Everybody Knows Bernanke Is a Joke

By: Robert_Murphy

As YouTube and other digital media move beyond computer-savvy young people into the ranks of even stodgy businessmen, these subversive outlets become serious problems for the ruling elite. This trend is epitomized by the radical change in the Federal Reserve's image. In just a few short years, the Fed has transformed in public opinion from a mysterious, wise, and boring institution into a fascinating engine of corruption and comedy.

Challenging Bernanke

The chinks in the Fed's armor of legitimacy are multiplying, all made possible by the ease of producing and distributing high-quality critiques. An early example was the spoof of The Police's "Every Breath You Take" that Columbia Business School students made in "honor" of Ben Bernanke's ascent to Fed chairman over their own dean, Glenn Hubbard.

It's true, the satirical music video really wasn't a critique of Bernanke's policies; after all, he had only just been given the keys to the printing press. Nonetheless, it illustrated the new power of the Internet. Creating the video took a lot of effort, and it would probably not have been worth doing had the students only been able to distribute it through, say, copying it on VHS cassettes.

At the same time, although the potential market — people who would have appreciated geeky references to "bips" (basis points) and the like — was substantial, it was dispersed throughout the population. Saturday Night Live certainly wouldn't have run such a video, and even higher-brow shows such as Bill Maher's wouldn't have done it either, simply because the niche was too limited.

The Internet, and specifically YouTube, solved these problems. As of this writing, the video has been watched some 1.7 million times, making it an obvious hit. The creative students were rewarded for their efforts in terms of esteem and fame, and hundreds of thousands of financially savvy people got a good laugh or two.

Laughing At "The Bernank," Not With Him

If the music satire was all in good fun, the more recent animated video, "Quantitative Easing Explained" was anything but. Relying on the same Xtranormal technology that I used for launching my debate challenge to Paul Krugman, this video features two bears discussing the Fed's program of massive bond purchases.

The tone of this video is much edgier and harsher than that of the music-video spoof. While the fake Sting dreams of punching Bernanke in the face, it is clearly in jest. In contrast, when the cute bears curse and accuse Bernanke of lying in order to shovel billions into the hands of his rich buddies, the creator really means it.

The Importance of "Common Knowledge"

As a grad student at NYU, I once listened to a fascinating presentation in the Austrian Colloquium on the importance of multiple levels of knowledge. The presenter argued that in certain areas of life, it wasn't enough for people to know (or believe) something, it was important that they know others know it too.

For example, if an advertiser buys a 30-second TV spot on the Super Bowl, it's not merely that tens of millions of people will see the ad. Beyond that is the crucial fact that tens of millions of people will know tens of millions of people are seeing the same ad. The presenter argued that this explains why advertisers push "network goods," such as smart phones or Macs versus PCs, during the Super Bowl and other events with high ratings.

In other words, if a particular good's value to a user depends not just on its intrinsic properties, but also on how many other people are using it, then (this presenter claimed) its producers tend to advertise it during the Super Bowl, or perhaps on a busy subway car, where people who see the ad will know that other people are seeing the ad too.

Moving to the political arena, the presenter elaborated on why totalitarian regimes are so quick to clean up graffiti and other public challenges to the authorities. It's possible for a dictator to remain in power even if a large number of his subjects hate him, so long as they think they are relatively isolated. But when someone writes, "Down with the Regime!" on a bridge, it is a signal that rallies the malcontents. Not only do they realize that they are not alone, but they know that other people like them are seeing the same subversive message.

In this context, the significance of YouTube and similar media is even larger than it seems at first glance. For example, I was thrilled when I saw "The Bernank" video, not because I learned something new from it — I already thought the Fed was a corrupt engine of inflation — but because I saw how many millions of other people had seen the video. And we can push it even further: I knew that they knew how many people were seeing the video.

This was the importance of "common knowledge," which the game theorists formally describe as something that (a) everyone knows, (b) everyone knows that everyone knows, (c) everyone knows that everyone knows that everyone knows … and so on forever. At first blush it might seem as if the deepening layers of knowledge are superfluous, but in some contexts they can be crucial.

To take an example adopted from the presenter at the NYU colloquium: Suppose Bill and John are on a crowded subway car, separated by dozens of people. The two are going to a Broadway show, and John is not familiar with the subway system, so Bill needs to signal to John when they should both get off the subway. However, because they are separated by so many densely packed people, the two men will have to use different exits to get off their car.

As the subway approaches the proper stop, Bill gives John a signal to get off. However, because there are so many people jostling about, Bill isn't quite sure that John saw his hand motion. So Bill isn't sure whether to get off himself, because it would be catastrophic if he stepped off and left John on the subway.

In this somewhat contrived example, we see the importance of layers of knowledge. Even if John did see the message — so that Bill knows it's time to get off, and John knows that it's time to get off — that isn't enough. Bill needs to know that John knows. Yet that too is insufficient, because John needs to know that Bill knows John knows, and so on. (If John thought that Bill didn't realize John had correctly interpreted Bill's signal, then John might expect Bill to stay on the subway car, not wanting to abandon John. Hence John might not get off the car himself, even though he knows it's the right stop, and even though Bill knows that John knows this.)

These fanciful musings shed more light on the power of YouTube's viewership statistics, which greatly amplify the impact of the Bernanke-bashing bears. It isn't merely that over 4 million people have seen the video blasting the Fed, but that we all know how many of us have seen it.

In a related vein, the surprising popularity of the Hayek-Keynes rap video, and the traffic rankings of explicitly Austrian sites such as Mises.org and LewRockwell.com, have encouraged more and more Austrians to come out of the closet, as it were. They can brush off the put-downs of the "respectable" mainstream economists, because they know that growing numbers of people agree that the Austrians have an important and neglected perspective when it comes to both economic theory and policy.

Not so long ago, the prevailing wisdom was that a young economist was committing career suicide by pursuing an explicitly Austrian research program. This is no longer the case. As I joked to the Grove City undergraduates at this year's Austrian Student Scholar's Conference, nowadays a young scholar is merely cutting off his left arm by announcing his love for Mises and Rothbard. This is progress!

Speaking Truth to Power

Commentators have extensively discussed the impact of Twitter and Facebook on the events in Egypt and elsewhere in the Middle East. What is less obvious is the tarnishing of the image of the Federal Reserve.

Last Saturday "AmpedStatus" (in affiliation with the hactivist group "Anonymous") announced "Operation Empire State Rebellion," in a YouTube video warning of nonviolent civil disobedience if the Federal Reserve doesn't change course. The creepy video — complete with a distorted voice — specifically demands the resignation of Ben Bernanke as a sign of good faith.

More generally, "disrespectful-punk" websites catering to financial readers, epitomized by ZeroHedge and EconomicPolicyJournal, take it as a matter of course that Bernanke has no clothes. The anonymity of the Internet ensures that plenty of respectable Wall Street pros turn to these alternative media to get the real news about the economy — when their boss isn't looking, of course.

