Ben Bernanke has officially announced quantitative easing and the markets are reacting with rising prices among all asset classes. QE2 is practically an economic tool to artificially raise asset prices to prevent deflationary forces. When asset prices decline due to a lack of demand you have deflation. Quantitative easing essentially is a preventive approach for central banks to prevent deflationary forces. This techniques is used when a central bank can no longer lower interest rates due to it being too close to zero, so they just print money devaluing the currency and raising asset prices across the board.
Once started with quantitative easing it’s very difficult for an economy to get off of it. As with many drugs, the high is great but the hangover comes the next morning and the repercussions are unknown. This is unchartered territory where you have a major devaluation of the world’s reserve currency. For every action of the central banks there are reactions.
Now we’re seeing a reaction with sovereign debt issues resurfacing in Europe as tensions grow over debt restructuring, bank bailouts, and budget issues. Borrowing costs are rising because unlike the Fed, the European Central Bank didn’t purchase debt. The ECB will need to address these concerns of a declining dollar and rising borrowing costs leading to a potential liquidity trap.
This may lead to a replay of the May flash crash where there were reports of banks refusing to lend to each other. It’s the beginning of a global trade war where countries engage in competitive protectionism through currency debasing. Interventions and market manipulations lead to market crashes.
A weak US dollar is an additional tax on the American consumer as many are still faced with poor job opportunities and falling home values. A devalued US currency puts pressure on emerging markets, which need a strong dollar to make their products competitive.
Today gold and silver made a breakout from the three-week consolidation from early October. In early October, I mentioned precious metals would have a pullback. Over three weeks gold pulled back and this latest quantitative easing has pushed the price up to the upper resistance level again. This isn’t a point where I buy or add to positions as during the past two years gold has made 20% to 30% runs and given about half of those gains. In this market — where interventions and manipulations are occurring — chasing markets could be treacherous. Taking profits when the news and the consensus is bullish is the disciplined trader’s approach. When everyone else is comfortable I get cautious.