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November 27, 2005 - In the
brief period since President Bush announced his choice for the new Federal
Reserve Board Chairman, a number of major financial markets have been
dramatically affected. The purpose of this essay is to explore whether the
hand of Alan Greenspan or his likely replacement, Ben Bernanke, were behind
them. Or, are the forces driving these normally divergent markets in the same
direction simply the result of the investment community’s expression of
support and agreement at the change of guard at the Fed, or is some other
force at work?
It has been four weeks since
October 24. This was when Ben Bernanke was named the president’s choice to
ascend to what is arguably the most powerful position in our nation if not
the world. No sooner did President Bush recommended his replacement for the
departing Alan Greenspan, than four of the most significant markets began to
react. The boldest and most persistently strong one has been the U.S. stock
market. At the time, the Dow Jones Industrials were in the midst of a
decline. It began about five weeks earlier from about 10,700, and had taken
the Dow to its pre-announcement level of about 10,300. On the day of his
recommendation, the Industrials appeared to greet Bernanke and strongly rose
170 points. The Dow then proceeded to fall for the next few days but has
since climbed nearly vertically to Friday’s 10,931 closing price. This places
its upward assault within striking distance of an all-time high.
The US Dollar Index was
trading at about 89.50. After a brief three day set-back it soared in
lock-step fashion with the Dow. Within three weeks it touched 92.50. When it
bumped into strong resistance at the 92.50 level it paused temporarily, but
is now working to overcome it.
Bonds were in a sustained
decline since late August. After President Bush’s announcement the bond
market severely reacted, and in three days lost 225 basis points. It then
proceeded lower for several more days, sharply reversed course, and then
joined common stocks and the dollar in their upward climb.
The gold market is the final
market of this quartet. After Bernanke’s nomination it rose strongly for a
few days and then fell sharply. After posting a 458 nadir it then reversed
direction and exploded in price. It now rests on the doorstep of a major
milestone, the 500 level.
Since Ben Bernanke’s
nomination, the world has experienced a rarely witnessed event. What is so
amazing is the fact that these major markets are driven by varying and opposing
forces, yet they are together trending higher. I cannot state that it is
unprecedented. However, after each had sufficiently digested the news, these
four crucial markets moved higher in tandem. By acting in this fashion they
are defying both historical market relationships, conventional wisdom, and
common sense.
The U.S. dollar and gold tend
to move in opposition to one another. This is due to gold’s historic negative
correlation with the dollar. U.S. common stocks and bonds were in defined
downtrends. Yet, Bernanke’s nomination seemed to virtually simultaneously put
wind behind the sails of all of these primary American markets. This may only
be a fleeting phenomenon, but if not, how and why are we witnessing this
seemingly surreal event?
One belief is that Alan
Greenspan orchestrated the market advances. Given his long tenure as Fed
chairman I am certain that he would like to leave his watch with the markets
calm. Stronger equity, bond and dollar markets that carried through his
departure, would certainly make his exit more fitting for what the American
Public would expect of the Maestro. It would also please Greenspan as it
would give future historians few negatives to discuss when describing his
legacy.
In a similar fashion, it would
be to Dr. Bernanke’s benefit if the markets appeared to rejoice in his
ascendency to the chairmanship of the Federal Reserve System. If this
transpired it would certainly comfort the market’s participants and onlookers
on the eve of Greenspan’s stepping down.
There are a plethora of
potential crisis generating conditions that are lurking in the wings of both
our nation and the world’s financial and economic systems. An easy transition
from a Greenspan to a Bernanke Fed would act to mitigate and assuage many
lingering fears.
After all, the derivative
monsters that envelop not only the currency and equity markets, but also the
bond, credit and various other markets, has the potential to bring down the
entire financial system if an accident emerges. This nearly occurred in1998,
with Long Term Capital Management, and possibly with the recent apparent
insolvency of Refco. The break-up of the latter company appears to be under
control. However, potential derivative or undisclosed losses may yet surface
and create havoc in the markets. Little information has been reported by the
regulators or the media to reasonably explain the speed with which the
company is being dismantled. Further, no one in the company seems to be
objecting.