The officials at the Federal Reserve and other power centers aren't ignoring the budding green shoots of dissent. Bernanke's duplicitous 60 Minutes appearance was a PR damage-control move that we normally would expect from politicians, not central bankers. Before the present financial crisis, the operations of the Federal Reserve were mysterious and boring.

"In central banking, as in politics, the ruling elite must keep the people in the dark."

But now — because of Bernanke's boldness, the ascendancy of the Ron Paul movement, and the resurgence in Austrian economics, among other factors — a large segment of the public is very interested indeed in what "the Bernank" is up to.

Conclusion

As Murray Rothbard emphasized, our modern banking system is based on fractional reserves, meaning the bankers are always vulnerable to a sudden loss in confidence. Just as political regimes can topple overnight with a change in public opinion, so too can the "strongest" of modern financial systems crumble in the face of a large-scale run on the banks.

In central banking, as in politics, the ruling elite must keep the people in the dark. The rise of the Internet, and in particular outlets such as YouTube, are making that task far more difficult.

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Monetary Lunatics, Is QE3 Ahead?

By: LewRockwell

Austrian School economists have often explained the business cycle using the metaphor of liquor or drugs. The expansion of paper money and credit gives a sense of exuberance, an economic high that leads to excessive risk-taking and ballooning production. But it can’t be sustained. There is a morning after. 

Then what? There is a choice: more drugs and liquor or sobriety. Sadly, the economy – meaning the choices made by you, me, and billions of others – is not permitted to make the choice. It is made for us by our lords and masters in Washington. Here are the meth dealers. Guess what choice they make. 

And so we had Bush’s QE1 (QE stands for "quantitative easing," a euphemism for printing money), but the effects didn’t last that long. Then there was Obama’s QE2, and the effects of which are likely to run out sometime this summer. (As an aside, maybe we should just start referring to the QE[n] administration, inserting the appropriate number, since otherwise these presidents are mostly interchangeable.)

Note the following important point. These various attempts to restore the inebriated happy time have unpredictable and uncontrollable effects, and the metaphor helps here, too. The body is weakened. It might take more of the drug to get the same effect. The drug promotes underlying disease. Each new dose makes the person ever less rational and coherent. 

The stimulant can land everywhere but where it is intended to land by the money printers. The Fed wanted to lift housing prices and re-stimulate the entire real estate sector. But guess what? Housing prices are still falling, and new home construction just tanked at a faster rate than at any time in 27 years. 

What is being stimulated? Stock prices, certainly, but that is not wealth. Stock prices are just prices. They are no different from apple prices, coffee prices, and gas prices. When these go up, do we say: fantastic news, we are wealthier! Of course not. The belief that a rising stock price is great news remains one of the most wicked of all economic myths. 

Then there is the problem of price increases more generally. The producer price index for February has generated terrifying results, though you probably haven’t heard about them. Predictions were for a 0.6% increase but the reality was 1.6%, which points to double digits on an annualized basis. 

And that's just the beginning. Food prices rose the most since November 1974. Prices of raw materials rose by 3.4% in February from the previous month. Intermediate prices climbed 2.0%, with diesel fuel up a monthly 12.6% in February. These huge increases were counterbalanced by falling prices in cars, trucks, warehousing, and other areas that are already showing signs of a post-boom slump.

Will there be a QE3? Most likely. Look at this exchange with Bernanke at the National Press Club:

Q: Will there be a Q3?

Bernanke: In the end, we'll just ask the same questions. Where's the economy going, and what do various inflation indicators look like? We'll ask those questions. If unemployment is still too low, then we may continue. If we're moving towards full employment, then we won't need to stimulate more.

And what is full employment? The Fed’s statisticians believe that it is 6% or so, and we are nowhere near headed that way. Plus, Bernanke is wholly wrong to believe that somehow employment can be used as a measure of economic health. For many decades, socialist economies bragged about zero unemployment, but the economies regressed year after year. Even in mixed economies like ours, high employment is most often an effect of prosperity and never a cause. 

Plus, we can’t believe Bernanke that employment data alone will drive the decision. He is an errand boy for the big banks and Wall Street. That will drive his decisions, along with politics. And we can be all-but-certain that there will be plenty of bad news around by the summer, which will provide enough cover for another round of stimulus. 

Meanwhile, what’s anyone going to do about the problem of much higher prices, which is the ghastly beast waiting around the corner? The truth is that the Fed pretends as if it has nothing to do with this. Bernanke routinely says that prices are formed by supply and demand – which is true enough in a free market, but money creation complicates the picture. 

Another truth is that the Fed doesn’t really care about inflation as much as it cares about the solvency of the banking and financial systems. Bernanke would drive us right into hyperinflation to save his industries. Savers living on pensions just don’t have the political clout to stop the money machine. 

And contrary to Bernanke’s promises, he does not have the ability to turn off the monetary spigot once prices start zooming. The economy is too globalized for that. Keep in mind that though the Fed has loads of power, it has no power to control inflationary expectations and the demand for cash generally – and in hyperinflationary environments these are the driving factors. 

History is littered with monetary managers who believed they were in total control, until the disaster they caused hit. It is hubris of the first order to believe themselves masters of the universe – but hubris is epidemic in Washington. 

QE3 is playing with fire. Or with a third dose of meth. Or another bottle of Four Roses. Choose your metaphor. It is a bad and deeply dangerous policy, all built on the insane view that if you stimulate a zombie with enough fiat money, it will start to live and breathe on its own. 

Reducing this even more, consider: If you drink enough, does your body start to generate its own liquor? The Fed and the government have hooked the American economy on a wicked drug. Our job is to drive the dealers from their seats of power.

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Farm commodities soar as Japan nuclear fears ease

by Agrimoney.com

Agricultural commodity prices staged a dramatic rebound, sending US corn, cotton and pork up the maximum allowed by exchanges, spurred by signs of a resolution to Japan's nuclear crisis and strong export data.

Wheat surged more than 8% in Chicago and Paris, while soybeans and New York sugar added 4%, as the run of bearish sentiment which brought crops to multi-month lows reversed.

Fears of meltdown at Japan's Fukushima nuclear plant eased amid reports that three of the six damaged reactors had been stabilised, with helicopters dumping seawater on the tsunami-damaged plant, and with work underway to resume electricity supplies which would allow conventional cooling systems to restart.

Meanwhile, the dollar sank 1% against a basket of currencies amid expectations of a large sell-the-dollar, buy-the-yen switch as Japanese assets are repatriated to pay for clearing up earthquake and tsunami damage.

A cheaper dollar makes dollar-denominated assets such as agricultural commodities more competitive as exports.

Export surge 

And data on Thursday, covering the week to March 10, showed that European and US exports were picking up even before last Friday's Japanese disaster sent prices of crops, and other riskier assets, into a tailspin.

