Dissecting the Federal Reserve

The minutes from the most recent Federal Open Market Committee meeting have been poured over by countless pundits who have shown the same level of consensus that Congress has on the sequester. But if you actually look at the Federal Reserve Board's prior statements and understand the dynamics of their meetings, it's rather apparent that its aggressive monetary policy will continue for a long time, possibly even after current Chairman Ben Bernanke retires.

The Fed's easy money policies have numerous potential unintended consequences, namely that inflation may accelerate faster than expectations, the dollar's dominance as a reserve currency will continue to wane and precious metals, including gold, will strengthen over the long term. This central bank policy, which supports the growth of debt, also enables a more lax fiscal policy and could lead to stagflation.

Throughout Chairman Ben Bernanke's term, the Fed's governors and district presidents have been able to openly express their views in public speeches, Congressional testimony and interviews. Anyone who reads these addresses will get a clear understanding of current and future monetary policy.

The minutes from Fed meetings also reflect summary comments from a large group of participants discussing a wide range of topics, the end result of which is usually a near unanimous (if not unanimous) vote for a summary policy statement. The chairman sets the agenda for the meetings, establishes the tone and direction of the conversation and has the ability to direct a vote towards a summary position.

Two speeches from the Fed in the past decade are particularly noteworthy. In November 2002, Bernanke provided a clear blueprint for today's quantitative easing policy. On the Fed's monetary authority, he remarked, "A central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition."

In fact, he concluded, it "retains considerable power to expand demand and economic activity," since a fiat money system permits the central bank to "generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero."

Bernanke went on to discuss holding short-term rates at zero for a specified time period and acquiring more long-term U.S. Treasury securities and U.S. agency paper (e.g. mortgage bonds). Since the Fed is prohibited from buying private debt directly, he suggested making low-interest loans to banks, even controlling interest rates on private debt through targeted lending to banks.

In effect, there is a wide range of options available to the Fed, all with the purpose of increasing the number of dollars in circulation and generating higher spending. He goes as far as to argue that the Japanese deflation of the 1990s resulted from a lack of political will to do all that was necessary.

The second speech, given by Chicago Fed President Charles Evans on September 18, 2012, outlines the rationale behind the current targeting of unemployment and inflation, often invoking Bernanke directly.

Announcing his approval of both the Fed's "more accommodative" policies as well as the Chairman's focus on the unemployment issue, Evans seems to agree with the Fed's decision that Quantitative Easing 3 should continue until unemployment drops below 7%. It's critical, he said, that the "inflation trigger" be used as "a safeguard against unacceptable outcomes with regard to price stability" and as a means of improving employment "beyond our recent highly beneficial actions."

Evans' lofty rhetoric imbues his plea to maintain easy monetary policy "for a considerable time" with a falsely idealistic hue. "Let me be clear," he concluded, "[t]his was the time to act. With the problems we face and the potential dangers lying ahead, it is essential to do as much as we can now to bolster the resiliency and vibrancy of the economy...I am optimistic that we can achieve better outcomes through more monetary policy accommodation."

Using forceful language, he called those who disagree with these policies "timid and unduly passive," forcing the country into "a gamble that is not worth taking."

Fed members are fully aware of each other's views and concerns. They are also aware of the current policy's obvious risks and potential consequences. But it appears that a large majority of the board is willing to stay the course under Bernanke's leadership. Non-voting Fed member and St. Louis Fed President James Bullard stated in an interview with CNBC last month that "Fed policy is very easy and it's going to stay easy for a long time." If Bernanke chooses to retire next year when his term expires, there are several members of the Fed who strongly share his view and could be appointed as the new Chairman.

It is clear that we currently find ourselves living in uncharted monetary waters. Without drastic changes to monetary policy, we will continue to allocate assets to stable havens that cannot be debased through excess money creation. Our primary stable is gold, where supply is rising at a rate of around 1.5% per year, far less than the increase in government debt and global currency reserves.

Until the Fed's stated economic goals are reached or serious unintended consequences occur, we should expect a continuation of the aggressive monetary policy that potentially sacrifices stable inflation levels for unemployment targets. These actions pose serious risks for investors and the American economy at large.

John Hummel is chief investment officer of AIS Group, a Connecticut asset management firm that oversees $400 million.

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