Axel Merk: What’s next for the U.S. Dollar? QE3?

Axel Merk, Merk Funds, has published a new "Merk Insights" newsletter entitled "What’s next for the U.S. Dollar? QE3?" where he discusses the outlook for the US currency.

The dismal U.S. jobs report for May, released last Friday, caused the price of gold to soar as the market appears to be pricing in an ever-greater chance of “QE3” – another round of quantitative easing by the Federal Reserve (Fed). But given that 10-year government debt is already down at 1.5%, the Fed may dive deeper into its toolbox in an effort to jumpstart the economy. Investors may want to consider taking advantage of the recent U.S. dollar rally to diversify out of the greenback ahead of QE3.

To a modern central banker, it may be very simple: if the economy does not steam ahead, sprinkle some money on the problem. The Fed has done its sprinkling; indeed, the Fed has employed what one may consider a fire hose. But after QE1 and QE2, we continue to have lackluster economic growth, unable to substantially boost employment. Never mind that the real problem the global monetary system is facing is that the free market has been taken out of the pricing of risk:

• When the Fed buys government securities, such securities are – by definition - intentionally overpriced. Historically, when a central bank buys government bonds, the currency tends to weaken, as investors look abroad for less manipulated returns.
• Policy makers increasingly manage asset prices, be that by pushing up equity prices through quantitative easing; artificially lowering the cost of borrowing of peripheral Eurozone countries; or by keeping ailing banks afloat.

Investors increasingly chase the next perceived move of policy makers, thus fostering capital misallocation. Policy makers in Spain may not like paying above 6% for their longer-term debt, but lowering such rates ought to be the result of prudent policies, not because of a game of chicken between the Spanish prime minister and other European policy makers (if we only knew who the other chickens were – they are all hiding!). Similarly, U.S. growth is lagging because – let’s just name a few of the root causes - of ongoing global de-leveraging; the de-leveraging of U.S. households; uncertainty over U.S. regulatory policy; uncertainty over U.S. fiscal policy.
But let’s keep it simple, as it doesn’t matter what we think. What matters is what our policy makers do. Bernanke has indicated that the Fed is willing to provide more support to the economy. The latest unemployment report might provide that impetus, especially given Bernanke’s view that “The central bank should act more preemptively and more aggressively than usual.” This quote comes straight from what may be considered Bernanke’s playbook: his 2002 “helicopter speech” on how deflation can be beaten. Last fall, we browsed through the playbook to pose the question: Operation Twist a Primer for QE3? To recall, Bernanke argues:

• Deflation is in almost all cases a side effect of a collapse of aggregate demand….The best way to get out of trouble is not to get into it in the first place…The Fed should try to preserve a buffer zone: …central banks … set … inflation targets … between 1 and 3 percent, … reducing the risk that a large … drop in aggregate demand will drive the economy far … into deflationary territory

When faced with deflation:

• The central bank should act more preemptively and more aggressively than usual…
• Deflation is always reversible under a fiat money system…the U.S. government has a technology, called a printing press (or, today, its electronic equivalent) that allows it to produce as many U.S. dollars as it wishes at essentially no cost… a determined government can always generate higher spending and hence positive inflation.

QE1 has come:

• The Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys.

Operation Twist and a commitment to keeping interest rates low for an extended period is also taken from the playbook:

• One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out the Treasury term structure – that is, rates on government bonds of longer maturities.
• One approach…would be for the Fed to commit to holding the overnight rate at zero for some specified period.
• A more direct method, which I [Bernanke] personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt. The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities… at prices consistent with the targeted yields... if operating in relatively short-dated Treasury debt [next two years] proved inefficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years.
• Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities [MBS] issued by Ginnie Mae, the Government National Mortgage Association).

We had the MBS purchase program as QE1. We don’t think a targeting of longer-term interest rates is in the cards, as rates are already quite low. To see what may be announced by the Fed in the near future, keep reading (emphasis added):

• Alternatively, the Fed could find other ways of injecting money into the system – for example, by making low-interest rate loans to banks or cooperating with the fiscal authorities
• If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities… the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window.
• The Fed could offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, amongst others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral.