Farm commodity prices as of 17:30 GMT Chicago corn: $6.46 ½ a bushel, +4.9% Chicago soybeans: $13.40 a bushel, +4.1% Chicago wheat: $7.12 ¾ a bushel, +7.7% Paris wheat: E223.25 a tonne, +8.2% London wheat: E192.00 a tonne, +7.9% New York cotton: 192.12 cents a pound, +3.8% New York sugar: 26.78 cents a pound, +3.6%

Weekly US exports of old crop corn more than doubled to 1.04m tonnes, topping 1m tonnes for the sixth week out of the last seven, with those for wheat, at about 860,000 tonnes for both the current crop year and 2011-12 combined, also exceeding market expectations.

In Europe, wheat exports for the current week hit 540,000 tonnes, the highest for two months.

In livestock markets, sentiment was also spurred by reports that Japan had bought pork, easing fears of interruptions to trade caused by damage to logistics in the top pork-importing nation.

'Strong fundamental intact'

The signs of demand gave vent to feelings among many investors that the falls in crop prices over the last month had been overplayed, with stocks of major farm commodities remaining tight enough to support firm prices even if Japan's disaster trimmed domestic demand and dented world economic growth.

"Amid the tumultuous and downward shift in prices, it would be easy to lose sight of the strong fundamental underpinning of the rally in agricultural markets which, in our view, remains intact," Barclays Capital said.

In fact, many analysts believe that Japan may need to increase imports to replace stocks or production lost to the tsunami.  

In the US, Mike Mawdsley at broker Market 1 said: "The talk was all about how much demand are we going to lose in Japan. Now it is all about how fast they need stuff."

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Why the Yen Should Become Stronger, Not Weaker, Japan Government Faces Debt Crisis

By: ECR_Research

Renate van Ginderen writes: Japan’s Economics Minister Kaoru Yosano stressed that damage from last week's devastating earth quake and tsunami to the country's economy would be limited. However, what he did not mention was that the adverse effects from damaged nuclear plants are likely to be much bigger. 

Additionally, Yosano stressed that he does not think that stock and currency markets are in a state of turmoil. This is a rather strange proclamation, given the stock market’s reaction to escalation of the nuclear problems with the Fukushime nuclear plant. Monday’s fall in the NIKKEI was over 10%; something not seen since the Lehman bankruptcy. Financial markets seem to believe the impact on the Japanese economy will be much bigger than as stated by Yosano.

Another peculiar event was the steep rise of the Yen vis-à-vis the American dollar within 30 minutes of trading, as presumably large Japanese financial institutions repatriate Japanese overseas assets, causing a large increase in the demand for Yen. The Ministry of Finance is watching the situation and will order the Bank of Japan to intervene, should the currency become too strong. In the past, the USD/JPY limit was 80. Anything below this level was crucial and thought to hurt Japanese (car) exporters too much.

However, there might be an important incentive for the Japanese central bank to intervene only if USD/JPY reaches even lower levels than 80, even as at these levels exporters are hurt already. Since a current lack of (nuclear) energy has and will - at least temporarily - disrupt parts of many supply chains, it is likely that Japan is not able to export much the coming months anyway. On the other hand, a strong yen in the coming few months would not be such a disaster for the rest of the economy. Japan is completely dependent on oil imports, as it has no own oil supplies. Now that a large part of the nuclear plants is damaged, whereas before the disaster Japan relied for over 30% of its energy consumption on nuclear energy, imports of oil or seaborne coal have to compensate a resulting energy shortfall. Given that the prices of these two commodities have risen rapidly in the past few months, a strong yen makes importing energy less expensive. Therefore, the advantages of a strong currency will weigh heavier than the disadvantages.

The advantages of a strong yen grow with increasing unrest in the Middle-East and when fears of disruption to the supply of oil - most notably in Saudi Arabia - become reality. In other words: the higher the price of oil (and other energy sources imported by Japan), the more Japan profits from a stronger Yen.

Notwithstanding the enormous toll the earthquake and tsunami take on human life and the damage done to buildings and infrastructure, rebuilding efforts starting shortly after the disaster should provide an economic boost. In this respect, the earthquake, tsunami and problems with nuclear plants should on average not hurt the economy. However, given that the government will take on a large part of the losses, any additional spending will imply a greater public deficit and debt. With a public gross debt that will be reaching perhaps even 220% of Japan’s GDP at the end of FY 2011, fiscal stimuli add to the burden. Declining government tax revenues from both firms and households worsen the problem further.

Many analysts have written that a larger debt does not automatically mean that government finances will run out of control. Given that 95% of public debt is in the hands of Japanese residents and its central bank, and given that the private sector has a large pool of savings left in the form of deposits and cash, Japanese government bond yields are not destined to rise within short due to a lack of capital to fund the deficit and rolling-over of old debt.

Nonetheless, the government’s debt was financed increasingly short-term over the past few years, and from the private sector the savings rate of households is already in negative territory and as the population ages, consumers are drawing down on their pool of savings. Additionally, firms will have to rely in the short term more on the built-up reserves to cover the costs from the current disaster.

To conclude, over the coming months less capital will be available to fund a growing public deficit. This is not automatically or necessarily problematic in the short run, but the problem is that nobody know exactly how large private savings are and to what extent the private sector will draw on reserves rather than invest in Japanese government bonds. For now, the Bank of Japan has proven willing to invest about 3 trillion yen more in JGBs than previously indicated, so this will stave off any capital shortfall. Importantly, there will be a point in time at which private sector savings are not sufficient and/or are not transferred into government bonds, and the Bank of Japan has truly reached its limit regarding monetization of public debt. Until this point, government bond yields will stay low. However, past this point, foreign investors have to be persuaded to invest in JGBs and at that moment, yields will quickly rise to historically high levels. The result is a sovereign debt crisis in the 3rd-largest world economy. 

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Is U.S. Inflation Already at 9%?

By: Money_Morning

Rising prices are hitting U.S. consumers a lot harder than the U.S. Federal Reserve - or the U.S. government - would have us believe. The government-issued consumer price index (CPI) for January showed that "core inflation" - which includes prices for all items except food and energy - was up only 1% from the same month the year before. 

By excluding food and energy prices, as volatile as they may be, the CPI fails to convey the pain that rising prices are inflicting on American households. Indeed, some economists have claimed that the true rate of inflation is closer to 8% or 9%.

To get a true picture of the current inflation situation - and to understand its impact and potential dangers (as well as several investment opportunities) - Money Morning Executive Editor William Patalon III sat down with Chief Investment Strategist Keith Fitz-Gerald for a question-and-answer session on the topic. 

William Patalon (Q): Keith, we talk a lot about "hidden inflation." Is inflation a problem right now? If so, how bad is it? The CPI for January said 1%. Given what we see in the marketplace, it sure looks like a case of hidden inflation. What's the real rate of inflation right now, and is it at its peak, or are prices going to continue to escalate? What do all the statistics in this accompanying chart (see accompanying info-graphic) say to you?

