Bernanke Fires off QE3, What’s Next?

(eToro Blog) The ECB’s plan to lend money to Spain sparked the beginning of the most dramatic two weeks markets have experienced in a long time, which reached a climax yesterday evening when Fed Chairman Ben Bernanke (or Big Ben, as we in the trade like to call him) launched QE3, the third round of quantitative easing. In his opening statement, Bernanke announced that the Fed will expand its current bond purchases to include $40 billion of U.S.-backed mortgage papers a month which, alongside the Fed’s Operation Twist, will amount to $85 billion worth of bond purchases. Let me repeat that; $85 billion, each and every month, until whenever.

Investors reacted with a buying spree, pushing the S&P500 to a record not seen since the end of 2007. Forex traders, charged with optimism, crowded into Euro and Sterling pushing the Euro above the $1.30 threshold and the Pound Sterling above $1.62. Gold bugs, which are extremely sensitive to inflation talk (as gold and inflation are closely linked), learned a very important message from Bernanke – inflation will be permitted to move higher if it means more jobs and more growth. Their reaction to Big Ben’s message was swift; gold bugs piled in in droves, and pushed gold prices higher by $60 in a run-up all the way to $1,780, with the precious metal outperforming all of the major indices and other commodities.

So what exactly is QE and what’s it got to do with a Currency War?

QE, also known as quantitative easing, is a newly formed method of injecting cash into the banking system at a huge scale and “charging” them next to nothing for the privilege of using it. Banks become flush with cash and use their cheap money to lend out into the economy thus encouraging growth, companies to invest and most importantly, unemployment to fall. At least that is the intent of the Fed’s QE.

Investors react to the cheap money with a whetted appetite for risk, buying assets and commodities such as gold, oil, stocks and real estate, and so optimism returns to the economy.

However, there is another side-effect to such an action, which currency traders know all too well. QE effectively floods the market with cheap dollars and as a result causes the value of the U.S. Dollar to strongly depreciate. The result is that U.S. exports are cheaper and therefore, a lot more competitive. Real estate is also more attractive, and moreover, hiring Americans who are paid with a weaker dollar becomes attractive (and cheaper) for companies.

Nevertheless, this seemingly positive side-effect is really a double edged sword. When you intentionally depreciate your currency you are making yourself competitive against those nations which have stronger currencies and this triggers another round of currency depreciation by those rival economies. Thus a war of currencies begins, with countries vying to have the cheapest, most attractive currency, to win over foreign investments. And when everybody is printing money global inflation jumps, with oil, gas and food prices spiking to new highs and spurring political tensions not unlike those of the Arab spring.

So What’s Next?

With both the U.S. and the Eurozone printing money and greasing their respective economies with cash, the alternative for money – gold –becomes the safest bet. Gold has one thing that can drive it higher and that is when inflation outpaces interest rates. And this is exactly what is happening now; both Bernanke and Draghi are printing money alongside the Bank of Japan and the Bank of England and global inflation will jump, and the only asset that can keep pace with inflation is gold. In other words, in the land of QE, gold is king. So what’s next, you ask? How about gold – at $2,000 an ounce.

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