Following The Bank of England is not a good thing. No other central bank in the OECD faces a more daunting task to revive credit. The United Kingdom, for all intents and purposes, is effectively broke. Its financial system is largely insolvent, the pound has crashed and the government already owns two of the largest banks. Unemployment in February hit its highest levels since 1971.

Deflation is attacking the United Kingdom and the central bank is throwing everything, including the kitchen sink, at credit markets. Yet London is not alone in this desperate anti-deflation battle.

The Federal Reserve surprised the markets late yesterday afternoon announcing it will purchase up to $1 trillion dollars’ worth of Treasury debt and mortgage-backed securities. Treasury bond yields immediately crashed more than 50 basis points in less than 20 minutes – the biggest such compression in yields since 1987 following the October stock market crash. Gold skyrocketed in after-hours trading and the dollar tanked against most foreign currencies.

The United States and other central banks want to grow inflation – now.

The Fed is clearly out of control as it expands its balance sheet by another quarter to roughly $4 trillion dollars and effectively goes down the destructive path of creating money or expanding credit like never before. The resultant endgame will be much higher inflation, probably 1970s-type inflation and possibly worse, if the central bank fails to rapidly drain excess liquidity from the financial system once credit markets finally stabilize.



This is a dangerous monetary precedent for the Fed. Like The Bank of England, which announced similar quantitative easing measures earlier this month, the Fed joins The Bank of Japan and the Swiss National Bank in their efforts to ease credit stress and keep interest rates low. The majority of OECD governments are now aggressively engaging deflation with all sorts of creative measures to boost the money-supply and, ultimately, inflation.

After months of relentless declines following their peak last July, inflation assets are surging this morning, including gold, silver, oil and most other commodities. Inflation-bugs are in good company following reports that Paulson & Co. – the best hedge fund in the world since 2006 – purchased a stake in South Africa’s Anglo-Gold Ashanti while boosting its gold position in GLD, or the exchange-traded gold fund.

The Fed will now purchase Treasury debt up to ten years on the maturity scale in order to keep interest rates down amid the worst recession in 27 years. The Fed will also boost its purchases of Fannie and Freddie debt where it has already spent more than $90 billion dollars since November. It also plans on buying TIPS, or Treasury Inflation-Protected Securities.

It’s obvious to me – more than ever – that the U.S. dollar and other fiat currencies are heading into the dustbin as this credit crisis drains central banks while forcing the expansion of the money supply. I’m not sure about you, but I’d have serious trouble sleeping at night in the absence of holding gold. The Fed’s announcement yesterday is just mind-boggling. Gold and other inflation hedges should start to form a new base and climb higher over the next several months in anticipation of renewed inflation starting in late 2010 or 2011.