Keith Fitz-Gerald: Short version? The CPI is a joke. Every American knows that in reality it's far higher than that based on what they feel in their wallets every day. Even my 8-year-old son, Kazuhiko, was asking me yesterday why the Lego set he's been saving for is now $33 instead of the $22 he initially spotted a few months ago.

My research suggests inflation is really running between 9% and 12%, which is more commensurate with what we all feel in our wallets every day. As for whether or not inflation has actually peaked, that's a tough call best left to those who deal in "official" numbers - and believe me when I tell you that I'm saying that with all the sarcasm I can muster. 

My view is that inflation is very real and it's already here - despite what those in Washington continue to believe ... either because their data is so heavily manipulated or because of their own deliberate ignorance. Using history as my guide, I also believe it's going to get a lot worse before it gets better.

Q: What are the big inflationary catalysts right now? And what's driving them?

Fitz-Gerald: I think there are a few, but the single-most-important contributory factor is the trillions of dollars central bankers around the world have pumped into the financial system since the crisis began in late 2007. Never mind that the crisis was caused by too much money to begin with; the central bankers have embarked on a course that ultimately risks destroying the very wealth they are trying to preserve.

Granted, 99% of Americans won't see or believe that because the markets have rebounded significantly as part of the reflation process. But they will definitely feel it.

The only reason we've been able to stave off complete inflationary disaster so far is that we've exported it to places like China, India and Brazil as part of our monetary policy, in exchange for the cheap goods we've come to depend on. However, that's coming to an end as those economies grow and begin to struggle with inflationary pressures of their own.

Eventually, inflation will come full circle and when there is no place else for us to export it, there's going to be hell to pay.

Q: How about the Middle East violence and uncertainty? How is that contributing to this?

Fitz-Gerald: Inflation was already well under way before the powder keg there exploded, so this is not as much a primary inflation driver as most people think. That's not to dismiss it, because there is a direct relationship between scarcity and higher prices especially at the consumer level. 

The key is time - and by that I mean time as in how fast prices climb and how long they stay at elevated levels.

Most companies are prepared to absorb short-term volatility. But longer-term, there is no doubt they'll pass along to consumers (you and me) the higher fuel and petroleum costs that are part of their manufacturing processes. Many, like airline and transportation companies, are already doing so. So are food suppliers and materials makers, for example.

I've noticed, for example, a dramatic price rise in what it takes for me to get home to Japan, or anywhere in the Pacific Rim this spring. My breakfast costs 60% more now than it did three years ago and my wife makes no bones about mentioning by just how much the cost of salmon has risen at our local Costco (Nasdaq: COST). Many readers have probably noticed similar things in their own lives.

But, getting back to the Middle East ... the risk there is that the unrest that's right now confined to a couple of countries spreads to the greater region ... where we're talking about 60% of the world's oil supply being potentially at risk. I've diligently prepared our Money Morning and Money Map Report readers for this over the past 12 months and we've already profited significantly from our actions. But - and I can't say this strongly enough - the game is just getting started.

Q: What's the end-game here? By that I mean, what's the potential fallout? Could it stall the recovery? With unemployment still up in the 9% neighborhood, are we in danger of experiencing a 1970s-style period of "stagflation?" If that occurs, what's the outcome you see there?

Fitz-Gerald: I don't think the end game is as clear-cut as many people would like to believe.

On one hand, the laws of money are immutable, so we will have to pay the piper, but let's not forget we have virtually the entire G-20's banking apparatus playing against that possibility. They're obviously well-intentioned. But it's all theory. T hey are complete economic morons when it comes to real money. 

That's a strong statement, so let me give you an example. New York Fed President William Dudley recently told business leaders that inflation was not a big deal, especially food inflation. He noted that people forget that even as food prices are rising, other prices are falling and mentioned the new Apple Inc. (Nasdaq: AAPL) iPad 2 as an example ... which elicited guffaws from much of his audience - and downright angered the rest who challenged him by asking how long it's been since he actually went shopping.

Dudley then went on to say that "while rising prices are giving some of you [audience members] headaches, they are not likely to lead to a sustained rise in inflation to levels inconsistent with our dual mandate."

I'm not sure these guys are on the same planet as the rest of us.

By removing the freedom to fail and, instead, insisting on bailout after bailout, our leaders are propping up zombie financial institutions that will ultimately come back to haunt us. History shows unequivocally that we cannot live on "free" money forever. And it's worth noting at the risk of sounding like a broken record that no nation in recorded history has ever bailed itself out by debasing its currency on anything other than a short period of time. That's never happened - and it's not likely to. 

Q: It seems to me that the U.S. Federal Reserve, which contributed to this escalation in prices with its "QE" policies, is now stuck between a rock and a hard place. The longer it maintains current policies and keeps rates at historic lows, the worse price escalation will get. But if it turns off the spigot, it risks shutting off the recovery, too. Is that how you see it?

Fitz-Gerald: I see it that way, too. By keeping rates so low for so long, the Fed is not only risking inflation, but the catastrophic collision of entitlements - like Medicare and Medicaid - to the tens of trillions related to everything from mortgage debt to personal credit cards. 

I think it's a financial deathtrap, for lack of a better term. What "Team Bernanke" is doing is locking down the short end of the yield curve while leaving longer-term risks to the markets in an effort to revive consumption, inventory build-out, and other short-term "stimulus" that will - at least according to theory, anyway - translate into sustainable growth.

The problem with this is twofold. First, as long as the U.S. is in the driver's seat, Bernanke can get away with it. But we now have nations like China calling their own shots [that are] increasingly unwilling to submit to Washington's policy missives. Second, "stimulus" spending - as Washington has defined it - doesn't work.

If it did, our economy would be screaming along at 8%, or more. Instead we're like a 1970s Pinto limping along on three cylinders and risking an explosion if we get rear-ended.

In financial terms, the rest of the world is losing faith as reflected in the premiums they're now attaching to the debt they purchase. And that makes sense for the following four reasons:

1.The Fed missed this crisis-in-formation, and even in late 2007 insisted that everything was hunky-dory. My favorite was Bernanke who fabulously stated that the risks were "contained." And we can see how accurate a call that proved to be. So if you're tempted to put your faith in Team Bernanke, ask yourself this: Given this earlier miscue, why would we believe the Fed will be able to spot the turning point when everything is "fine" and back off the quantitative easing accordingly, which is one of the central bank's key arguments for taking the actions that it has taken?

2.Our financial markets have gotten hooked on super-low interest rates in much the same way someone gets hooked on drugs. Just think about what happens when you take away the narcotics ... history suggests we'll see the same "withdrawal" in the financial markets when cheap money gets taken away. From a political standpoint, this is a real time bomb: There will be untold pressures to make sure things are really recovering before the Fed raises interest rates. Of course, what this means in practical terms is that the Fed will keep rates too low for too long - and make too much money available - until it is "sure" we're on our way. Many market-watchers, analysts and traders - myself included - believe this will inflate another financial "bubble." Truth be told, I think the central bankers have already done that. 