What does that mean? Look at Europe’s Long Term Refinancing Operations (LTROs). In Europe, the European Central Bank (ECB) has been providing unlimited liquidity to the banking system, allowing banks to get liquidity in return for a broad range of collateral. While U.S. banks are not in as dire a situation as European banks, Bernanke may be motivated to provide LTROs Fed style because it would allow banks, such as Bank of America, to turn their illiquid mortgage backed securities onto the Fed in return for liquidity. Key differences to QE1 and QE2 are:

• An LTRO is demand driven. Rather than the Fed buying a colossal amount of securities, unsure of what to do with a bloated balance sheet, the LTRO gets the money where it is in demand. A bank that wants increased liquidity – presumably to invest the money in riskier assets – will be willing to participate in the LTRO.
• LTROs are extremely profitable to banks rather than the Fed. Currently, the Fed earns over $80 billion a year: the more money a central bank prints, the more interest paying securities are purchased, thus the more “profitable” the central bank is (never mind the potentially eroded purchasing power as a result of having printed the money). The ECB, in contrast, only charges 1% in return for cash provided on collateral. Given the near zero interest rates in the U.S., expect the Fed to charge only a nominal amount to turn securities held by banks into cash.

What may hold Bernanke back is that he can’t be sure of the impact a U.S. style LTRO might have:

• One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies.

Indeed, we have been critics of the ECB’s LTRO because over one trillion euros in liquidity will need to be drained within a matter of weeks should the LTRO be closed out. We don’t think this is feasible. However, the reason why these “nonstandard measures” have not caused major inflation is because policies in the U.S. and the Eurozone have not worked – the money doesn’t “stick.” With the U.S. recovery further along than the Eurozone recovery, the risk for Bernanke – and with that to the purchasing power of the U.S. dollar – is that banks will actually use the LTRO to get the economy going. If so, Bernanke claims to be able to raise rates in 15 minutes. We will see about that, especially in the context of his conviction that one of the biggest mistakes during the Great Depression was to raise rates too early. In our assessment, Bernanke must err on the side of inflation if he wants to stay true to his convictions. It’s in that context that he has been willing to commit to keeping interest rates low until the end of 2014; incidentally, by that time, odds are high that much of the foreclosure pipeline will have been worked through thus allowing the Fed to return to more traditional monetary policy. That’s the theory. In practice, little has worked out since the onset of the financial crisis as has been envisioned by policy makers; then again, the Fed is rarely accused of being too far sighted…
In summary, we believe the next major initiative by the Fed will be the announcement of a U.S. style LTRO. Just in case that doesn’t jumpstart the U.S. economy either, we will have to revert back to Bernanke’s playbook to glimpse what else may be in store:

• The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchases by the Fed is several times the stock of U.S. government debt.

This policy suggestion demonstrates Bernanke’s lack of appreciation for the political consequences of his actions. In his speech, he tries to address that:

• I want to be absolutely clear that I am today neither forecasting nor recommending any attempt by U.S. policymakers to target the international value of the dollar. Although… it’s worth noting that there have been times when exchange rate policy has been an effective weapon against deflation.

Our read is that Bernanke won’t consider the outright purchases of peripheral Eurozone debt until after the U.S. elections. Even then, such a step may go beyond the bizarre. Then again, what hasn’t been bizarre in U.S. monetary policy in recent years?
Back to the LTRO, such a policy would boost the Fed’s balance sheet yet again. New money would be “printed” to provide the liquidity offered to the banking system. We live in an environment where central banks hope for the best, but plan for the worst. A U.S. LTRO would squarely fit that scheme. In that environment, the U.S. dollar may weaken and currencies sensitive to monetary stimulus may shine yet again. Having said that, we have long argued that there may not be any safe asset anymore and investors may want to take a diversified approach to something as mundane as cash.

Merk G10 Currencies Monetary Score

Merk Funds has recently released a white paper entitled "G10 Currencies: A Monetary Policy Analysis" where they analyzed G10 currencies and gave a "Merk Monetary Score" to each of those.

The Merk Fiscal Score and a Merk Economic Score are aggregated together with the The Merk Monetary Score into an overall Merk Currency Score

In this 7-page white paper, they explains their methodology and the Merk Monetary Policy Score eventually ranks monetary zones as follows:

1. Australia
2. Canada
3. New Zealand
4. U.S.
5. Sweden
6. Euro Area
7. Norway
8. Japan
9. UK
10. Switzerland

The best currencies in terms of monetary policy would then be the Australian dollar and the Canadian dollar and the  worst currencies the British pound and the Swiss franc.