Other potential dangers
surround the fate of common stocks and real estate. Despite their recent
impressive strength, equities may shortly experience a continuation of their
secular Bear Market decline. Numerous indicators are signaling warnings of
their impending weakness. Additionally, the housing market may be taking a
breather, but the future of its Bull Market appears tenuous at present. If
either of these markets soften substantially, it has the potential to
snowball and not only damage the underpinnings of the other, but also the
general economy. Additionally, how long will the rest of the world continue
to desire the fiat dollars that our Federal Reserve System creates at will?
Given our unsustainable balance of trade, payments, and budget deficits, the
United States NEEDS the rest of the world to continue to accept our dollars
and purchase our Treasuries. If they eventually rebel, it will devastate our
economy and unleash a likely inflationary firestorm when their dollars return
to our shores.
The possibility of these and
other potential disasters will soon consume the waking hours of Dr. Ben S.
Bernanke. If the markets do not appear to accept him when he takes control of
the Fed, he may be forced to endure a test of fire.
This would not be unique. Both
former Fed chairmen Paul Volker and Alan Greenspan were greeted by major
economic convulsions shortly after they each took their oath to office.
Volker watched short term interest rates soar to 20% and a recession unfold,
and Greenspan presided over the devastating stock market crash of October, 1987.
The classical methods that
Alan Greenspan can utilize to foster rising bond, stock and dollar markets
are not foreign to long-term observers of the Fed in action. The problem is
that all of these markets can’t be simultaneously stimulated with these means.
The Federal Reserve routinely purchases U.S. Treasuries in the open market.
This acts to strengthen the bond market, reduces interest rates, and allows
the Fed to immediately inject a substantial number of dollars into the
banking system. Or, Greenspan can lower the Federal Reserve member banks’
reserve requirements. This action gives the banks the capacity to expand
their lending ability, which through a multiplier effect also increases the
money supply. The Fed can also manipulate the Federal Funds and Discount
rates lower, thereby suppressing interest rates. All of these actions
increase our domestic liquidity and have been primary drivers of higher stock
prices.
As for the dollar, rising
interest rates tend to buoy its strength while falling rates weaken it. Also,
Federal Reserve open market sales of Treasuries withdraw dollars from the
monetary system thus increasing dollar desirability on the world’s markets.
If fewer dollars exist, by supply and demand, the remaining ones will
ultimately experience an increase in their purchasing power. However, these
standard market influencing Fed actions all take time to work their way
through the system. Further, as you can see they conflict with one another in
the varying effects that they have upon these markets. They could not
simultaneously, positively influence the bond, stock and U.S. dollar markets,
let alone gold prices.
While Dr. Bernanke has not yet
been installed as Fed chairman he may be operating behind the scenes with
Greenspan’s guidance. Bernanke essentially came from out of nowhere in 2002,
and uttered numerous highly controversial statements. Then, earlier this year
found himself appointed to the lead post of President Bush’s personal
economic advisors. In this position he was likely personally groomed for his
future Federal Reserve position.
I believe that it is
reasonable to assume that Alan Greenspan’s replacement by Ben Bernanke was
made long before the official announcement. It certainly appears that he
caught President Bush’s attention with his 2002 statements if not earlier.
Unfortunately, given the fact
that he will likely be our next Fed chairman I think it was a mistake to
broadcast his intentions in advance. This will limit their effectiveness if
and when they are implemented.
If he used the conventional
Fed methods to effect monetary policy as I described above, Dr. Bernanke
would have no greater ability than Alan Greenspan to move these markets
higher in concert. For this reason, if classical Federal Reserve techniques
were solely utilized, I believe that one can eliminate Greenspan and Bernanke
as the influencing forces behind the concurrent rises in these markets.
Where does this leave us in
determining the causative forces behind the simultaneous uptrends in all of
these markets? It could be a coincidence. Yet, a few days would be one thing,
but for three weeks already is a different story.
IF
IT’S NOT GREENSPAN, BERNANKE
OR A COINCIDENCE,
THEN WHAT?