3.An increase in interest rates will be the financial equivalent of a self-inflicted wound. It will dramatically increase our refinancing costs as borrowing costs go up. In very real terms, this will mean that banks have to potentially pay more on their deposits than they make from their investments as rates rise. Bear in mind that the Fed actually needs low rates to pay for all the debt it has pumped into the financial system. In that sense, rising rates will be like the adjustable mortgage from hell as the federal government struggles - and has to make tough choices - in an effort to service this debt.

4.And finally, don't forget that t he Fed has been buying trash as part of the bailout process - mortgage-backed securities, swaps, worthless bonds and other unconventional debt conjured up by investment banks - from Wall Street and from other parts of our economy. And while our central bankers may believe that they will be able to easily sell these assets "when the time comes," that clearly won't be the case. 

Think about it. Those assets will be worth less because a.) their value moves opposite interest rates, meaning any increase in rates will drive down their value, and b.) these assets were junk to start with. The banks that offloaded it to Uncle Sam are all too glad to be rid of it and I can't think of any reason why they'd take it back.

Folks often refer to Hollywood as "La La Land." I submit t hose folks have never been to Washington.

Q: I've asked you this type of question before, and you always seem to have a great response. So I'm going to pose it again. If President Barack Obama and U.S. Federal Reserve Chairman Ben Bernanke hired you to help the U.S. government arrest this rise in costs, what advice would you provide? What strategy would you employ?

Fitz-Gerald: I think the path here is very simple. But it won't be popular. And it won't be painless. I would tell the administration to:

1.End the bailouts and stop printing money. You cannot suspend free-market forces and still have the economy function. If a company is going to fail, let it fail. 

2.Outlaw "non-deliverable" credit-default swaps to remove the speculative component from the debt market. By doing this, we will shift the focus of the economic recovery from Wall Street back to Main Street - where it belongs.

3.Start to raise interest rates immediately - before the market does it for you. If you wait for that to happen, you'll not only lose control of your domestic destiny, you'll lose what little global respect this economy still commands.

4.Partially tie our currency to oil and commodities - a move that's important because it will remove the uncertainty about what the U.S. dollar is actually "worth."

5.Freeze the budget and allow private sector growth to compensate. Quit trying to "help" us and get out of the way. 

6.Simplify the tax code and flatten it out so that everyone contributes equally. The U.S. tax code is 8 million lines long ... need I say more?

7.Make it easier to start a business. Give people a reason to put their money to work and an environment that makes hiring people cost effective and not punitive.

8.Address Social Security - privatize it if you have to - and Medicare while you're at it. 

9.And, finally, restructure the system in a way that encourages ownership and equity, instead of the current one that encourages people ... and companies ... to borrow money at seemingly ever-increasing levels. It's time to acknowledge reality.

Q: Lastly, given what you see for the markets, could you give investors a couple of ideas as to how they should invest - both to protect themselves and, even better, to profit?

Fitz-Gerald: You bet. In my talks around the world, I like to remind investors of an important point - it's kind of a mantra of mine: Chaos is actually opportunity in disguise. Washington is creating chaos - but from that we'll see many wealth-building opportunities arise.

For investors, the key thing to do in the years to come is to make investment choices that can weather the storm, and profit from the opportunities that emerge. Here are some very sound choices for turbulent times:

•Altria Group Inc (NYSE: MO), recent price: $24.43: Altria is a giant cigarette producer with a 6.23% yield that's a smart choice in rough markets. You may not like smoking any more than I do, but t he firm's beta is a very low 0.47, which means the stock is slightly less than half as volatile as the broader markets. Operating margin is a healthy 39%.

•Ecopetrol SA (NYSE ADR: EC), recent price: $39.70: Ecopetrol is a vertically integrated oil company that's based in Colombia. That makes it a play on Latin America's robust growth - with a nice 2.5% dividend, to boot. This stock has a beta of 1.01 - which means it's about as volatile as the overall markets. However, I'm willing to overlook that volatility, since the company's five-year Price/Earnings/Growth Rate (PEG) ratio is 0.53 which suggests there is still good value at a fair price.

•iShares Barclays TIPS Bond Fund (AMEX: TIP), recent price: $110.09: This exchange-traded fund (ETF) invests exclusively in Treasury Inflation Protected Securities (TIPS). W hen inflation really blooms, so, too, will its share price. The yield is still 2.4%, which is not much in the scheme of things but given its ability to help hedge off rising prices, I'll take it.

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Tsunami risk to Japan's self-sufficiency in rice

by Agrimoney.com

Soil damage caused by the tsunami may cost Japan its prized self-sufficiency in rice, a leading farm academic has said, adding his voice to those forecasting that the disaster will increase the country's crop imports.

The Tohuku region of northern Japan, which bore the brunt of the tsunami, may see its predominance in national rice production threatened if salt water left by the disaster caused significant fertility loss to land, grain economist Mark Welch said.

Salt water damage to land following tsunamis is a widely-recognised threat, by bodies including the UN's Food and Agriculture Organisation, which rates rice as a crop with medium-tolerance to salt, less than that of barley and cotton.

"Japan is self-sufficient in rice production but this capability may be threatened if sea water from the tsunami contaminated farm land," Mr Welch said.

Tohoku accounted for 26% of Japan's rice area last year, according to Japanese farm ministry data, with Kanto to the south, which includes Tokyo, and which suffered some tsunami damage, accounting for a further 19%.

Iconic crop

Japanese, while eating on average half as much rice as they did 50 years ago, still see the grain as a part of the national culture, prizing the sticky quality of home-grown grain, which is also used for making the alcoholic drink sake.

The country has encouraged self-sufficiency in rice, even while importing hefty quantities of other grains and, through subsidies, kept production near levels of consumption.

While the country typically imports some 700,000 tonnes of rice a year, this is often down merely to meeting World Trade Organisation requirements, imposed in recognition of the subsidy regime.

'Increase in imports' 

Mr Welch's comments came he warned that Japanese farming "may face long-term impacts" from the earthquake and tsunami.

Breakdown of Japan's rice-growing regions, 2010 - area, and % of total Tohoku: 419,000 hectares, 26% Kanto Tosan: 302,000 hectares, 19% Hokuriku (NW Chubu): 211,000 hectares, 13% Kyushu: 190,000 hectares, 12% Chugoku: 118,000 hectares, 7% Hokkaido: 115,000 hectares, 7% Kinki: 111,000 hectares, 7% Tokai (south Chubu): 104,000 hectares, 6% Shikoku: 58,000 hectares, 4% Data: MAFF, Tamu. Rounding takes total of percentages to 101%

"Even if the major ports are still functioning, inland transportation systems are seriously damaged," Mr Welch, at Texas-based agricultural university Tamu said.

"The net effect of the disaster on the grain trade may be an increase in commodity imports to replace domestic production."

A report from US Department of Agriculture attaches in Tokyo released late on Wednesday, but drawn up before the earthquake, had forecast Japan's corn imports – the world's biggest - holding steady  at around 16m tonnes in both 2010-11 and 2011-12.

