Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
S&P 500 – Is a 5% Correction Enough? - 6th Dec 21
Global Stock Markets It’s Do-Or-Die Time - 6th Dec 21
Hawks Triumph, Doves Lose, Gold Bulls Cry! - 6th Dec 21
How Stock Investors Can Cash in on President Biden’s new Climate Plan - 6th Dec 21
The Lithium Tech That Could Send The EV Boom Into Overdrive - 6th Dec 21
How Stagflation Effects Stocks - 5th Dec 21
Bitcoin FLASH CRASH! Cryptos Blood Bath as Exchanges Run Stops, An Early Christmas Present for Some? - 5th Dec 21
TESCO Pre Omicron Panic Christmas Decorations Festive Shop 2021 - 5th Dec 21
Dow Stock Market Trend Forecast Into Mid 2022 - 4th Dec 21
INVESTING LESSON - Give your Portfolio Some Breathing Space - 4th Dec 21
Don’t Get Yourself Into a Bull Trap With Gold - 4th Dec 21
GOLD HAS LOTS OF POTENTIAL DOWNSIDE - 4th Dec 21
4 Tips To Help You Take Better Care Of Your Personal Finances- 4th Dec 21
What Is A Golden Cross Pattern In Trading? - 4th Dec 21
Bitcoin Price TRIGGER for Accumulating Into Alt Coins for 2022 Price Explosion - Part 2 - 3rd Dec 21
Stock Market Major Turning Point Taking Place - 3rd Dec 21
The Masters of the Universe and Gold - 3rd Dec 21
This simple Stock Market mindset shift could help you make millions - 3rd Dec 21
Will the Glasgow Summit (COP26) Affect Energy Prices? - 3rd Dec 21
Peloton 35% CRASH a Lesson of What Happens When One Over Pays for a Loss Making Growth Stock - 1st Dec 21
Stock Market Sentiment Speaks: I Fear For Retirees For The Next 20 Years - 1st Dec 21 t
Will the Anointed Finanical Experts Get It Wrong Again? - 1st Dec 21
Main Differences Between the UK and Canadian Gaming Markets - 1st Dec 21
Bitcoin Price TRIGGER for Accumulating Into Alt Coins for 2022 Price Explosion - 30th Nov 21
Omicron Covid Wave 4 Impact on Financial Markets - 30th Nov 21
Can You Hear It? That’s the Crowd Booing Gold’s Downturn - 30th Nov 21
Economic and Market Impacts of Omicron Strain Covid 4th Wave - 30th Nov 21
Stock Market Historical Trends Suggest A Strengthening Bullish Trend In December - 30th Nov 21
Crypto Market Analysis: What Trading Will Look Like in 2022 for Novice and Veteran Traders? - 30th Nov 21
Best Stocks for Investing to Profit form the Metaverse and Get Rich - 29th Nov 21
Should You Invest In Real Estate In 2021? - 29th Nov 21
Silver Long-term Trend Analysis - 28th Nov 21
Silver Mining Stocks Fundamentals - 28th Nov 21
Crude Oil Didn’t Like Thanksgiving Turkey This Year - 28th Nov 21
Sheffield First Snow Winter 2021 - Snowballs and Snowmen Fun - 28th Nov 21
Stock Market Investing LESSON - Buying Value - 27th Nov 21
Corsair MP600 NVME M.2 SSD 66% Performance Loss After 6 Months of Use - Benchmark Tests - 27th Nov 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Fed to Debase U.S. Dollar?

Currencies / US Dollar Sep 19, 2012 - 03:59 AM GMT

By: Axel_Merk

Currencies

Best Financial Markets Analysis ArticleIs the Fed’s goal to debase the U.S. dollar? The Federal Reserve’s announcement of a third round of quantitative easing (QE3) might have been the worst kept secret, yet the dollar plunged upon the announcement. Here we share our analysis on what makes the FOMC tick, to allow investors to position themselves for what may be ahead.


We have heard policy makers justify bailouts and monetary activism because, as we are told, these are no ordinary times: extraordinary times require extraordinary measures. Acronyms are needed, as we are told that things are complicated. We respectfully disagree. It’s quite simple: we have had a credit driven boom; we have had a credit bust; and Fed Chairman Bernanke thinks monetary policy can fix it. Merk Senior Economic Adviser and former St. Louis Fed President William Poole points us to the fact that the Soviet Union, Cuba and North Korea have one thing in common: monetary policy could not have compensated for the shortcomings of the respective regimes. The successor nations to the Soviet Union, as well as China had economic booms because they opened up, not because of printing presses being deployed. Monetary policy affects nominal price levels, not structural deficiencies. In the U.S., the economy may be held back because of uncertainty over future taxes (the “fiscal cliff”) and regulation; monetary policy cannot fix these.

But the above experiences have something else in common: they refer to lessons of recent decades. Bernanke, in contrast, is a student of the Great Depression, the 1930s. Bernanke firmly believes that tightening monetary policy too early during the Great Depression was a grave mistake, prolonging the Depression. Never mind that there had been major policy blunders by the Roosevelt administration that might have been driving factors; Bernanke’s research squarely focuses on how history would have evolved differently had his prescription for monetary policy been implemented.

