Not too long ago, the Federal Reserve could only buy Treasuries. If it injected any liquidity in to the financial markets, it was limited to reserve bank credit. Nowadays, it can give generous cash gifts to investment banks, mortgage lenders, money market funds, consumer finance companies and any other financial company it feels like bailing out.

In essence the Federal Reserve has turned into a hedge fund. It still owns some Treasuries and gold, but a lot of its assets now include agency debt, repurchase agreements from various financial companies, pieces of Bear Sterns and AIG debt, and foreign currency paper. Pretty soon, it’ll include actual mortgages and consumer debt! After all, the American consumers are the only group that hasn’t been explicitly bailed out yet.

According to newsletter writer Ed Bugos, people will stop eventually believing Bernanke’s rhetoric of deflation. Massive reinflation efforts are under way and eventually gold prices will start to reflect this. My stock portfolio which is heavily weighted towards Gold and Energy Stocks has gotten massacred in the past 10 days.

So do I bail or do I maintain the conviction that printing money hand over fist leads to inflation and an increase in gold prices? For the time being, I’m going to maintain the status quo, but given that we’ve seen the worst trading week since 1931, its getting tough to stick to one’s beliefs.

Wasn’t it Milton Friedman who said “The markets can remain irrational longer than you can remain solvent“?