Pearls Before Swine – Perils of Free Money

By: Axel_Merk

The swine flu could not have come at a worse time. Just when there were signs of a nascent recovery, confidence takes another hit. As a result, “reflation trades” may be put on ice if investors revert to “panic mode” again. While it is difficult to assess the full economic impact of the swine flu, we believe some of the dynamics are foreshadowed. This flu may reinforce long-term trends and provide an opportunity for investors to position themselves accordingly.

Trade and travel has already been impacted. However, some regions in the world may be better prepared than others. Asia in particular, due to its experience with the bird flu (avian flu or SARS virus) in 2003, has processes in place that allow them to slow the spread of any potential pandemic far better now. Amongst others, airports in many Asian cities scan body temperatures to identify passengers with fever. Such measures will not prevent a virus from spreading, but reduces panic and the feeling of helplessness – key factors in contributing to overall individual and business risk appetite. Similarly, the U.S. and Europe have substantially improved their alert systems and coordination. In California, as a neighbor to Mexico, the continuous threat of earthquakes provides for a culture of coordination and cooperation at various levels of government and emergency services. Conversely, however, Mexico may not be as well prepared to deal with the swine flu.

Some experts say that no matter how severe the flu will be, it is quite likely going to follow seasonal flu patterns. If this forecast comes to pass, it may be to the detriment of the Southern Hemisphere as the flu season is coming to an end in the North. Tourism and trade is likely to be affected all over the world, but the perception of the level of preparedness and actions in different regions may affect which regions will fare better or worse as the extent of the virus evolves.

To get the world out of the financial crisis, governments around the world want to get credit flowing again. The outbreak of the swine flu is yet another headwind policymakers have to deal with. Even if the evolution of this flu is unclear, it is a fair assumption that policymakers will attempt to alleviate its impact nonetheless. In the eyes of the Federal Reserve (Fed), it may be yet another catalyst to keep the floodgates of money supply open. We would caution with so much latent inflationary pressure in the system already, such action may only serve to compound future economic ramifications. Hence our title: the Fed may be creating significant unintended consequences via its market interventions.

Similarly, (and while we cannot know this for certain) odds are that we will get through the swine flu relatively unscathed. This is not to belittle the risk – indeed, it may be only a matter of time until the world faces a truly devastating pandemic. From our initial assessment, the swine flu will be a wake up call to further improve preparedness everywhere in the world, but may not transpire to be as detrimental as some may think. It is our view that we have more to fear from the long-term inflationary impact of the Fed’s printing of money to pay for government spending than the flu.

In a recent commentary published in the Financial Times (click here), we argued that “rather than curing the patient, present initiatives may be over-prescribing the patient with medication that causes significant side effects.” The U.S. economy has been sick for some time and our reference referred to monetary and fiscal policy, not the reaction to the swine flu. We are now not only concerned that the seeds of inflation will bear fruit, but that this latest scare may provide the Fed and government with additional impetus to further drive up the level of inflationary pressure in the system. Cynically (and we in no way want to trivialize the risk), at least policy makers now have a scapegoat in the flu if policies to jumpstart the economy do not pan out.

In our assessment, the dollar rally may be short-lived as the world starts to cope with the realities of the swine flu. Investors may want to consider whether gold, hard or Asian currency components may provide valuable diversification to their portfolios. In recent analyses, we discussed whether there are any hard currencies left; potential depression currency plays; as well as who may benefit as the world tries to reflate. To be informed as we continue these discussions, subscribe to our newsletter at www.merkfund.com/newsletter.

Separately, we will host numerous events at the Las Vegas Money Show (May 12 – 14). Please come and visit us – we would love to see you there (click here for more information and to register); not only will we discuss the economy and the dollar, we will also provide a first preview of  “SustainableWealth”, a book written by Chief Investment Officer Axel Merk. SustainableWealth, due in bookstores this fall, is about understanding how the greater economic universe works, how that may affect your finances, and how to manage those finances to seek financial stability. Click here to be notified when the book becomes available.

We manage the Merk Hard and Asian Currency Funds, no-load mutual funds seeking to protect against a decline in the dollar by investing in baskets

By Axel Merk

Chief Investment Officer and Manager of the Merk Hard and Asian Currency Funds, www.merkfund.com

Mr. Merk predicted the credit crisis early. As early as 2003 , he outlined the looming battle of inflationary and deflationary forces. In 2005 , Mr. Merk predicted Ben Bernanke would succeed Greenspan as Federal Reserve Chairman months before his nomination. In early 2007 , Mr. Merk warned volatility would surge and cause a painful global credit contraction affecting all asset classes. In the fall of 2007 , he was an early critic of inefficient government reaction to the credit crisis. In 2008 , Mr. Merk was one of the first to urge the recapitalization of financial institutions. Mr. Merk typically puts his money where his mouth is. He became a global investor in the 1990s when diversification within the U.S. became less effective; as of 2000, he has shifted towards a more macro-oriented investment approach with substantial cash and precious metals holdings.

© 2009 Merk Investments® LLC

The Merk Asian Currency Fund invests in a basket of Asian currencies. Asian currencies the Fund may invest in include, but are not limited to, the currencies of China, Hong Kong, Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand.

The Merk Hard Currency Fund invests in a basket of hard currencies. Hard currencies are currencies backed by sound monetary policy; sound monetary policy focuses on price stability.

The Funds may be appropriate for you if you are pursuing a long-term goal with a hard or Asian currency component to your portfolio; are willing to tolerate the risks associated with investments in foreign currencies; or are looking for a way to potentially mitigate downside risk in or profit from a secular bear market. For more information on the Funds and to download a prospectus, please visit www.merkfund.com.

Investors should consider the investment objectives, risks and charges and expenses of the Merk Funds carefully before investing. This and other information is in the prospectus, a copy of which may be obtained by visiting the Funds' website at www.merkfund.com or calling 866-MERK FUND. Please read the prospectus carefully before you invest.

The Funds primarily invests in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Funds owns and the price of the Funds' shares. Investing in foreign instruments bears a greater risk than investing in domestic instruments for reasons such as volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. The Funds are subject to interest rate risk which is the risk that debt securities in the Funds' portfolio will decline in value because of increases in market interest rates. The Funds may also invest in derivative securities which can be volatile and involve various types and degrees of risk. As a non-diversified fund, the Merk Hard Currency Fund will be subject to more investment risk and potential for volatility than a diversified fund because its portfolio may, at times, focus on a limited number of issuers. For a more complete discussion of these and other Fund risks please refer to the Funds' prospectuses.

The views in this article were those of Axel Merk as of the newsletter's publication date and may not reflect his views at any time thereafter. These views and opinions should not be construed as investment advice nor considered as an offer to sell or a solicitation of an offer to buy shares of any securities mentioned herein. Mr. Merk is the founder and president of Merk Investments LLC and is the portfolio manager for the Merk Hard and Asian Currency Funds. Foreside Fund Services, LLC, distributor.

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