Axel Merk: Eurozone Election Hangover

Axel Merk, Merk Funds, published a new "Merk Insights" newsletter entitled "Eurozone Election Hangover" where he discuss the possible consequence of recent elections in France and Greece for the Euro and other currencies.

 With the hangover from elections in the Eurozone lingering, which answer is correct?

a) A socialist is in charge in France;
b) Nobody is in charge in Greece; or
c) None of the above

The good news about a socialist running France is that his honeymoon shall be rather short. It took the previous socialist President François Mitterrand two years before he shelved his activist agenda and became a moderate. The market won’t be that patient; that’s why we pick answer c) above: the language of the bond market will be the only language policy makers listen to. The bond market is in charge.

What about Greece? It might be possible to put together a minority government of Antonis Samaras “New Democracy” and the former ruling “PASOK” party that is tolerated by the “Independent Greeks.” Panos Kammenos founded Independent Greeks after disagreeing to the terms of his country’s bailout when he was a member of the New Democracy. In the eyes of the Greeks, Germany and the International Monetary Fund (IMF) appear to be in charge; with anger over yielding to demands of those with money, German flags are frequently put on fire during Greek elections. One way to manage Greece’s future would be to give Greece money with no strings attached, except to tell them that no more money will follow suit. That way, the Greek people will own their own problems and can no longer blame others for their plight. In practice, Greece is likely to fall into chaos at some point, as the country has been unable to achieve a primary surplus, i.e. be able to operate before making interest payments; the question in our view is where the resulting anger will be focused.

What does it mean for the euro? The euro is recovering after a dire Monday morning; keep in mind, though, that much of Asia had a holiday and missed digesting the disappointing U.S. unemployment report; liquidity is low, as London is closed for a holiday. Medium term, however, our bigger concern is that big money, such as the Norwegian sovereign wealth fund, is taking a step back from the Eurozone. As such, the odds of more liquidity provisions from the European Central Bank (ECB) have increased. We believe the euro will underperform other European currencies; note, though, that the world, including the U.S., will remain awash in money. The rocky road will continue as policy makers hope for the best, but plan for the worst. This should bode well for commodity currencies in the medium term; of these, the Canadian Dollar, Norwegian Krone and New Zealand Dollar are currently our favorites.

Silver and Gold Chart Technical Analysis by Mike Maloney

One way to to protect yourself against a currency crisis is to buy real assets such as Gold and Silver. If you want to time your purchase you can do so with technical analysis.

Mike Maloney, of gold-silver.com,  has done just that for his subscribers in April 2012 and he released the video to the general public today. He sees an inverted head and shoulder pattern both for Gold and Silver which is a buying opportunity. The Gold chart has also gone under its 200-day moving average, which has been a great buying signal for 7 times during the 12-year bull market.

He also advices people not to wait to getting invested in Silver and Gold, as you need to be prepared while the price is still low and the real crisis occur. Of course, he's biased since his company sells precious metals,  but I believe he's a trustworthy person.

Trade in Precious Metals with Heimerle+Meule 1 Gram Gold & Silver Bars

When there is a serious currency crisis (e.g. hyperinflation), people lose faith in the local currency, and often trade in foreign currencies and in some cases gold powder.

In the years ahead, there is a non-zero risk, that people will lose confidence in fiat currencies worldwide and find other ways to trade such as using Gold and Silver. It's quite likely governments raise tax significantly, and trading in precious metals could be a way to reduce taxes to be paid. However, the problem with 1-ounce Gold coins is that they hold too much for daily expenses and Silver coins are usually more appropriate.


But now a German company (Heimerle+Meule) starts to provide 1g gold bars (about 50 USD at current Gold price) and 1g silver bars (about 1 USD at current Silver price) that would allow to trade goods in Gold and Silver more easily. Those are sold in 50 and 100 pieces set (CombiBars) and each bar is detachable. This could be use to buy things or as gifts.

For details check the Combibar Flyer, and Heimerle+Meule website.

Axel Merk: Recovery – Who are We Kidding?

