggests that it’s the hedge funds pushing gold lower. They’re not dumping physical gold, they’re dumping paper gold in the form of futures contracts and short selling gold as an FX currency (which trades under the FX code of XAU).

Hedge funds represent a huge pool of global capital. They’re trend following herd runners. As a group, their performance over the past few years has been average. So when they see a market trending strongly, they go in for the kill. Gold is in a cyclical bear market (within a secular bull) so they’re jumping on the short side of the trade.

Blogger Dan Norcini follows the gold futures market closely, which is where the speculators hang out. Here’s what he had to say about the overnight price smash:

So much for quiet trading ahead of today’s release of the FOMC minutes from their last meeting! Volume had just dried up with the market killing time as the hour of the release drew near when a batch of large sell orders came out of nowhere and caught the market sleeping. The intention was to run the stops sitting down below yesterday’s lows – guess what? They got them!

The surge in volume caused a temporary halt in trading. When trading resumed, momentum based selling then entered in large size dropping gold further. It fell through $1258 which was acting as a temporary floor.

Here is another example of how hedge funds can push price by taking advantage of lulls in liquidity. I am sure some in the gold camp will once again credit this "takedown" to the big bullion banks but that is simply not the case. They continue to lift their existing short positions and add to their exposure on the long side of the market. It is hedge funds who continue to reduce long side exposure and add to their growing, and profitable, number of short positions.’

All this means at some point there will be a major short covering rally. But first, we would expect to see more selling. Then, when prices become too cheap to ignore, you’ll see a wave of new capital coming into the market to push prices much higher than where they are now. But the reality is that the hedge funds have the paper gold market by the scruff of the neck. And it wouldn’t surprise to see them take gold to a new, washout low. Stay tuned…


Greg Canavan+
for Markets and Money

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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