Goldman Sachs: The Fed is about to restart the money pump

Goldman Sachs is a lot of things to a lot of people. The Wall Street firm is certainly not without controversy.

But one thing critics and fans alike will admit about Goldman Sachs is that the firm has insider knowledge of the Federal Reserve. That’s because for years there has been a revolving door between Goldman Sachs and the Treasury Department.

Employees go back and forth between the Wall Street firm and government service at the Treasury Department in general and the Federal Reserve in particular.

That’s why when Goldman Sachs makes a statement about Federal Reserve monetary policy, investors need to listen carefully.

This week Goldman Sachs has issued an advisory forecasting that the Federal Reserve will soon resume an accommodative monetary policy designed to spur economic activity. The method Goldman Sachs says the Fed will use to do this will be to go out in the open market and buy US Treasuries as well as US mortgage-backed securities, such as bonds issues by GNMA, FNMA and Freddie Mac.

The idea is to inject cash into the economy and attempt to keep interest rates on Treasury and mortgage-backed issues down.

It is a theory that looks good on paper, but one which has not really worked all that well in practice. The Fed has been priming its money pump over and over for some time now and yet the US economy has remained anemic.

These types of monetary policy moves are much more likely to undermine the value of the US dollar and create new bubbles than they are to actually stimulate real economic activity.

The world is already awash in dollars. Adding more dollars at this point should meet squarely with the law of diminishing returns. All injecting more dollars into the system will do at this point is further undermine the value of the existing dollars.

It is simple supply and demand at work. If the supply of an item is increased with no corresponding increase in demand for that item, the value of that item falls.

And make no mistake, there is no increasing demand for dollars. If there was, the Fed wouldn’t have to go out on the open market and buy US Treasuries in the first place. If demand for US Treasuries was already robust, the Fed would be seeking other means to stimulate economic activity.

No doubt the markets will cheer this move by the Fed because more money swashing around in the system over the short term means more money available to invest in the stock market. And low interest rates on Treasuries means that there is less competition for those stocks from what were formerly thought of as “risk-free” government bonds. (Is it any wonder why S&P downgraded the USA‘s credit rating 10 months ago?)

But the real play here is gold. Because gold will not only benefit from the low interest rate policies over the short-term, but, unlike stocks, will also benefit from the undermining of our dollar over the long-term.

Gold serves as a counterweight to the US dollar because the US dollar is the world’s reserve currency of choice and also because gold is priced in dollars. Any decrease in the value of the dollar is usually met with an increase in the price of gold.

This week, at least according to Goldman Sachs, the Federal Reserve is planting the seeds for rising gold prices down the road.

Get your gold now while the price is still low.

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