The Cliff Nobody is Talking About… Coming December 12

By Evaldo Albuquerque, Editor of Pure Income

I’m sure you’ve heard the term “fiscal cliff.” But just in case you’ve been living in a cave for the past few weeks, it refers to the automatic tax hikes and benefit cuts that could take place on January 1.

There has been a lot of media hype about the fiscal cliff. CNBC is even handing out "Rise Above" buttons with great fanfare as a call to action for policymakers to reach a deal.

What’s interesting is that nobody is talking about another cliff that’s coming in about two weeks.

I call it “the dollar cliff.”

The Fed is About to Push the Dollar Off the Cliff

Under what's known as Operation Twist, the Fed has been buying $45 billion a month of long-term Treasury bonds. At the same time, it has been selling an equal amount of short-term Treasuries from its portfolio.

Because it’s just replacing some assets for others, this operation doesn’t increase the size of its balance sheet. So it’s not as aggressive as outright purchases of Treasury bonds.

Operation Twist will expire at the end of the year. Since the Fed is meeting on December 12, it will now have to announce whether it will extend the twist, let it expire or replace it with something else.

The chances the Fed will just extend its Operation Twist, as it did back in June, are small. The Fed doesn’t have enough short-term maturity Treasuries to sell to finance the purchase of long-term Treasuries.

The chances the Fed will just let the program expire are even smaller. The market has become addicted to monetary stimulus. If the Fed does nothing, the market will be extremely disappointed.

Even if Congress reaches a deal to avoid the fiscal cliff, it’s very likely the compromise will involve some sort of tax hikes. This will slow down the economy, and the Fed doesn’t want to add to the problems by sending a signal to the market it's not going to print more money.

That’s why it’s very likely the Fed will replace the Twist program with purchases of Treasuries. In fact, some members of the Fed have already expressed that opinion.

John Williams, president of the San Francisco Fed, for example, recently said he favors more money-printing. According to him, the Fed’s balance sheet hasn't grown "anywhere near" the kind of limits that might impede the Fed from doing more QE.

My bet is the Fed will follow his suggestion. And that will send us over the dollar cliff.
What to Expect on December 12

Besides Operation Twist, the Fed has also been buying $40 billion per month in mortgage-backed securities. Although that’s the amount it authorized in its last meeting, the Fed made clear this quantitative easing is both open-ended and flexible. Here’s what the Fed said:

"If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”

In other words, the Fed has the flexibility to increase the size of its asset purchases anytime it wants by any amount it deems appropriate. That’s why financial analysts call that last round of money-printing “QE infinity.”

With Operation Twist expiring soon, the Fed will have to announce what it will do next. My guess is the Fed will continue to buy $40 billion a month of mortgage-backed bonds. But it will also start buying at least $45 billion a month of Treasury bonds. If this happens, the Fed will be printing $85 billion every single month.
The Last Time This Happened, These Metals Rallied 15% and 97%

Since the Fed already holds $2.873 trillion in its balance sheet, $85 billion doesn’t sound like much. But let’s not forget this is a monthly amount.

If it does that for six months, the Fed will add about $500 billion to its balance sheet. And if it does it for all of 2013, it will add a little more than $1 trillion. To put that in perspective, QE II consisted of $600 billion in Treasury purchases. So if the Fed does what I expect, this new round of money-printing could easily be as big as QE II.

If I’m right, you will have a great opportunity to profit by investing in precious metals. Gold and silver performed extremely well after QE II.

While gold rallied 15% in less than a year, silver almost doubled during the same period. The Fed could announce a program as big as QE II in two weeks. This will be very good news to gold and silver. Those metals already had an impressive rally in the past six months, but this is just the beginning.

Regards,


Evaldo Albuquerque
Editor, Pure Income