Thursday, 27 June 2013

Why QE Was Never Bullish For GLD And Why The Taper Will Hurt It Further

By Nick Abe

It's been a long time since I've written anything but given the recent market upheaval (ostensibly related to the tapering and possible end of QE), I thought it might be a good time to dip my toe back into the water. Specifically I want to look at gold (GLD) and the idea that QE (or any of its various iterations) is inherently inflationary or hyper-inflationary due to the increase in the monetary base. This misconception has, in my opinion, led to gold being overvalued by approximately 30%.

I'm sure we all remember Grade 9 economics and the explanation of how fractional reserve banking works. The idea is pretty simple: a bank receives a $100 deposit from Client A and with a reserve ratio of 10% is allowed to lend 90% of it to Client B. Client B then deposits his $90 into another bank account and the bank is free to lend another $81 to Client C. In the end we end up with $900 held in client accounts and $100 held in reserve by the bank. So the obvious inference here is that the more money that the Federal Reserve prints (or as Mr. Bernanke likes to put it, "digitally creates") the greater the supply of money in the banking system. In this particular case, 9 times greater (incidentally 10% is the required reserve ratio for the United States and as such this would be the expected multiplier for the US).

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