Upon further evaluation of
this puzzle a though occurred to me. It took me back to Dr. Bernanke’s
November, 2002 statements when he was a relative unknown. He stated that the
Fed had the ability to create dollars at will by various unconventional
means. In this regard I truly believe him.
I personally do not believe
that the markets are sufficiently convinced that Dr. Benjamin S. Bernanke
will be an able replacement for Alan Greenspan. He very well may be, but he
is as yet unproven. From my long experience observing and studying the
markets, I have found that they typically react negatively to any form of
uncertainty! And, to my mind, any replacement of the revered Alan Greenspan,
would be looked upon with a questioning eye by all national leaders and
anyone concerned about the markets.
If I am correct, the
uncertainty generated by any untested, new Fed chairman would at best cause
the markets to pause if not decline. I believe that the bond market’s initial
sell-off was and should be the typical response. Then why would stocks,
bonds, the dollar and gold instead simultaneously rise? To my mind, the only
logical explanation would be a concerted market intervention effort.
I for one believe in free,
uncontrolled markets. I also believe that our government recognizes the
unwelcomed fashion in which the markets greeted both Paul Volker and Alan
Greenspan upon their appointments as Fed chairmen. For this reason it seems
likely that they would do their best to smooth the path for the January,
2006, Fed chairman transition. This truly would be to the benefit of all
Americans. While I do not agree with this action, I do understand the
reasoning behind it if this is indeed what is occurring. And, I am certain of
their ability to execute these effects, at least in the short term.
But, why would they want a
strong gold price? The answer is that they wouldn’t! That to me is the most
telling market performance produced by Dr. Bernanke’s nomination!
I believe that gold’s
powerful, positive reaction indicates that a number of world governments and
important market players also believe Bernanke. They realize that when he
implements his stated actions the result will be an extended, substantial
decline in the dollar’s value. Further, I am convinced that the Fed’s recent
decision to withhold future changes in the broad measure of the U.S. money supply,
M3, has confirmed that belief in the minds of many government and other
influential leaders. Much has occurred in the four weeks since Ben Bernanke’s
nomination!
On November 10, the Fed
announced that M3 is costly to produce and is no longer significant in
determining our nation’s monetary policy. They gave these as the reasons for
its discontinuance effective on March 23, 2006. Additionally, they will
simultaneously cease to publish future changes in Eurodollar and repurchase
agreement balances.
I suspect that this statement
was internationally viewed as a method for our nation to cloak a likely
massive future explosion of U.S. dollar credits. Further, I believe that Dr.
Bernanke’s nomination and this announcement that shortly followed it, were the
primary influences behind the recent strength of gold that quickly took it to
a new Bull Market high. If my reasoning is sound, the stage is now set for an
increasing number of important national and international dollar holders to
begin moving into gold. As time passes, this will benefit not only gold and
gold shares, but numerous commodities and other tangible items. This will be
the result of a flight from the dollar into these investments!
I hope that it doesn’t come to
pass. However, if Dr. Bernanke makes good on his word, he will likely go down
in history as the Fed chairman who was responsible for creating the greatest
flood of dollars, and the most damage to its domestic and international
purchasing power in history. In this event, gold and gold related items will
be the savior of the common man.
The above was excerpted from
the December 2005 issue of Financial Insights © November 27, 2005.
*******
I publish Financial Insights.
It is a monthly newsletter in which I discuss gold, the financial markets, as
well as various junior resource stocks that I believe offer great price
appreciation potential.
CAVEAT
I expect to have positions in
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always place limit orders when making purchases. If you don't, you run the
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yourself a significant sum of money. In order to have a chance for success in
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you should divide your available risk money into equal increments. These are
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afford to lose all of
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FINANCIAL INSIGHTS is written and published by Dr. Richard Appel and is made
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he directly or indirectly has a position in any of the securities mentioned.
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It is in your best interest to contact any company in which you consider
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Further, you should thoroughly research and consult with a professional
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In accordance with the safe harbor provisions of the Private Securities
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