While smaller livestock herds are decreasing use in fodder, "the general trend in recent years is that increases in food corn imports have been compensating for declines in feed corn imports", the attaches said.

"The driving force in food corn demand comes from the beverage sector, particularly for high fructose corn syrup used in low alcoholic drinks like happoshu [a light beer] and other alcoholic beverages.

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World War III is coming: Marc Faber

by Commodity Online

The earthquake, tsunami and subsequent nuclear catastrophe in Japan will lead the country to spend heavily into re-building infrastructure. While this will lead to inflation in Japan, the current global economic problems along with the US quantitative easing (up to QE18) will result in World War III, says Marc Faber, noted global economic analyst.

In an interview to CNBC, Faber, the editor of The Gloom, Boom & Doom report made a set of predictions – which included many more rounds of quantitative easing (up to QE18), and eventually World War III.

Following are some of his key comments on Japan earthquake,  nuclear disaster and the possibility of World War III.

**The damage from the Japanese crisis will necessitate very heavy spending to rebuild infrastructure, and “that will be somewhat inflationary for the Japanese economy.

**The situation in Japan is very negative for the Yen in the long run. This is a turning point for the Yen.

**The damage is a huge financial burden on Japan government that is already indebted.

**I think it’s healthy that the markets start to focus on something else than what Mr. Bernanke is telling the press all the time. And then QE3 will come, QE4, QE5, QE6, QE7, whatever you want. The money printer will continue to print, that I’m sure.

**Mr. Bernanke doesn’t know much about the global economy, but he watches the S&P every day. I would fully expect more quantitative easing. There’s nothing else they (the Federal Reserve) can do actually.”

**Oil is very attractive from a risk/reward point of view. Faber's macroeconomic forecast is an “ultra-bearish scenario” where “everything will collapse and that there will be World War III, and collapsing countries in the middle east, and then the supply will be curtailed and prices will go up.

**Until very recently the Fed has had very few critics. Very few people criticized the Fed’s policies under Mr. Greenspan and Mr. Bernanke. Over the last few months a lot of critical comments have come up about the Fed and its money printing habit, but I beg you, the S&P drops 20%, all the critics will be silenced, and they will all applaud renewed money printing. Sadly, sadly.”

Faber did not specifically mention gold in this interview, but considering he has been bullish on the yellow metal for much of the past decade and sees so many additional rounds of QE ahead, he likely remains quite positive on gold.

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UN: Radiation to Hit U.S. By Friday

By Guest Author

A United Nations forecast of the possible movement of the radioactive plume coming from crippled Japanese reactors shows it churning across the Pacific and touching the Aleutian Islands on Thursday before hitting Southern California late Friday.
***
The projection, by the Comprehensive Test Ban Treaty Organization, an arm of the United Nations in Vienna, gives no information about actual radiation levels but only shows how a radioactive plume would probably move and disperse.
***
The forecast, calculated Tuesday, is based on patterns of Pacific winds at that time and the predicted path is likely to change as weather patterns shift.
***
The Japan forecast shows that the radioactive plume will probably miss the agency’s monitoring stations at Midway and in the Hawaiian Islands but is likely to be detected in the Aleutians and at a monitoring station in Sacramento.The forecast assumes that radioactivity in Japan is released continuously and forms a rising plume. It ends with the plume heading into Southern California and the American Southwest, including Nevada, Utah and Arizona. The plume would have continued eastward if the United Nations scientists had run the projection forward.

The Times provides a series of images to illustrate the projected path of radiation, ending with this one:

(click here for a moving graphic timeline.)

Similarly, Yoichi Shimatsu – former editor of the Japan Times Weekly, who led the field research for an architectural report on structural design flaws that led to the tsunami death toll in Thailand – wrote a couple of days ago:

The Pacific jetstream is currently flowing due east directly toward the United States. In the event of a major meltdown and continuous large-volume radioactive release, airborne particles will be carried across the ocean in bands that will cross over the southern halves of Oregon, Montana and Idaho, all of California, Nevada, Utah, Colorado, Wyoming, the Dakotas, northern Nebraska and Iowa and ending in Wisconsin and Illinois, with possible further eastward drift depending on surface wind direction.

The timeline of the UN’s forecast is suprising, given that the earthquake hit on March 11th, and Accuweather formerly estimated the following times for radiation – in a worst-case scenario – to reach the West Coast:

Calculated time for radioactive particles to cross the Pacific from the power plants in Japan to big West Coast cities if the particles take a direct path and move at a speed of 20 mph:

Cities	Est. Distance (miles)	Est. Time to Cross Pacific (days)
Anchorage	3,457	7
Honolulu	3,847	8
Seattle	4,792	10
Los Angeles	5,477	11

But it is vital to note that many experts are saying that only extremely low levels of radiation will hit Americans. As the New York Times reports:

Health and nuclear experts emphasize that radiation in the plume will be diluted as it travels and, at worst, would have extremely minor health consequences in the United States, even if hints of it are ultimately detectable. In a similar way, radiation from the Chernobyl disaster in 1986 spread around the globe and reached the West Coast of the United States in 10 days, its levels measurable but minuscule.
***
On Sunday, the United States Nuclear Regulatory Commission said it expected that no “harmful levels of radioactivity” would travel from Japan to the United States “given the thousands of miles between the two countries.”
***
On Wednesday, the agency declined to release its Japanese forecast, which The New York Times obtained from other sources. The forecast was distributed widely to the agency’s member states.
***
The chairman of the Nuclear Regulatory Commission, Gregory B. Jaczko, said Monday that the plume posed no danger to the United States. “You just aren’t going to have any radiological material that, by the time it traveled those large distances, could present any risk to the American public,” he said in a White House briefing.
***
In Germany on Wednesday, the Federal Office for Radiation Protection held a news conference that described the threat from the Japanese plume as trifling and said there was no need for people to take iodine tablets.

It is also important to remember that this is likely not just a one-day freak-out kind of event. As the Times previously noted:

Experts in Japan and the United States say the country is now facing a cascade of accumulating problems that suggest that radioactive releases of steam from the crippled plants could go on for weeks or even months.

And keep in mind that iodide only protects against one particular radioactive element: radioactive iodine, technically known as iodine-131. Iodine-131 has a half life of only 8.02 days. That means that the iodine loses half of its radioactivity within 8 days.

In contrast, plutonium has a half life of up to 80 million years, and is one of the most hazardous substances in the world. Fukushima reactor number 3 burned a plutonium-uranium mix, and has lost containment.

However, as NPR points out:

Although plutonium is a long-lived emitter of radiation, it is also quite heavy, so it is not likely to move very far downwind from its source.

Therefore, Americans will likely not be exposed to any plutonium.

Other possible radioactive elements from Japan include some elements – like radioactive nitrogen (with a half life of seven seconds) – decay so quickly that they could not possibly make it to the U.S. in radioactive form.

