Fed Declares War on Savers

Does this title sound extreme? If you've been one of those Americans who has saved more than you borrowed and think your wealth is safe in savings accounts and bonds, this may not be extreme at all. As bond owners, CD holders and passbook savers, consciously or unconsciously Americans have stored wealth believing that the US government has their back. This week the Fed made it clear that additional quantitative easing is on the way and that savers of dollar-denominated investments won't be protected to any degree by Washington.

The message, that the government has decided it's politically acceptable to torpedo the life savings of many Americans, is disconcerting. The fact that once again this is being done 80 days before elections to ease the burdens of even those who have borrowed in a reckless fashion is an unspoken but clear decision.

Skeptical? Think about the intrinsic value of the dollar and think about all of the Americans who measure their wealth in checking accounts, money markets, CDs, and bonds because “they’re safe." The revenue-generating ability of the government doesn't increase with “quantitative easing,” better known simply as “money printing," and the value of past US government promises to pay weakens while the supply of dollars increases. Ask any freshman econ student and he'll tell you that increasing supply without commensurate demand increase doesn't bode well for an asset.

Does this title sound extreme? If you've been one of those Americans who has saved more than you borrowed and think your wealth is safe in savings accounts and bonds, this may not be extreme at all. As bond owners, CD holders and passbook savers, consciously or unconsciously Americans have stored wealth believing that the US government has their back. This week the Fed made it clear that additional quantitative easing is on the way and that savers of dollar-denominated investments won't be protected to any degree by Washington.

The message, that the government has decided it's politically acceptable to torpedo the life savings of many Americans, is disconcerting. The fact that once again this is being done 80 days before elections to ease the burdens of even those who have borrowed in a reckless fashion is an unspoken but clear decision.

Skeptical? Think about the intrinsic value of the dollar and think about all of the Americans who measure their wealth in checking accounts, money markets, CDs, and bonds because “they’re safe." The revenue-generating ability of the government doesn't increase with “quantitative easing,” better known simply as “money printing," and the value of past US government promises to pay weakens while the supply of dollars increases. Ask any freshman econ student and he'll tell you that increasing supply without commensurate demand increase doesn't bode well for an asset.

Perhaps this is why, referring to the dollar, OPEC’s Mahmoud Ahmadinejad said: “They get our oil and give us a worthless piece of paper.” That's not a comforting comment to those American savers who are betting their financial future on “worthless piece[s] of paper” in the form of savings accounts, money market accounts, and bond holdings.

At some point the dramatic expansion of our money supply (the simple definition of inflation) will lead to obviously decreased purchasing power of our dollars. As David Rosenberg highlighted, America is 234 years old yet more than half of our nation’s money supply has been created within the last four years. A 1929 repeat of being unable to get your dollars is unlikely, but historical precedent suggests the purchasing power of those dollars will be severely impaired. Recall the Bureau of Labor Statistics already shows that the purchasing power of the dollar is down by 80% in our lifetimes, yet looking forward the dollars' fundamentals have never been worse. Perhaps this is why in 1792 America’s founders instituted the death penalty for those who debased the savings of America’s citizens -- the way the Fed is doing today. Washington knows what it's doing to savers and the middle class in particular, but its actions shout that it doesn't care.

Bond market devotees, however, dismiss this, making the claim that for the first time in the history of civilization, it will be different this time, and that the debasement of the dollar somehow won’t be a problem. They point to Treasury yields at record lows as being indicative that no inflation is on the horizon.

The problem is that the bond markets have consistently failed to discount inflation. Consider even the dramatic inflationary cycle of the 1970s when inflation peaked at 14.8% on March 31, 1980. Bond yields as measured by the 10-year didn't peak until October 2, 1981 at 15.84%, a year and a half after inflation had already reversed. If one looks back to 1967, which is the first date of continuous Fed data on the 10-year bond, the credit markets have only predicted 0.06% of future inflation. Just this week Nassim Taleb, author of The Black Swan, supported this view saying he's “betting on the collapse of government bonds” despite today’s all-clear sign manifest in record low yields. He continued that if investors hedge “against inflation you won’t regret it in two years.”

You may say, however, that deflation is the most pressing issue today and so it isn’t urgent to have metals exposure for protection. Consider another data point from this week.

On August 12, 2010 the jobless number was reported at 8:30 a.m. The results were disappointing, i.e. deflationary, as the specter of scores of unemployed Americans hit the tape. Deflationists would suggest that such an outcome is horrible for the metals because the jobless wouldn't have any money to spend, and all goods would be priced lower. But look at the performance of the metal below, specifically at 8:30 a.m.:


Click to enlarge

(SPDR Gold Shares (GLD) is currently +1.20 to 119.94 in pre-market trading.)

What you see is that when the deflationary jobless number was released, gold went vertical, breaking out to a new trading level and pushing back through $1,200. Why? The market is voting that if there's any deflationary pressure, our government will print boatloads of money, cheapening the value of the dollar and rewarding gold owners who cannot be debased by government money-printing. Just because the Fed won’t raise interest rates in order to protect its own self interests doesn't mean that inflation will remain subdued -- inflation and Fed policy can, and likely will, diverge.

These realities -- that the Fed is content to see the cash and fixed-income savings of Americans impaired to rescue debtors, and that the bond market hasn't been a good predictor of inflation -- argue for diversification into precious metals, which perform well in periods of money-printing. With gold only measuring ~2.5% of all financial assets, there's simply not enough to go around at current prices when investors begin to seek diversification. Two thousand years of data supports that metals protect the wealth of their owners -- and if you’re convinced I’m wrong, my firm would like to buy your metals or your funds’ metals from you as we're usually in the market daily paying above spot.

If you've been fortunate enough to be successful, why wouldn’t you diversify away from dollars given our government’s overt disregard for protecting your wealth?