1) On November 3, 2010, the Federal Reserve was set to announce details of its second round of quantitative easing (QE2). This was expected to increase liquidity in financial markets. 2) While increased liquidity from QE2 would raise bank reserves, it was not clear how much would spread to the broader economy due to banks preferring to hold reserves with the Fed paying higher interest than equivalent market rates. 3) The document discusses how increased liquidity from QE2 may flow more into financial markets like bonds, gold and silver than new bank lending, benefiting these assets.

1. What Does (QE 2) Quantitative Easing Mean? By Thomas H. Wilkins, CFAJoseph Jekyll Advisers LLC Tuesday, November 9, 2010, 9:30 AM -11 A.M At The University Club, at the corner of 5th Avenue and 54th Street, 7th Floor, New York City (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 1

2. Shanghai, China November 03, 2010 2:15 PM, Washington Time, the QE2 Moment By Thomas Wilkins, CFA At the above time, on Wednesday, November 3, 2010, world financial markets should know how the Federal Reserve Board intends to implement its Quantitative Easing, known as "QE2." The effect on the U.S. market should be heavily influenced by the action by the Federal Reserve Board. International markets may be impacted as the US dollar may depreciate in exchange markets and other currencies may see increased demand (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 2

3. Who Was Joseph Jekyll and What Does He Have to Do with Quantitative Easing? (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 3

4. Jekyll Island, Georgia was named after Joseph Jekyll He never came to Georgia, but without his help in Parliament, the struggling Colony of Georgia, starting without slave labor, could easily have failed. He was on a House of Commons committee to investigate the atrocious crimes inflicted on debtors who rotten in prison. We will be talking about debtors today. Joseph Jekyll Advisers LLC honors this 18th century Englishman. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 4

5. The Idea of the Federal Reserve In 1907 several banking firms in New York collapsed as depositors make a “run on these banks.” One hundred years ago this month (November, 1910) Wall Street representatives met secretly in the secluded, private resort of J. P. Morgan on Jekyll Island and thrashed out the intellectual foundations of a U.S. central bank. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 5

6. 100 Years Later What Does Quantitative Easing 2 Mean for Investors? (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 6

7. What Did the Federal Reserve Not Do on the day after the November 2, 2010 Election? Anyone want to be interactive with today’s discussion? (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 7

8. What the Federal Reserve Did Not Do on Wednesday, November 3, 2010 Did not Stop Paying interest on required and excess bank reserves held at Federal Reserve Banks. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 8

9. What do you think is important about that question? Anyone? (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 9

10. Background on interest on reserves Immediately after the Lehman Brothers bankruptcy, Congress accelerated from October 1, 2011 to October, 1, 2008. Previously, bank reserves received no interest on their required and excess reserves against specified deposit liabilities. These reserves must be held in the form of vault cash or deposits with Federal Reserve Banks. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 10

11. What is the most common way to describe the economic effect of these reserves? Answers requested from the audience to test if we are all on the same page. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 11

12. Opportunity Cost or Tax? Since these bank assets earned no interest, bank lost the opportunity to earn interest on some alternative asset. 10% of a banks specified deposit liabilities earned no interest. In describing this issue, the Federal Reserve has referred to this procedure as a “tax” and by paying tax on deposits, eliminates this “tax.” (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 12

13. What rate Does the Federal Reserve pay on these reserves after 10/2008? Anyone? (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 13

14. Current Rates Paid on Required and Excess Reserve by Federal Reserve Interest Rates Paid on Required Reserve Balances: 25 Basis Points Interest Rates Paid on Excess Reserve Balances 25 Basis Points (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 14

15. Compare 25 Basis Points on Reserves to 5 basis points on one month Treasury Bills At last check, all the Treasury Bills from 1 month out to 1 year were less than the interest paid by the Fed on reserves. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 15

16. So did the previous Quantitative Easing end up in the economy? A great deal of the Federal Reserves’ payment for Mortgage Backed Securities and Treasuries ended up in Fed’s own balance, not the economy, as Reserves. Any surprise in the next two charts? (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 16

17. What Does Excess Reserves Tell You? (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 17

18. What does this tell you?Data last updated 10/29/2010 (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 18

19. This Tells Us That Isn’t it fair to say that paying interest on excess balances permits the Fed to increase the liquidity of the financial system. As a result: Most banks do not need to reduce these excess reserves several reasons: Corporations are flush with liquid assets. Individuals are deleveraging Banks are resolving there problem loans. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 19

20. What is the effect of having the rate for reserves higher than the 1 month T-Bill rate? An incentive to keep liquidity at the Federal Reserve. It does not stimulate lending through the 10 to 1 multiplier effect of the 10% reserve requirement. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 20