The New York Times noted last week that – in addition to iodine-131, the big danger is cesium:

Over the long term, the big threat to human health is cesium-137, which has a half-life of 30 years.
At that rate of disintegration, John Emsley wrote in “Nature’s Building Blocks” (Oxford, 2001), “it takes over 200 years to reduce it to 1 percent of its former level.”
It is cesium-137 that still contaminates much of the land in Ukraine around the Chernobyl reactor.
***
Cesium-137 mixes easily with water and is chemically similar to potassium. It thus mimics how potassium gets metabolized in the body and can enter through many foods, including milk.
***
The Environmental Protection Agency says that … once dispersed in the environment … cesium-137 “is impossible to avoid.”

Cesium-137 is light enough to be carried by the wind a substantial distance.

But this is still largely conjecture, as neither the government or private sector scientists have yet publicly disclosed the exact radioactive elements headed towards the U.S.

Again, the important thing is whether a little or a lot of radiation makes it to America. If only a little bit, it’s no big deal. We’ve all had x-rays, eaten bananas (which – believe it or not – contain radioactive potassium-40), and been exposed to other forms of low=level radiation. Indeed, the Times notes we’ve all been exposed to some cesium-137 our whole lives:

The Environmental Protection Agency says that everyone in the United States is exposed to very small amounts of cesium-137 in soil and water because of atmospheric fallout from the nuclear detonations of the cold war.

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U.S. Government Evermore Reliant on Foreign Investors to Finance Debt

By: Kieran_Osborne

Despite the Fed recently surpassing China as the largest owner of U.S. government debt, the U.S. remains heavily reliant on foreigners to fund the government’s ongoing fiscal largess. Geithner’s Treasury Department has firmly focused new issues at the mid to longer end of the yield curve (since Geithner assumed office, the average length of marketable Treasury debt held publicly has increased by nearly one year). Despite the Treasury taking advantage of the ultra-low interest rate and funding environment, there are substantial refinancing issues over the near term; moreover, many of these maturing issues are foreign owned. Should sovereign fiscal concerns spread to the U.S., in concert with the evermore attractive interest rates offered internationally, refinancing the U.S. debt could become increasingly difficult if foreign investors turn their backs.

The total outstanding marketable U.S. Treasury debt has expanded considerably recently (total outstanding debt stands at over $14 trillion; marketable debt excludes a substantial portion of intra-governmental holdings). Indeed, through February 28, 2011, total marketable debt increased 22.2% from the year before:

At the same time, much of the new Treasury issuance has been targeted at the middle to long end of the yield curve. The annual change in total marketable Treasury notes (securities issued with maturities of 2 – 10 years) and bonds (securities issued with a maturity of 30 years) through February 28, 2011 was 32.6% and 23.1%, respectively. This trend is evidenced by the decline in the percentage of total marketable debt outstanding that is maturing over the next one, two and three year time periods:

At a glance, the above chart would imply that refinancing pressure may have abated somewhat, but this is not necessarily the case. In fact, total U.S. marketable Treasury debt maturing in the next 12 months has held relatively constant, at historically high levels, while the total debt maturing within two and three years continues to expand.

Simultaneously, the percentage of total US marketable Treasury debt owned by foreigners has been trending upwards, albeit experiencing a moderate drop-off recently.

Implying that the overall level of foreign owned US Treasury debt that is maturing in the coming one, two and three years also continues to trend upwards:

To put this in context, over the coming 12 months, the U.S. Treasury must refinance, on average, approximately $5.4 billion dollars in foreign owned debt every single business day. This number doesn’t include any new issuance. Given the U.S. government just posted a record monthly budget gap for February, the substantial fiscal financing requirements aren’t going away anytime soon. Suffice it to say, the US remains highly reliant on foreigners to fund the ongoing elevated levels of government debt and immediate refinancing concerns are apparent, despite recent Treasury issuance targeted at the longer end of the yield curve.

Now consider this: the U.S. fiscal situation has deteriorated significantly; based on numerous metrics of fiscal health, the U.S. is in a relatively worse situation than many of its international peers. Combined with the Fed’s policies of intentionally overvaluing U.S. Treasury securities via quantitative easing policies (as stated above, the Fed is now the largest holder of U.S. government debt; who says the Fed isn’t monetizing the debt?), in the process driving U.S. rates to evermore unattractive levels relative to sovereign debt yields found outside of the U.S. As a result, rational investors may increasingly seek to access less manipulated, more attractive returns in countries that appear much more fiscally sound. We are already seeing this dynamic play out, albeit at the margin. The U.S. dollar weakness is a manifestation of this shift in investor preference. Investors may want to consider positioning themselves accordingly, should these marginal shifts in investor sentiment adjust

We manage the Merk Hard and Asian Currency Funds, no-load mutual funds seeking to protect against a decline in the dollar by investing in baskets of hard and Asian currencies, respectively. To learn more about the Funds, or to subscribe to our free newsletter, please visit www.merkfund.com.

Kieran Osborne

Merk Mutual Funds

Kieran Osborne is Senior Analyst and member of the portfolio management group at Merk Investments; he is an expert on macro trends and currencies and has significant international market experience. Prior to Merk Investments, Mr. Osborne was an equity analyst at Brook Asset Management, where he worked in both the Australian and New Zealand markets. He has also worked in New York for MCM Associates, a U.S. hedge fund.

The Merk Asian Currency Fund invests in a basket of Asian currencies. Asian currencies the Fund may invest in 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 invests in a basket of hard currencies. 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 hard or Asian 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.merkfund.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.merkfund.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.

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Will Fed Hint at QE3 and Surprise the Stock Market Bears?

By: Chris_Ciovacco

Will the Fed Hint atGiven the stark contrast between asset class performance before and after the implied announcement of QE2, the Fed’s statements related to quantitative easing in the coming weeks will have a significant impact on the outlook for stocks and the relative attractiveness of asset classes, market sectors, and subsectors. 

The Fed is scheduled to issue statements on March 15 and April 27, 2011 with the following concerns as a backdrop:

• Higher food and oil prices.
• Unemployment hovering near 9%.
• Turmoil in the Middle East.
• Devastation and ongoing uncertainty in Japan.

With QE2 set to end on June 30, the natural questions for market participants are:

• Should we be concerned?
• Did QE1 and QE2 impact asset prices?
• Is QE3 a possibility?

We believe the answers to all three questions are “yes”. The chart below shows the very uncomfortable transition from QE1 to QE2.

For those market participants who doubt whether QE3 hints by the Fed will have an impact on asset prices, the chart below shows the S&P 500’s performance after Ben Bernanke’s August 27, 2010 Jackson Hole speech, which basically told the markets QE2 was on the way.

The role of asset prices, balance sheets, and ‘full employment’ in the Fed’s decision-making process are often underestimated by those who focus primarily on inflationary pressures. Consequently, many investors and economists are forecasting the U.S. Federal Reserve will raise rates sooner than history would suggest. The chart below was published by Bloomberg on February 9, 2011. 