Axel Merk published a new Merk Insights newsletter entitled "Recovery - Who are We Kidding?", where he explains we are in a period of war between inflation forces (central banks) and deflationary forces (markets), talks about the potential consequence of Ben Bernanke monetary policies and recommend diversifying into hard currencies including Gold on US dollar strength.

The global economy is healing, so we are told. Yet, the moment the Federal Reserve (Fed) indicates just that – and thus implying no additional stimulus may be warranted – the markets appear to throw a tantrum. In the process, the U.S. dollar has enjoyed what may be a temporary lift. To make sense of the recent turmoil, let’s look at the drivers of this “recovery” and potential implications for the U.S. dollar, gold, bonds and the stock market.

In our assessment, what we see unfolding is the latest chapter in the tug of war between inflationary and deflationary forces. During the “goldilocks” economy of the last decade, investors levered themselves up. Homeowners treated their homes as if they were ATMs; banks set up off-balance sheet Special Investment Vehicles (SIVs); governments engaging in arrangements to get cheap loans that may cost future generations dearly. Cumulatively, it was an amazing money generation process; yet, central banks remained on the sidelines, as inflation – according to the metrics focused on - appeared contained. Indeed, we have argued in the past that central banks lost control of the money creation process, as they could not keep up with the plethora of “financial innovation” that justified greater leverage. It was only a matter of time before the world no longer appeared quite so risk-free. Rational investors thus reduced their exposure: de-levered. When de-leveraging spreads, however, massive deflationary forces may be put in motion. The financial system itself was at risk, as institutions did not hold sufficiently liquid assets to de-lever in an orderly way. Without intervention, deflationary forces might have thrown the global economy into a depression.

The trouble occurs when the money creation process takes on a life of its own, because the money destruction process is rather difficult to stop. However, it hasn’t stopped policy makers from trying: in an effort to fight what may have been a disorderly collapse of the financial system, unprecedented monetary and fiscal initiatives were undertaken to stem against market forces. Trillion dollar deficits, trillions in securities purchased by the Fed with money created out of thin air (when the Fed buys securities, it merely credits the account of the bank with an accounting entry – while no physical dollar bills are printed, many – including us – refer to this process as the printing of money).

Will it work? The Fed thinks it might. But nobody really knows. We do know that a depression works in removing the excesses of a bubble. However, the cost of a depression may be severe, both in social and monetary terms. Critics of the “let ‘em fail” argument say that businesses and jobs beyond those that have engaged in bad decisions will be caught by contagion effects and may ultimately be bound to fail too. Fed Chair Bernanke, a student of the Great Depression, frequently warns against repeating the policy mistakes of that era. So does the reflationary argument work, i.e. does printing and spending money help bring an economy back from the brink of disaster? We cannot find an example in history where it has. As Bernanke points out, policy makers have learned a great deal by studying crises of the past. Our reservation comes from the following observation: central bankers at any time have always been considered amongst the smartest of their era, yet – with hindsight – they may have engaged in terrible mistakes. While we certainly wish that Bernanke is right, we nonetheless maintain a degree of skepticism and believe it is any investor’s duty to take the risk that the world does not evolve the way he envisions into account. Our policy makers also might be well served to be more humble, as they are putting the world’s savings at risk. Yet, the reason central bankers are bold, not humble, is because they fear hesitation will lead to deflationary forces taking the upper hand yet again. Bernanke’s contention, that one of the biggest mistakes during the Great Depression was to tighten monetary policy too early, stems from that fear. In its recently released minutes, the Federal Reserve Open Market Committee (FOMC) placed that fear in today’s context: “While recent employment data had been encouraging, a number of members perceived a non negligible risk that improvements in employment could diminish as the year progressed, as had occurred in 2010 and 2011, and saw this risk as reinforcing the case for leaving the forward guidance unchanged at this meeting."

In our view, the reason why the Fed is committed to keeping rates low until the end of 2014 is precisely because the Fed does not want to be perceived as tightening too early. Why the end of 2014? Well, because it’s not today or tomorrow. We believe nobody – not even at the Fed – knows whether the end of 2014 is the right date. The problem with that policy will be when the market no longer buys it. The market just needs to see one member of the FOMC turn more hawkish, as a result of improving economic data, to interpret that we may be starting down the road of monetary tightening. Yet, if the market thinks the Fed may tighten, deflationary forces take over, possibly unraveling all the “hard work” the Fed has done.

