Gold price appreciation says adding liquidity will increase inflation pressure – what can the Federal Reserve and ECB do now?
Fred Day
Sep. 23, 2007

The financial markets did not take well the additional liquidity the European Central Bank (ECB) and the Federal Reserve added to the system to avoid skyrocketing effects in overnight rates.

The Fed eventually decreased the rates. The gold bulls ran with vengeances. The market gurus saw this as the effect of the lower rates. But in reality it was something different. The gold price is inversely proportional to the increasing budget deficit. The additional liquidity cannot solve the sub prime and other bad loans. It is just a water hose to get rid of the local brush fire. The water gets wasted, and it can never be recovered. The additional liquidity Fed and the ECB added is actually coming from additional budget deficit.

The gold price shot up the moment the market realized that the central banks would not hesitate to print more currency to cool down the local fire. The short term band aid is in place but what happens long term is a different ball game.

The question is what can Fed and ECB do to fight the effects of stagflation?

They can lower the rates. That will raise the inflation pressure. They can do nothing and that will allow stagflation to get converted into deflation. The central banks should go deep into the cause of these bubbles one after the other. It should convince the lawmakers to reduce trade and budget deficit. The value of the dollar must be strengthened through reduction of budget deficit and trade deficit.

Gold price appreciation says adding liquidity will increase inflation pressure – what can the Federal Reserve and ECB do now?
Fred Day
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