I mentioned in September that the Fed's QE3 totalled $85 billion per month when combined with operation twist. In less than a few weeks operation twist will be over. But don't think that QE is.

The last FOMC meeting took place this week. It's also the last Fed meeting before the fiscal cliff deadline. Since the Fed has no control over the fiscal cliff, it's firing its bullets.

We now have QE4.

Quantitative Easing 4: $2 Trillion +

The Fed will now "print" $85 billion a month until the unemployment rate falls below 6.5% and inflation projections remain no more than half a percentage point above 2% for two years out. In addition to buying Both Treasuries and Mortgage Backed Securities with the $85 billion, the Fed will also begin rolling over its maturing Treasuries as of January.

But here's the big kicker: For the first time, the Fed is now pegging QE directly to quantitative thresholds - namely, inflation and unemployment data, as opposed to its normal calendar-based guidance. That means it will print until the problem is solved. Furthermore, now that the inflation neutral operation twist is out of the picture, the additional $45 billion per month is coming directly from the printing press.

As I mentioned last week, QE3 would cost over $1 trillion if calculated over a one year span. With QE4 now in place, we're going to see $85 billion of stimulus per month for at least 2 more years. That's a total of more than $2 trillion in additional stimulus.

Considering this is the biggest QE of all, why aren't the markets rallying as they did for previous QE's?

Furthermore, with so much money printed, why aren't we experiencing a major rise in inflation?

According to the Fed:

"...inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored."

Why is inflation so low?

The Velocity of Money

Central banks fear deflation more than anything else because it produces slow growth, high unemployment, and worldwide imbalance.

Over the past several years, the Fed and central banks around the world have been trying to combat these pressures by flooding the world with newly created money; fighting deflation with inflation. But it hasn't worked.

Why?

Because while the Fed can print as many dollars as they want, they cannot control how the dollars are used once it enters the system. Inflation can only occur when money is being spent.

We call this the velocity of money.

The velocity of money measures the rate at which money flows through an economy, in other words, how much money changes hands; it has to do with the amount of economic activity associated with a given money supply. It's also is a key input in the determination of an economy's inflation calculation.

A higher velocity means the same quantity of money is being used for a greater number of transactions. As a result, it means people are not just making money, they're spending it. Economies that exhibit a higher velocity of money relative to others tend to be further along in the business cycle; thus, should have a higher rate of inflation, all things being constant.

But the opposite is true of lower velocity. A low velocity means people aren't spending; thus, the economy struggles and inflation remains low.

Take a look at the graph below that represents the Velocity of MZM (Money Zero Maturity) Money Stock:

This is a measurement of all liquid money within the economy. MZM represents all money in M2, less the time deposits, plus all money market funds.

MZM has become one of the preferred measures of money supply because it better represents money readily available within the economy for spending and consumption.

As you can see, the velocity of the MZM money stock is now at its lowest level since the currency crisis of the 1960s that led to the end of the Bretton Woods system in 1971. The last time we witnessed such dramatic drops in money velocity? The Great Depression.

The Fed and other central banks around the world are trying to avoid another Great Depression scenario. That's why they are printing so much. They want inflation to happen so they can turn this whole money velocity downfall around.

However, what they're doing is counterproductive because no matter how much money gets printed, the Fed cannot force people to use it; they can only instill confidence. So the more money they print, the more supply they produce which causes the velocity of money to go further downhill, provided consumer spending remains constant.

As I mentioned in a past letter, we're battling between inflation and deflation. The dramatic shocks of the original QE's are already turning around with commodity prices falling, and food prices now at two-year lows. Right now, we're stuck in the middle of this battle.

It's no wonder why the Fed has boldly reemphasized a massive, and thus far unlimited, round of QE.

Continued Growth

Early this year, when I predicted the stock market would climb, people thought I was nuts. Yet here we are, and the markets are looking stronger.

The market relies on confidence and it seems that everyone believes the fiscal cliff issue will be resolved, as I had mentioned before. If people thought otherwise, the market would still be falling.

World stocks are rising, signalling that investors believe the global economy has stabilized and is on the path to growth. Remember that sentiment, not true fundamentals, dictate the market; often becoming a self-fulfilling prophecy.

If this keeps up, bonds will finally fall out of favour and that means more money available for stocks.

Given that there's no end in sight for the Fed's fixation on low interest rates, those looking for return in cash and fixed income won't get it from conventional debt instruments like Treasurys and money market funds.

So how do conservative investors and pension funds, who require an average of 8 per cent return to remain viable, balance their portfolio without adding more risk?

Eventually, they'll have to turn to assets like stocks, commodities and higher-yielding bond products that carry greater return - and greater risk. But that's exactly what the Fed wants. The Fed wants you to spend, take risks, and consume to increase the velocity of money.

I expect that stocks will soon outperform bonds, but be weary of short term fiscal cliff related dips.

The Turnaround

There's no way to predict the exact time when things will turn around. But if confidence continues to grow and translates into true market fundamentals, inflationary pressures will eventually take over as the velocity of money will finally increase. It won't happen overnight but there's a strong possibility we could slowly see this in the market next year if the global economy continues to stabilize and growth patterns continue.

Then gold will climb much higher.

Gold No Longer Rising?

Despite the Fed openly announcing a $2 trillion QE last Wednesday, gold remained quiet.

It's possible that the muted inflation rates announced by the Fed have coerced investors into believing that there's no need to hedge inflation with gold. Or perhaps the manipulatory forces are hard at work to prevent gold from rising. Regardless, don't fall for it.

Gold will continue to its upward trend, despite minor hiccups along the way. The down dips in gold simply present us with more buying opportunities.