21. Ancient Régime and New Régime Without interest on reserves and opportunity cost, the multiplier went on and on until excess reserves were eliminated. The money multiplier was functional. With interest paid on reserves and market interest rates are lower than the rate paid by the Fed, the incentive to eliminate opportunity cost and lend out excess reserves disappears and the multiplier effect is dysfunctional (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 21

22. Monetary Base Contrary to the opinions of many people, the monetary base is not money. Inflation is expected by many who argue that the monetary base has expanded significantly. Economist Milton Friedman’s mechanism from money to inflation has been misunderstood by these people who reason that an increase in the Federal Reserve’s balance sheet is axiomatic for inflation. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 22

23. Monetary Base, continued The “money multiplier” is effectively zero. M2 is now growing at one of the slowest paces in many years. Also, when people pay down debt, this decreases the money supply. While debt in Washington has increased, private debt has gone in the other direction this year. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 23

24. Effect of Build up of Reserves Under the new regime, the large increase in the monetary base does not axiomatically spill over into the money supply. Inflation is also constrained by excess supply of labor, of factories, office space, warehouse and retail outlets. Due to the reduction in home values, and because bank lending uses a great deal of real estate as collateral, then it is reasonable to expect a continued slowdown in credit creation for “an extended period of time.” (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 24

25. Review: The Equation of Exchange MV = Py M= Money V= Velocity P = Prices Y= Real economic output (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 25

26. Separating the parts of MV=PY Money growth is nowhere near growth rates experienced in the past. Velocity tends to fall when inflation is expected to decline. From the above, PY is expected to increase slowly. Bonds should perform well in this environment because the large forces discussed above are helping bonds. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 26

27. Pop Quiz Why do bond prices change in opposite direction from the change in yield? (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 27

28. Choose one answer below: 1. Because people want safe assets. 2. As discount rates increase, bond prices increase. 3. Because bond prices are the present value of cash flows. As discount rate increases, the present value of coupons and lump sum payout decreases. 4. Bond prices do not represent present values but future values of cash flows. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 28

29. Why do bond prices change in opposite direction from the change in yield? Because bond prices are the present value of cash flows. As discount rate increases, the present value of coupons and lump sum payout decreases. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 29

30. The 4% US Note due 8/15/2018 Is up 12.7% year to date.* And paid out interest yielding 3.9% based on 12/31/2009 closing price. * Based on 11/4/2010 closing price. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 30

31. Capital Gains A 10 year bond appreciating when the market changes from 3% yield to maturity (YTM) to 2% YTM gives more capital appreciation percentage wise than a 10 year bond appreciating when the market changes a 10% YTM to a 9% YTM. Therefore, even at low current interest rates, bonds can show capital gains. Source: A Gary Shilling, The Age of Deleveraging, New York, 2011, page 430. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 31

32. But will Bonds Outperform other financial assets going forward ? Yes, it is possible to see good gains in bonds over the next year, but will their performance surpass the performance of other instruments? In the past, gold was considered an inflation hedge. But now without inflation, gold is outperforming bonds and the stock market. If increased liquidity is not spilling over into the money supply as we have discussed, then what outlets can it find? (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 32

33. Let’s add a sub title to today’s talk: What Does Quantitative Easing 2 Mean for Investors ? And Why Studies of Monetary Policy Are an Excellent Tool for Gold and Silver Investing? (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 33

34. Where can Liquidity Go? Assets with somewhat limited supply increases are ideal targets when liquidity swells the financial system. Gold and Silver are perfect beneficiaries for heightened liquidity. The study of monetary policy is a prerequisite for performance in precious metals because of everything mentioned in the previous slides. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 34

35. Shanghai, China November 03, 2010 2:15 PM, Washington Time, the QE2 Moment By Thomas Wilkins, CFA At the above time, on Wednesday, November 3, 2010, world financial markets should know how the Federal Reserve Board intends to implement its Quantitative Easing, known as "QE2." The effect on the U.S. market should be heavily influenced by the action by the Federal Reserve Board. International markets may be impacted as the US dollar may depreciate in exchange markets and other currencies may see increased demand (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 35

36. The QE2 Moment On November 3rd as in the financial crisis of 2008-2009, the markets should see increased liquidity in the banking system. But as new loans are required to spread these reserves into the real economy, the transmission process of converting reserves to checking accounts is expected to be slow due to the obvious reasons about a slowly growing economy. The bottom line is: This increased liquidity is expected to show up more in financial markets, especially bonds, gold, silver and stocks than in new loans which are one supposedly objective for improving the economy. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 36

