Quantitative Easing, Currency Movement, & the Price of Silver

Jennifer Gorton

In early November, all speculation was laid to rest when Ben Bernanke & Co. formally announced that the Federal Reserve was going to move forward with a second round of Quantitative Easing (QE2) to the tune of $600 billion. Basically, for those unfamiliar with the very scientific and complex process of quantitative easing, it essentially means the Federal Reserve has just created an additional $600 billion out of thin air. It’s very similar to a drug addict counterfeiting money in his basement in order to use the fake money to satisfy his drug habit, except the drug addict will go to prison if he gets caught, while it’s all good with the Federal Reserve. What a fascinating world we live in.

This current QE2 move has been met with much skepticism and criticism among global leaders such as Germany, China, and Russia. Suffice to say, they are a bit perturbed that the U.S. keeps increasing the number of U.S. dollars at such an incredible rate. These countries argue that QE2 is going to artificially devalue the U.S. dollar, and that it will undoubtedly lead to increased capital flows into emerging markets such as Russia, China, and India.

This upsets these other countries because increased capital flows will result in two things. First of all, their currency exchange rate will go up, and this will make their exports less attractive. Second of all, these increased capital flows into emerging markets will heat up emerging market economies substantially, and the risk of inflation will subsequently rise. Suffice to say, America is not necessarily on Germany, China, and Russia’s good side at the moment.

Currency prices operate on the same basic economic principle as any other good in the marketplace – supply and demand. As the supply of a currency increases, its value will subsequently decrease. QE2 combined with QE1 increased the supply of U.S. dollars by over 2 trillion. Do you think that will drive down the value of the dollar? It’s not exactly rocket science….

Global Bailouts

The United States is not alone in bailout packages and QE behavior, however. The European Central Bank and International Monetary Fund bailed out Ireland recently to the tune of 85 billion euros, and the ECB has been very busy in the sovereign bond market, as they have been the primary buyer of government bonds in Greece, Portugal, Spain, and Ireland in the last two weeks.

All of this uncertainty in the currency market has caused many fund managers to direct capital into hard assets such as gold and silver. Silver is absolutely killing it right now, rising nearly every day as a direct result of QE2 and general uncertainty in the currency markets.

The chart to the left is a Daily Chart for silver spot prices during the month of November. You can see that price has risen consistently during the month of November. During the last 3 weeks of November there was a bit of volatility, as priced chopped back and forth a bit before it continued rising higher. Currently, price is making fresh HI’s each day during the first week of December.

Currently, investor attention has largely shifted away from the United States. The United States economy is not doing great, but there does not seem to be a strong possibility of an imminent blowup. QE2 has stabilized the markets in the near-term, even if the stabilization is simply a band-aid on a much bigger underlying problem.

Investor attention has shifted to Europe, as sovereign default in Portugal and Spain seem very likely, and currency trading prices remain volatile. Silver prices will most likely continue to be the beneficiary of an increasingly uncertain global economic environment.