Silver spot price: At highest point since Fed taper announcement

January 16, 2014

London (Jan 16)  The spot price of silver yesterday reached $20.603, the highest level traded since the US Federal Reserve announced last month a scaling back of stimulus. Tapering was widely expected to be bad for silver but it seems precious metals are experiencing renewed appeal as inflation hedges.

In 2013, economists were pondering if quantitative easing was inflationary but at the dawn of the new year, a more important question has emerged: Will QE tapering prove to be inflationary?

At the heart of the question lies the fact that quantitative easing has failed to sustainably boost prices in advanced economies. Even that lonely outpost of inflation which is the United Kingdom, where annual consumer price increases spent four years above the Bank of England’s target - with attribution to higher import costs on account of the substantial depreciation of the pound from its pre-crisis peak, has now seen its CPI slip back to ‘normal’ at two percent.

Quantitative easing has been panned by its critics as being essentially money-printing which will eventually lead to hyperinflation, but Societe Generale’s global head of economics Michala Marcussen disagrees. The unorthodox monetary policy tool “is by design set to be inflationary” but Marcussen notes that this effect on prices “is only temporary as the assets are in the future set to either be sold to private investors or redeemed to central banks, thus exerting a ‘deflationary’ impact”.

For QE to be inflationary in the long-run, the SG economist says that “central banks should simply forgive their considerable holdings of debt thus making the increase in base money permanent”. Only then would the unconventional stimulus constitute money-printing.

Although such debt cancellation may be tempting to an ECB or US Fed struggling with stubbornly low inflation, Marcussen and her colleagues at Societe Generale “are concerned that such a policy could ultimately prove inflationary in a bad way (think Weimar Republic)”.

Since the Federal Open Market Committee announced the start of stimulus trimming on 18 December, Treasury Inflation Protected Securities (TIPS) have turned higher (see chart above), indicating that the market may now think that QE tapering is indeed inflationary.

Typically, the value of TIPS rises with inflation, as measured by the US Consumer Price Index, while their interest rate remains fixed. When there are no CPI releases, the prices of those securities essentially reflect inflationary expectations. The TIPS’ price plunged after commencement of the third round of US-style QE, but since the taper announcement has surpassed its 50-day Simple Moving Average and appears to be forming an inverse head and shoulders pattern.


As to when inflation might become a concern, Charles Schwab chief investment strategist Liza Ann Sonders notes that “historically inflation hasn’t been much of an issue without money changing hands at a rapid pace – this is referred to as the ‘velocity of money’, which is extremely low at present”.

Sonders elaborates: “The Federal Reserve has flooded money through the financial system via several round of QE, but there hasn’t been enough demand for borrowing or supply of lending to promote inflation.”

The higher mortgage rates in the United States since last May could counterintuitively spur credit growth, according to economists from Deutsche Bank. ‘’The fact that credit is more available, albeit at a higher price, is more stimulative to the economy than when the price of credit was cheaper but unavailable.’’

This argument invites qualification. While banks borrow at the short-end of the US Treasury yield curve where rates are still low, they usually lend at a rate which is fixed to long-term US government bond yields, which have increased substantially over the last year. The profit margin is now bigger and US financial institutions may now be willing to lend more and to more borrowers than hitherto.

Right now, spot silver is trading at around 20.043, 1.18 percent lower intraday.

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