37. What is the rationale for Gold and Silver Now? The growth of liquidity is slightly neutral on economic activity. The money supply is not causing inflation. Liquidity seeks outlets. The outlet is in financial markets. Many European banks have gotten out of gold over the past decades. Central bank supply is declining. Export economies are likely candidates to put a portion of their trade surpluses into gold. Whereas they may not tell us that they are doing this, it is reasonable to expect. The Federal Reserve is lending long term (via purchases of bonds) but borrowing short term through the reserve market. Is this an accident waiting to happen, making gold the best insurance policy to protect against “the feared accident waiting to happen.” Due to the skepticism in the bond market, even though some maturities should increase in value, the positive factors in the gold and silver market are much stronger than the positive factors in the bond. Accordingly gold and silver should outperform the bond market. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 37

38. Going forward, can we expect: Does monetary history to repeat itself? After many wars, deflation occurs, sometimes for short periods and sometimes for long periods. Can this cycle be altered? Aren’t budget cuts at both the federal and state level is expected? Discuss the 1951 accord between the US Treasury and the Federal Reserve. Could we return to a pre-1951 regime? Or are we already there, but not recognized ? Does the Fed have three mandates, rather than two…price stability, employment maximization, and making sure there are no failed auctions for Treasury debt? (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 38

39. Recap of my argument As long as interest paid on excess reserves is greater than equivalent money market rates, the banks will be holding large amount of excess reserves with the Federal Reserve. These excess reserves should not be creating large increases in the money supply. Inflation should not be a problem. Recall Friedman’s dictum: “Inflation is a monetary phenomemon. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 39

40. Recap of my argument, continued Large reserve balances expected to remain at the Federal Reserves. The Fed’s cost on its liability ( i.e., reserves) is 0.0025% but its current yield on its assets, i.e., US Treasuries, is much higher. The Fed is making money. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 40

41. Recall of my argument, continued Negative repercussions: Increase in debt but no debtor’s prison as in the 18th century. “Extended period of time” sounds Japaneseque. Positive Benefits: Refinancing of corporate debt home mortgages improves income. PE ratios on stocks should increase due to lower discount rates of future earnings. The PE ratio on 10 years US Treasuries is 40. Stocks are cheap compared to bonds. Wealth effect (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 41

42. Recap of my argument, continued Grid Lock in bank reserves which spells over into the financial markets, namely, bonds, commodities and stocks. Improvement comes after improvement in the financial markets. It is not inflation which is driving the gold and silver markets, but liquidity. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 42

43. Sources: Griffin, G. Edward Griffin, The Creature from Jekyll Island: A Second Look at the Federal Reserve, America Media, Westlake Village, CA., 14th printing, 2003. Keister, Todd and James J. McAndrews, “Why are Banks Holding So Many Excess Reserves?,” Federal Reserve Bank of New York, Current Issues in Economics and Finance, Volume 15, Number 8, December, 2009. Selgin, George, Less Than Zero: The Case for Falling Price Level in a Growing Economy, The Institute of Economic Affairs, London, 1997. Timberlake, Jr., Richard, Monetary Policy in the United States: An Intellectual and Institutional History, The University of Chicago Press, 1978 & 1993, Wilkins, Thomas Hart , “Sir Joseph Jekyll and His Impact on Oglethorpe’s Georgia,” The Georgia Historical Quarterly, Volume XCI, Number 2, Summer 2007. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 43

44. Joseph Jekyll Advisers LLC Joseph Jekyll Advisers LLC honors an unsung hero of American history, Sir Joseph Jekyll. He was Master of the Rolls, jurist, and member of the House of Commons. His motion to grant money to the Colony of Georgia on May 10, 1733 in the House of Commons was the first ever support by the British government for an American colony. See article by Thomas Hart Wilkins in The Georgia Historical Quarterly, Volume XCI, Summer, 2007, Number 2. Thomas Hart Wilkins is Chief Executive Manager of Joseph Jekyll Advisers LLC. He earned his M.A. from the University of Georgia where his thesis depicted An Economic Interpretation of the Founding of the colony of Georgia. He is a Chartered Financial Analyst, a Georgia-registered Investment Adviser, a member of the New York Society of Security Analysts, where he was once a Director and Chairman of the Program Committee. He is also a member of the CFA Institute, and the CFA Society of Atlanta, He was an exam grader for the 2009 Investment Research Challenge at the New York Society of Security Analysts, won by the Yale University out of 14 competing university teams. He was an exam grader for the 2010 competition, and is to be a grader and judge in the 2011 competition. He spoke in New York on gold on March 25, 2010 at the world’s largest security analysts’ society. He is a columnist for Shanghai-based ChinaStakes.com. As Chairman and President of Wilkins Foundation, Inc, he and his wife, who is Vice President of the foundation, have published four Christian books, by Brother John-Charles, the last of which has been translated into Kinyarwanda, a Bantu language spoken by eight million people in Rwanda and parts of Burundi, Congo (Kinshasa), Uganda and Tanzania. (c) Joseph Jekyll Advisers LLC jekylladvisers@charter.net 44