Will tightening ever be bearable for the economy again? U.S. financial institutions are in a stronger position than they were in 2008. Conversely, governments around the world – not just the U.S. government – are in far weaker positions, given the large amounts of debt they have incurred, in an effort to manage the financial crisis. Many consumers have downsized (read: lost their homes / filed for bankruptcy), but there continues to be downward pressure on the housing market, as millions of homes remain in the foreclosure process and are only slowly making it to the market. Bernanke may have chosen the end of 2014 as the earliest time to raise rates because it represents a date when the housing market may have freed itself from much of the foreclosure pipeline. Indeed, Fed research suggests that residential construction won’t fully recover until 2014. We don’t think that is a coincidence. To Bernanke, a thriving home market appears to be key to a healthy consumer and thus a healthy and sustainable recovery in consumer spending.

Tying monetary policy to the calendar has created alarm with economic “hawks” – not just the Fed itself, with the lone hawkish voting FOMC member, Richmond Fed President Jeff Lacker, openly dissenting. But if one follows Bernanke’s line of thinking, what’s the alternative? The alternative would be to firmly err on the side of inflation, as the Fed thinks inflation is the one problem it knows how to fight. Except that a central bank must never communicate that it wants to induce inflation, as it may derail the markets. So the 2nd best option, from Bernanke’s point of view, may be to commit to keeping rates low until the end of 2014; the “risk” that the economy might perform better than expected (and thus earlier tightening warranted) appears to be shoved aside. Just to make sure the markets behave, the Fed also introduced an inflation target, assuring the markets not to worry, all will be fine on the inflation front.

Unfortunately, we don’t think Bernanke’s plan will work. The reason is that inflation may not be as easily fought as Bernanke thinks. The extraordinary policies that have been pursued have not only planted the seeds of inflation, but have re-introduced leverage into the system. While Bernanke claims he can raise rates in 15 minutes, we believe there is simply too much leverage in the economy to raise rates as much as former Fed Chair Paul Volcker did in the early 1980s to convince the markets the Fed is serious about inflation. Given the increased interest rate sensitivity of the economy, much less tightening would likely be necessary. We are not as optimistic as many current and former Fed officials that it will be possible to engineer a sustainable economic growth while adhering to the Fed’s inflation target. The Fed is ultimately responsible for inflation; however, we have also learned that the modern Fed is unlikely to risk severe economic hardship to achieve its price stability mandate.

What does it all mean for the markets? Deflationary forces have favored the U.S. dollar and been a negative for gold. As indicated, however, we don't think the Fed will sit by idly as the markets price in tightening before the economy is “ready”. As such, a flight into the dollar out of gold might be an opportunity to diversify out of the dollar into a basket of hard currencies, including gold. With regard to the bond market, we are rather concerned that the long end of the yield curve has been extraordinarily well behaved until just a few weeks ago. The reason for our concern is that periods of low volatility in any asset class usually means that money has entered the space that might leave on short notice: we call it fast money chasing yields. We don’t need a crisis for investors to run for the hills in the bond market; we may just need a return to more normal levels of volatility. As such, investors may want to consider keeping interest risk low, i.e. staying on the short-end of the yield curve, both in U.S. dollars and other currencies. With regard to the stock market, it may do well should the Fed think of another round of easing, but let’s keep in mind that the stock market has had a tremendous rally in recent months.

If investors consider investing in the stock market because of the Fed’s monetary policy, why not express that same view in the currency market? After all, currencies – when no leverage is employed – are historically less volatile than domestic (or international) equities. Currencies may give investors the opportunity to take advantage of the risks and opportunities provided by our policy makers without taking on the equity risk.

Marc Faber: Buy Real Estate To Protect Yourself Against Wealth Destruction

Marc Faber is interviewed on Yahoo Finance on the 9th of April 2012 where he explains that home prices in the south of the U.S., in Arizona, Georgia, Nevada and so fourth, are relatively inexpensive compared to other asset prices and recommend people to buy real estate to protect themselves - or as he puts it: "lose the least" - against massive wealth destruction when that happens. He further explains that he does not know when the collapse will happen, maybe when the Dow Jones is at 20,000, 100 millions or 100 billions depending on how much money Mr. Bernanke is ready to print.

He does not recommend buying real estate builder stocks however, as those have increased a lot recently and are likely to correct.