by Tony Davis – Atlanta Gold & Coin Buyers ……….
Janet Yellen, the vice chairperson of the Federal Reserve, is expected to be formally announced today by President Obama as the candidate to succeed Ben Bernanke as the chairperson of the Federal Reserve. The markets have been anticipating this announcement since Former Treasury Secretary Larry Summers withdrew his nomination for the position a couple of weeks ago. Wall Street appears to be in favor of Yellen as Bernanke’s successor. Furthermore, it’s expected that she will be confirmed by Congress by a wide margin. As most investors of gold and silver coins and bullion are aware, the monetary policies established by the Federal Reserve can have a significant impact on the precious metals market. Therefore, we thought it would be worthwhile to analyze Yellen’s expected confirmation as the new chairperson to determine how the gold and silver markets are likely to be affected in the short and long term.
Dr. Yellen has had an established track record of being a dove. In other words, she is a proponent of an accommodating monetary policy, and has consistently voted with Bernanke with respect to continuing the Fed’s quantitative easing efforts. Assuming that Yellen continues to support the Fed’s easy monetary policies until they reach their target of a 6.5% unemployment rate or 2% inflation rate, it’s anticipated that the Fed will continue to expand their monetary base for the foreseeable future. Below are several scenarios that may play out if the Fed stays the course as well as the projected impact on the gold and silver markets.
The U.S. Dollar
The monetary policies of the Federal Reserve have a direct impact on the value of the dollar. Loose monetary policies, or the expansion of the Fed’s monetary base, tend to push the value of the dollar down relative to other currencies, making U.S. exports more attractive. Additionally, since gold and silver are typically inversely related to the strength of the dollar, we will likely continue to see upward movement in the gold and silver markets if the Fed stays the course. On the other hand, if the Fed reverses course, a tightening of the monetary base will result in a strengthening dollar and make exports less appealing, which would have a negative impact on the gold and silver market.
Even though the Fed has increased their monetary base four-fold over the past several years, currently sitting at a record level of $3.6 trillion, we have seen little to no impact on the monetary supply. The monetary supply is only impacted when the monetary base is multiplied through lending. Some people refer to this as the velocity of money. At present, lending has been dismal. Whether the lack of lending is due to unqualified candidates, a lack of capital investment by companies or fear of default from bankers, it’s clear that the Fed’s efforts have had little impact on the current lending environment. However, if lending increases and the monetary supply begins to expand, the threat of inflation becomes a valid concern.
Inflation occurs when there’s an expansion of the money supply and credit markets. However, as mentioned above, this will only occur when banks begin lending. The fractional reserve banking system further expands the monetary supply, as 100% of reserves aren’t required to be maintained by banks. In fact, banks are only required to maintain approximately 10% in reserves. In other words, they’re only required to keep in reserves $1 for every $10 that they lend. While inflation has been a non-factor in recent years, a rapid expansion of the monetary supply and credit could result in double digit inflation rates in relatively short fashion. If this occurs, we expect for precious metals to outperform other asset classes.
You’ve probably heard the saying that a rising tide lifts all boats. This is essentially what we’ve been seeing in the stock market over the past couple of years, as the Fed’s loose monetary policies have had a dramatic impact on the stock market. In fact, one of the Fed’s intended goals was to goose the stock market, which thus far has been quite successful. Unfortunately the economic fundamentals don’t appear to support current stock market levels, as unemployment remains stubbornly high, GDP has been dismal at best, manufacturing numbers have been down, capital investment remains low, and corporate cash holdings are near an all-time high. If, in fact, we’re in a bubble, which ultimately bursts, gold and silver may be the recipients of a flight to quality as investors search for a safe haven.
While Janet Yellen may not be the best choice for the health and future economic wellbeing of the U.S. economy, her nomination should bode well for the gold and silver markets at present as well as in the future. Continued loose monetary policies should debase the U.S. dollar relative to other major currencies, likely resulting in a strong performing gold and silver market. If the expansion of the monetary base results in an increase of the money supply, we’ll likely see higher inflation rates, which should also play out well for the gold and silver markets. Lastly, gold and silver have historically served as a safe haven in the midst of financial crises, so if the stock market has a steep sell off from its current levels, look for gold and silver to be a beacon in an otherwise uncertain environment.
Tony Davis is the owner of Atlanta Gold & Coin Buyers, a full service Atlanta based coin and bullion dealer specializing in buying, selling and appraising coins and coin collections of all types and sizes. Visit his website at www.atlantagoldandcoin.com for additional information on the products, services and educational resources offered by his company. Tony can be reached at [email protected] or at 404-236-9744.