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There never
really could be much doubt that the current experiment in competitive global
currency debasement would end in anything less than a total war. There was
always a chance that one or more of the principal players would snap out of
it, change course and save their citizenry from a never ending cycle of
devaluation. But developments since September 13, when the U.S. Federal
Reserve finally laid all its cards on the table and went "all in"
on permanent quantitative easing, indicate that the brainwashing is widely
established and will be difficult to break. The vast majority of the world's
leading central bankers seem content to walk in lock step down the path of
money creation as a means to economic salvation. Never mind that the path
will prevent real growth and may ultimately lead off a cliff. The herd is
moving. And if it can't be turned, the only thing that one can do is attempt
to get out of its way.
The details
of the Fed's new plan (which I christened Operation Screw
in last week's commentary) are not nearly as important as the philosophy it
reveals. The Federal Reserve has already unleashed two huge waves of
quantitative easing (purchases of either government securities or mortgage-backed
securities) in order to stimulate consumer spending and ignite business
activity. But the economy has not responded as hoped. GDP growth has
languished below trend, the unemployment rate has stayed north of 8%, and the
labor participation rate has fallen to all-time lows. In the meantime,
America's fiscal position has grown significantly worse with government debt
climbing to unimaginable territory. Despite the lack of results, the
conclusion at the Federal Reserve is that the programs were too small and too
incremental to be effective. They have determined that something larger, and
potentially permanent, would be more likely to do the trick.
However, in
making its new plan public, the Fed made a startling admission. At his press
conference, Ben Bernanke backed away from previous assertions that printed
money would be effective in directly pushing up business activity. Instead he
explained how the new stimulus would be focused directly at the housing
market through purchases of mortgage backed securities. He made clear that
this strategy is intended to spark a surge in home prices that will in turn
pull up the broader economy. Such a belief requires a dangerous amnesia to
the events of the last decade. Despite x²the calamity that followed the
bursting of our last housing bubble, economists feel this to be a wise
strategy, proving that a poor memory is a prerequisite for the profession.
But now that
the Fed is thus committed, the focus has shifted to foreign capitals. Not
surprisingly, the dollar came under immediate pressure as soon as the plan
was announced. In the 24 hours following the announcement, the Greenback was
down 2.2% against the euro, 1.6% against the Australian Dollar, and 1.1%
against the Canadian Dollar. A week after the Fed's move, the Mexican Peso
had appreciated 2.7% against the US dollar. Many currency watchers noted that
more dollar declines would be likely if foreign central banks failed to match
the Fed in their commitments to print money. On cue, the foreign bankers
responded.
It is seen as
gospel in our current "through the looking glass" economic world
that a weak currency is something to be desired and a strong currency is
something to be disdained. Weak currencies are supposed to offer advantages
to exporters and are seen as an easy way to boost GDP. In reality, weak
currencies simply create the illusion of growth while eroding real purchasing
power. Strong currencies confer greater wealth and potency to an economy. But
in today's world,no
central banker is prepared to stand idly by while their currency appreciates.
As a result, foreign central banks are rolling out their own heavy artillery
to combat the Fed.
Perhaps
anticipating the Fed's actions, on September 6th the European Central Bank
announced its own plan of unlimited buying of debt of troubled EU nations
(however, the plan did come with important concessions to the German point of
view - see
John Browne's commentary). On September 17th, the Brazilian central bank
auctioned $2.17 billion of reverse swap contracts to help push down the
Brazilian Real. The next day, Peru and Turkey cut rates more than expected.
On September 19th, the Bank of Japan increased its asset purchase program
from 70 trillion yen to 80 trillion and extended the program by six months.
It's clear we are seeing a central banking domino effect that is not likely
to end in the foreseeable future.
Although the
Fed is directing its fire towards the housing market, the needle they are
actually hoping to move is not home prices, but the unemployment rate. Until
that rate falls to the desired levels (some at the Fed have suggested 5.5%),
then we can be fairly certain that these injections will continue. This will
place permanent pressure on banks around the world to follow suit.
All of this
simultaneous money creation will likely be a boon for nominal stock and real
estate prices. But in real terms such gains will likely not keep pace with
dollar depreciation. Inflation pushes up prices for just about everything, so
stocks and real estate are not likely to prove to be exceptions. Even bond
prices can rise in the short term, but their real values are the most
vulnerable to decline. In fact, even nominal bond prices will ultimately
fall, as inflation eventually sends interest rates climbing. But prices for
hard assets, precious metals, commodities, and even those few remaining
relatively hard currencies should be on the leading edge of the upward trend
in prices.
While I
believe the Fed's plan will be a disaster for the economy, the silver lining
is that it provides investors with a road map. As the policy of the Fed is to
debase the currency, those holding dollar based assets may seek alternatives
in hard assets and in the currencies of the few remaining countries whose
bankers have not drunken so freely from the Keynesian Kool-Aid. We believe
that such opportunities do exist. Some broad ideas are outlined in the latest
edition of my Global
Investor Newsletter, which became available for download this week. I
encourage those looking for ways to distance their wealth from the policies
of Ben Bernanke to start their search today.
Peter Schiff is CEO of Euro Pacific
Precious Metals, a gold and silver dealer selling
reputable, well-known bullion coins and bars at competitive prices.
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