Bloomberg’s commentary related to the chart above:

After the past two U.S. recessions, the Fed didn’t start raising policy rates until joblessness had fallen about three- quarters of the way back to the full-employment level, the CHART OF THE DAY (above) shows. To satisfy that requirement, the jobless rate would need to be 6.5 percent, compared with today’s 9 percent.

Just as the chart above implies rates may stay lower longer than most believe, it is also possible the market may be underestimating the odds of the Fed bringing QE3 to life in the coming months. If any portion of the March 15 and/or April 27, 2011 Fed statements leave the door open to QE3, the impact on the markets could be significant. We recently studied the performance of ninety-two assets classes/sectors/investment options when:

• QE1 Was Not In Play: Between April 23, 2010 and August 26, 2010.
• QE2 Was In Play: Between August 27, 2010 and March 9, 2011.

The results of the study will help us focus on different areas of the market based on the Fed’s statements related to quantitative easing. The table below summarizes our findings when looking at the top eighteen performers under the two scenarios. The very limited overlap in asset class performance between the left and right sides of the table below highlights the importance of the Fed’s stance on quantitative easing relative to the outlook for both defensive and inflationary/economically-sensitive assets.

The investments that provided the detail behind the summary table above are shown in the colored tables below. Notice only two investments, silver (SLV) and agriculture (RJA), performed well in both QE environments. The investments highlighted in blue below recently showed improving relative strength which supported raising some additional cash in the last week. 

If the Fed leans toward more quantitative easing, we will focus on assets on the right side of the tables above and below, including expanding our search to similar inflationary options. If the Fed leans toward wrapping up quantitative easing in June, we will consider the relative merits of the defensive assets on the left side of the tables above and below.

All bull markets have backing from market participants based on both speculation and fundamentals. Speculators are a normal part of functioning asset markets since they provide needed liquidity. A healthy and sustainable bull market has a reasonable balance between its reliance on fundamentals and speculation.

The rally off the 2010 summer lows, in our opinion, was based heavily on speculation. On August 27, 2010 with the financial markets teetering on the deflationary abyss, Ben Bernanke signaled QE2 was on the way in his Jackson Hole speech.

The speculative bent to investing since the summer 2010 lows has many market participants, including us, concerned that an end to quantitative easing could usher in a repeat of the sharp declines in asset prices seen between April 23 and August 26, 2010. If this scenario plays out, we will monitor the relative strength of the defensive assets and inflationary assets listed above in order to make more informed investment decisions.

As we await the Fed’s statements due on March 15 and April 27, we should keep in mind Federal Reserve Chairman Ben Bernanke’s response, while recently at the National Press Club, to a question about the potential for QE3:

“In the end, we’ll just ask the same questions. Where’s the economy going, and what do various inflation indicator look like? We’ll ask those questions. If unemployment is still too low, then we may continue. If we’re moving towards full employment, then we won’t need to stimulate more.”

Remarks from William Dudley, President of the Federal Reserve Bank of New York, during a recent speech at New York University may also provide some insight to the Fed’s stance:

“The economy can be allowed to grow rapidly for quite some time before there is a real risk that shrinking slack will result in a rise in underlying inflation.”

The recent drop in the unemployment rate may also factor into the Fed’s decision-making process. Caroline Baum noted in a recent opinion piece:

In the last two months, the civilian unemployment rate plummeted from 9.8 percent to 9 percent. While payroll growth, derived from a separate survey of businesses, was tepid, history suggests such steep falls aren’t a drop in the bucket. Large month-to-month declines in the unemployment rate are rare and “usually signal the start of a very strong upturn in growth,” says Joe Carson, director of economic research at AllianceBernstein in New York.

With a weak stock market, high unemployment, and recent events in Japan, comments made by Charles Evans, President of the Federal Reserve Bank of Chicago, during a recent interview with the Financial Times may foreshadow Fed statements in March and/or April geared toward accommodative policy:

“The message that comes out of what I think of as high-quality research on this subject is that policy ought to remain accommodative for really quite a while, even a while after conditions start to improve.”

A March 2 BusinessWeek/Bloomberg article covering the possible continuation of the Fed’s asset purchase program stated:

A third round of purchases “has to be a decision” of the Federal Open Market Committee, and “it depends again on our mandate” for stable prices and maximum employment, Bernanke said in response to Texas Representative Jeb Hensarling, the House panel’s vice chairman and a critic of QE2.

Responding to a question from Representative Nydia Velazquez, a New York Democrat, Bernanke said the Fed’s policy of keeping its benchmark rate near zero for an “extended period” helps provide support to the economy, “which in our judgment, it still needs. The economy’s recovery is not firmly established, and we think monetary policy needs to be supportive,” he said.

Looking at the case for ending QE2, Bloomberg noted on March 4:

Economists such as Joseph Lavorgna say the Fed should stick to its commitment to end the program in June. “What markets would like are clear rules,” said Lavorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. “If they said they are going to end in June, they should end in June.” That’s a view shared by the Philadelphia Fed’s Plosser, who is also a voting member of the FOMC this year.

Regardless of whether it is embedded in the March 15 or April 27 Fed statement, based on the remarks from the Atlanta Fed’s Dennis Lockhart, we can expect some direction from the Fed relative to where they are headed with quantitative easing:

“It is important that we communicate so we don’t surprise markets, regardless of the chosen path of that particular policy,” he told reporters after a speech in Tallahassee, Florida.

An AP article from March 14 does a good job summing up the situation as the Fed heads into their March 15 meeting:

The Fed chief and a majority of his colleagues argue that the economy still needs support from the bond purchases, especially with unemployment still high and home prices in many areas depressed. But a vocal minority on the Fed has raised concerns that the bond purchases, combined with higher prices for food, fuel and other commodities, will spread inflation through the economy. They also say they worry that the purchases could feed speculative buying that could inflate new bubbles in the prices of stocks or other assets.

We believe the key portions of the AP statement above are the “Fed chief and a majority of his colleagues” versus “a vocal minority”. The history of the Fed in recent years is that the Chairman tends to set policy. Since Ben Bernanke remains at the helm, we will remain open to the possibility of a third quantitative easing program (QE3), which could significantly alter the market’s general outlook and relative performance of asset classes. Another scenario, a stronger than expected economy, could discount the need for QE3, but under those conditions inflationary assets will most likely outperform defensive assets.

Some anecdotal evidence that traders positioned themselves for the possibility of inflationary statements from the Fed comes via the relative strength charts below. The charts show Monday’s trading session. Notice how defensive assets weakened relative to the S&P 500 in the afternoon.

Inflationary assets drew more interest from buyers late in the day. These charts mean little except that the expectation on the street is leaning toward inflationary rather than deflationary statements from the Fed on March 15.

Monday’s market action did contribute to our decision to take no further defensive actions near the close. We will wait for the Fed’s statement and monitor the market’s reaction both on Tuesday afternoon and Wednesday morning.

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