The reason why Bernanke thinks tightening too early after a credit bust is a grave mistake is because a credit bust unleashes deflationary market forces. Left untamed, a deflationary spiral may ensue driving many otherwise healthy businesses into bankruptcy. Nowadays, we hear “it’s a liquidity, not a solvency crisis.” With easy money, the Fed can stem the tide. Whenever the Fed has the upper hand, the glass is half full, “risk is on” as traders like to say; but then it appears that not quite enough money has been printed and, alas, the glass is half empty, “risk is off.” The high correlation across asset classes is, in our assessment, a direct result of the heavy involvement of policy makers. Sure, markets may move up when money is printed; the trouble is everything moves up in tandem, making it ever more difficult to find diversification, so that on the way down, investors find protection. It’s for that reason, by the way, that we focus on currencies: why bother taking on the noise of the equity markets if investors buy or sell securities merely because they try to front-run the next perceived intervention of policy makers? In our assessment, the currency markets are a great place to take a position on the “mania” of policy makers. Note that if one does not employ leverage, currencies are historically less risky than equities.

So we know Bernanke wants low interest rates. But there’s more to it: as we saw earlier this year, a string of good economic indicators sent the bond market into a nosedive. Treasuries were bailed out by subsequent mediocre economic news, allowing bond prices to recover. The challenge here, in our assessment of Bernanke’s thinking, is that the bond market can do the tightening for you. When Bernanke bragged in his Jackson Hole speech in late August that a well-behaved bond market is proof that his policies are well received, we had a more somber interpretation: the reason the bond market is well behaved is because the economy is in the doldrums. Let all the money that has been printed “stick”, i.e. let this economy kick into high gear. Sure, Bernanke says he can raise rates in 15 minutes (he can pay interest on deposits at the Fed), but given the leverage in the economy, any tightening that comes too early might undo all the “progress” that has been achieved so far. Differently said – and we are putting words into Bernanke’s mouth here – Bernanke has to err on the side of inflation.

But how do you err on the side of inflation, without the bond market throwing a fit? A central banker is most unlikely to ever call for higher inflation. You do it with “communication strategy”, a commitment to keeping interest rates low; you do it with quantitative easing, i.e. buying Mortgage-Backed and Treasury securities; you do it with Operation Twist, depressing yields by buying longer dated Treasury securities. But, “when inflation is already low…” as Bernanke stated in his 2002 “Helicopter Ben” speech, “the central bank should act more preemptively and more aggressively than usual.” How do you do that? First, you create an open-ended buying program, so that the market cannot price in all easing within moments of the announcements. And more importantly, you break the link between monetary policy and inflation. Bernanke wants to make sure investors realize that policy is now tied to a “substantial improvement in the labor market” rather than its inflation target. It’s only then that the Fed can go all out on promoting growth without having the bond market sell off.

Does it work? Judging from the initial market reaction, no. Bond prices have fallen, inflation expectations as expressed in the spreads between inflation protected Treasury securities (TIPS) and underlying Treasuries have shot higher. It might be because the dust from the Fed’s bombshell hasn’t settled; or it might be that the Fed hasn’t had time to intervene in the market by buying TIPS (while not extensively, the Fed has been buying TIPS on occasion) depressing inflation indicators.

Either way, however, many observers have wondered whether lowering interest rates a tad further is really the panacea the economy needs. Part of it is that mortgage rates aren’t falling at this stage, if for no other reason than banks have such dramatic backlogs, that they have little incentive to open the floodgates even more for further refinancing activity. But even without such backlogs, how many more projects are worth financing with the 10-year bond trading at 1.6% versus 1.8%? Interest rates are low, no matter how one slices it.

That leaves one other interpretation open. Don’t take our word for it, but read the 2002 Helicopter Ben speech: “Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today [in 2002], it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation.” The argument here is that a lower dollar boosts exports and thus the economy. Ignored is the fact that Vietnam might try to compete on price, but an advanced economy should work hard to compete on value added. As such, we are only providing a dis-incentive to invest in competitiveness if the Fed’s printing press provides the illusion of competitiveness. We use the term printing press because it is Bernanke in the aforementioned 2002 speech that refers to the Fed’s buying of securities (QEn) as the electronic equivalent of the printing press.

So don’t let anyone fool you. Things are not complicated. In our assessment, the Fed may be out to debase the dollar. Investors may want to get rid of the textbook notion of a risk-free asset, as the purchasing power of the U.S. dollar may increasingly be at risk. There is no risk-free alternative, but investors may want to consider a managed basket of currencies including gold, akin to how some central banks manage their reserves, as a way to mitigate the risk that the Fed is getting what we think it is bargaining for.

Please sign up to our newsletter to be informed as we discuss global dynamics and their impact on currencies. Please also follow me on Twitter to receive real-time updates on the economy, currencies, and global dynamics.

Manager of the Merk Hard, Asian and Absolute Return Currency Funds, www.merkfunds.com

Axel Merk, President & CIO of Merk Investments, LLC, is an expert on hard money, macro trends and international investing. He is considered an authority on currencies. Axel Merk wrote the book on Sustainable Wealth; order your copy today.

The Merk Absolute Return Currency Fund seeks to generate positive absolute returns by investing in currencies. The Fund is a pure-play on currencies, aiming to profit regardless of the direction of the U.S. dollar or traditional asset classes.

The Merk Asian Currency Fund seeks to profit from a rise in Asian currencies versus the U.S. dollar. The Fund typically invests in a basket of Asian currencies that may 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 seeks to profit from a rise in hard currencies versus the U.S. dollar. 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 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.merkfunds.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.merkfunds.com or calling 866-MERK FUND. Please read the prospectus carefully before you invest.

The Funds primarily invest in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Funds own 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.

This report was prepared by Merk Investments LLC, and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advice. Foreside Fund Services, LLC, distributor.

Axel Merk Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in