Bernanke May Quickly Move the Markets

November 3 2005 – Prior to 2002, few people had heard of the newly appointed Federal Reserve governor, Dr. Benjamin S. Bernanke. However, by the end of that year due to some well-publicized statements that he made, he became quite visible at least to those in the gold camp.

I will not bore the reader with numerous quotes that you have likely repeatedly read or heard. However, I must briefly quote a few in order to help you follow my logic. On November 21, 2002, Bernanke stated before the National Economists Club in Washington D.C. that; “Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But 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.” He went on to say that: “...If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately reverse a deflation.”

Throughout this now famous speech, Bernanke described the various methods that the Fed could use to inject liquidity into the banking system. He stated that in addition to acquiring federal backed debt such as Ginnie Mae securities, they could purchase, “foreign government debt, as well as domestic government debt”.

With the above and other statements, Dr. Bernanke has loudly announced the approach that he would take if business conditions ever appear to worsen. He would produce paper dollars or electronic dollars “at essentially no cost”, monetize various forms of debt or assets, or stimulate borrowing.

In each of these instances the result would be the creation from thin air and at will, of a potentially massive amount of newly issued dollar credits. This, in turn, would dilute the value of those dollars already in existence. Unfortunately, while he appears to be quite concerned about a deflationary event, he seems to care little about the negative consequences of the actions he would take to either prevent or reverse one.
If Ben Bernanke is indeed appointed to head the Federal Reserve System and performs as he has stated, I believe that the dollar will at best resume in its Bear Market, and at worst will collapse on the world’s currency markets.

In the January 2003 issue of Financial Insights, written shortly after Bernanke made his momentous speech, I discussed what I believed was the significance and the ultimate impact of his comments. In that issue I stated: “Picture yourself as a foreign banker, fund manager, or any of a number of individuals controlling substantial wealth. Remember, the U.S. dollar is the reserve currency of all of the major nations, and our Treasury Paper is held as their major asset, representing upwards of 75% of their reserves. Further, an enormous amount of foreign wealth, the Arabs included, is invested in these U.S. Treasuries and dollar accounts. How would you react if you learned that the most powerful person in the U.S. was prepared to issue an unlimited amount of additional dollars? Wouldn’t you feel some level of fear that those dollars owed you, or owned by you, were destined to depreciate in value? Wouldn’t you feel betrayed by a nation in which you had invested so much of your hard earned money? Wouldn’t you be angered by the fact that the Federal Reserve was unconcerned about maintaining the integrity and value of the currency which they had convinced you, that they would forever protect?”

I then wrote, “I believe that the die has been cast for a substantial rise in the price of gold, silver and virtually all tangibles! Further, we are witnessing the early days of what will likely become the most severe dollar decline in the history of the United States. It is potentially destined to pale that which occurred during the decade of the 1970's”. Gold was trading at about $315 an ounce at the time.

A major issue that I believe few people recognize is the ramification of the fact that Alan Greenspan will no longer head the Federal Reserve Board. To me, Greenspan’s legacy will be that he was responsible for creating the greatest amount of dollars of any other Federal Reserve chairman in history. He did this in order to forestall the inevitable severe economic downturn to which Bernanke is referring and will likely have to address. However, Greenspan is portrayed and is revered by most Americans as possessing deity-like powers in the economic and financial spheres. To the typical American, Alan Greenspan is the “Maestro”.

In truth, Greenspan’s proclivity for dollar creation was not altogether a bad thing. Had he not acted in this fashion Americans would have missed the additional years to enjoy the good life, because we would have already likely been in the throes of the worst economic period since the Great Depression.

Ben Bernanke will most likely be his predecessor. Yet, despite his credentials he is untested, and he is not an Alan Greenspan. I have to wonder if Greenspan’s exit will foster a degree of concern in the mind of the American Public as well as across the globe. No longer will the omnipotent Greenspan be there to save us if a major problem arises. It is impossible to measure, but I believe that a level of fear, doubt and uncertainty is growing in the minds of the world’s inhabitants. This in and of itself can turn an average market decline into a major sell-off.

This potential is augmented by my belief that common stocks have been in a secular Bear Market since early 2000. Not only are they still enormously overvalued by historical standards, but their low dividend yields are more in line with those normally seen at the top of a major Bull Market. Further, the Dow Industrials have been contained in a band between about 9,700 at the low end and about 11,000 as its upper limit for two years. Extended periods of low volatility such as this, are often followed by displays of great price movements. Also, a number of important technical indices are signaling that the resolution of this trading range will be resolved on the downside. All of this is transpiring when the Maestro is leaving, and an unproven replacement is taking control of what is arguably the most important position on earth!

There are numerous question marks surrounding Dr. Bernanke beyond his ability to handle the day to day Federal Reserve operations. The real world is far different from the classroom, in which he excelled as an educator. While he is an expert in economic theory, will its implementation actually work when it is needed? Will he be competent to handle financial or economic mishaps as has Greenspan? Further, the now widely dispersed comments regarding his seemingly lack of concern for the integrity of the dollar will likely have widespread consequences. It has to alter the fashion in which foreigners view the dollar’s future and thus their desire to hold it!

The primary support for the dollar is the world’s confidence in its issuer, the United States. Bernanke is already on record. He believes that creating dollars virtually at will can reverse any economic downturn. But what will the cost be to foreign holders of our currency or to the American Public? If he does as he says, our foreign creditors and dollar holders will suffer enormous currency losses in the process. Likewise will all Americans as its domestic purchasing power plummets. That is, if a deflation doesn’t destroy dollar credits quicker than he can create them.

It is important to recognize that Bernanke’s 2002, defining statements were not heard by all of the world’s market participants. However, in the short period since the announcement of his Fed Chairman candidacy, the media across the continents has been filled with these comments. For this reason, I would not be surprised if the markets shortly respond to the threat to the dollar that they portend.

Interestingly, both the dollar and stock market sharply rose on the day of Dr. Bernanke’s nomination. This was accompanied by a sharp sell-off in gold which carried through the next day. One would think that the widespread exposure of such quotes as stated above, would at least shake the markets about his potential appointment. Further, at minimum, the uncertainty that surrounds his taking the Fed helm away from Greenspan, would be expected to roil the markets for a period. However, not only didn’t these anticipated events transpire, but the markets seemed to welcome this alleged “inflation hawk” Even if you don’t believe that the allegations of the Gold Antitrust Action Committee (GATA.org) have any merit, given this series of events, I believe that most people should at least question if there isn’t some truth in them.

It appears inevitable that Benjamin S. Bernanke will become Alan Greenspan’s replacement. Yet, despite his defining the actions that he would take to prevent a deflation, it remains to be seen if his affect upon the markets will ultimately be much different from Greenspan’s. While Alan Greenspan did not verbalize how he would attack deflation or a serious economic decline, the fashion in which he acted during his tenure as Federal Reserve chairman to prevent their appearance, is certainly in line with Dr. Bernanke’s stated approach.

If Ben S. Bernanke performs in the fashion that he has repeatedly stated, both the dollar’s and gold’s fate are sealed. The dollar will move far lower on the currency markets of the world, and gold far higher.

Importantly, we may not have to wait for Dr. Bernanke to make good on his comments. The investment world and government heads have heard his words. They may preempt him by first themselves taking action. If this occurs, the dollar’s Bear Market and gold’s Bull Market may shortly resume their respective primary paths, before Bernanke takes command of the Federal Reserve.

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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.

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