We have been tracking the Monetary base for a few years now as the FED went through its QE 1, QE 2, Operation Twist, and current QE 3 liquidity programs. As you are aware the Base, if you have been following our updates, has been unfolding in its own Elliott Wave bull market pattern.
Notice the Base has already completed four Primary waves, with a divided Primary III, and is currently in its fifth Primary wave. We did some Fibonacci calculations, using the previous waves, to project a potential high for its bull market. They are posted in the lower right corner. With the Base currently at $3.105 tln, it is already close to the first target of $3.143 tln. Since QE 3 is opened-ended, with no definitive end date. We are using the Fibonacci numbers to help determine when it will end. With the FED purchasing $85 bln in Gov’t Bonds/Mortgage backed Securities per month, our first target will be reached by month’s end. The next target, $3.330 tln, would appear to be about two months away, end of July. The third target, $3.486 tln, could be reached by September. And the fourth, $3.788 tln by January 2014.
Many have wondered if the stock market is rising because of this massive increase in liquidity, or just because of an economic recovery. Others suggest the bull market in equities will continue even after the liquidity ends. While many are speculating on these scenarios we took a look back into history, to a similar period in time — the 1930’s.
During the last deflationary Secular cycle the stock market collapsed into 1932. Those in charge of financial/monetary policy chose austerity rather than liquidity. Our international trading partners started sending Gold to the US, in exchange for USD’s. This Gold went directly to the FED, since we were on a Gold standard then, increasing the Monetary base.
The stock market then bottomed in July 1932 and started to rise. In 1933 after FDR took office he: closed the banks for a holiday, called in all the Gold in the country, opened the banks, started many new government spending programs, then re-priced Gold to $35/oz. Initially the Monetary base fell, but started to increase again as the US remained on the Gold standard. Gold was flowing in from our international trading partners. And, US equities were now in a liquidity driven Cycle  bull market.
For nearly four years, all this Gold went to the FED increasing the Monetary base. Then in December 1936 the US Treasury Department, fearing inflation, started sending the Gold received into the Treasury, rather than to the FED. When the Monetary base started to decline, the stock market topped in March 1937 and entered a Cycle  bear market. The Treasury, realizing their error, re-routed the Gold back to the FED. But it was too late. The economy had already contracted and World War II was on the horizon. Notice the five Primary waves into that top in 1936.
The last point we would like to make is about the FED’s exit strategy. Ever since the FED started the first liquidity program, QE 1, in October 2008. Later expanded dramatically in March 2009. There has been talk by the FED, and others, of an exit strategy when, optimistically, quantitative easing is no longer needed. The market’s fear, when the open ended QE 3 ends, the FED will start decreasing the size of the Monetary base initiating an economic recession or worse.
Historically, ever since the FED was created in 1913, there has never been an exit strategy. In fact, the Monetary base has grown, and grown, and grown for nearly a century. With the exception of the US Treasury’s policy, a fiasco in 1936, the Monetary base has never really contracted much at all. At best, it has just gone sideways for a while before ramping on up again.
Conclusions: The FED’s massive liquidity build up has been driving risk assets higher, currently mostly stocks, since March 2009. When this build up ends, either due to the FED’s actions or the Government’s. The stock market will enter a Cycle wave  bear market just like it did in the late 1930’s. Then after some period of consolidation in liquidity, possibly a few years, the Monetary base build up will begin again. An exit strategy is not required. Simply because the economy will not allow an exit to be implemented. What is already in the monetary system will remain in the system. In fact, after the bear market gets underway, additional liquidity will be required to get the economy going again. Welcome to the century of quantitative easing.