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Ben Bernanke’s smiling face on the cover of
the April issue of The Atlantic is a testimony to how short America’s
collective memory is. While
the Fed chief is feted as the savior of the
global economy thanks to his monetary policy genius, it’s apparent how quickly
many have forgotten how his sluggish response to the brewing credit storm in 2006-2007 brought the U.S.
to the edge of the abyss.
A more recent example of a dilatory central bank response to a major economic crisis can be seen
in the European Central Bank’s
(ECB) eleventh hour decision to roll out a €1 trillion rescue package for the troubled
eurozone. Where was the ECB in 2010 and 2011 when such decisive
action could have prevented
– or at least mitigated
– much of the global market
volatility and European economic misery?
The problem confronting the global economy
has more to do with the hyper-aggressive
action of the central banks than
it does their unresponsiveness to
crises. What are the economic
consequences of $600 billion worth
of quantitative easing combines with
a €1 trillion ECB bailout? In the days before interconnected
economies perhaps these sums would
have been relegated to the regions
in question. But today, rash monetary
policy action has global repercussions.
Indeed, we’re already seeing the unintended results of this liquidity explosion. Although so-called “core” inflation
remains muted in the U.S.
and other developed
nations, retail food and
fuel prices are rising globally and have led to major
social and economic problems
in less developed
countries in the Middle East. Especially hard hit
by this aspect of price inflation
are the elderly and the poor.
As the writer of Ecclesiastes tells us, “money answereth
all things,” so there is a basis for believing that artificial money creation by
central banks can at least temporarily ameliorate debt crises. The problem is that
is that money and credit should enter the economy through normal channels without creating imbalances. The only way this
can happen is if the money is backed by a nation’s productivity. Production is the
ultimate money standard and with
insufficient demand for
money arising from diminished production, it follows that excess liquidity will flow into less productive channels. Stock
and commodity speculation
are among the biggest such liquidity traps today and are clearly benefiting from the recent liquidity creation of the
central banks.
Oil and gasoline prices may yet prove
to be the Achilles Heel
of the U.S. recovery, however.
It would indeed be ironic if a commodity (oil) for which there is
ample domestic supply and
decreased demand should prove to be the undoing of the central bank’s efforts at resuscitating the economy. The Fed’s dual mandate involves
maintaining optimal levels
of employment and promoting
price stability. By
“price stability”
Chairman Bernanke has made clear
he means to fight deflation with every monetary
policy weapon at his disposal.
Deflation (falling prices) is the free market’s way of internally cleansing itself after a sustained bout of
inflation (rising prices).
The old saying that “price cures price” sums it up nicely. Whenever prices for goods are bid too high by the free market, buyers pull back and price eventually falls to a level the market will bear. When
price isn’t allowed to fall to its natural level
and central banks insist
on artificially boosting prices to prevent natural deflation, the market never fully works out its excesses and becomes even more imbalanced as prices rise every higher
without properly “correcting.” At some point along this artificial continuum, a
crash becomes inevitable.
Just as periodic sickness is nature’s
way of purging the body, bear markets are the market’s way of purging excesses that have built up along the way. The problem we face today is that
the Fed never allowed sufficient time for the market
to “cure” high retail good prices before it acted to stimulate
the economy in 2009 and beyond. Chairman Bernanke betrayed an anti- free market bias when he
told The
Atlantic that “there
is still scope for policy to ameliorate the effects of necessary rebalancing on the public, to help shorten
the recession….where
you can, you try to short-circuit the process.”
By not letter financial nature take its course artificial pressures
continue to build within
the monetary system. If the U.S. had not been insistent on avoiding
the day of reckoning so that it
could bailout the big banks, all that bailout money could have been used to directly stimulate the U.S. economy. Instead, the Fed chose
to repair the elite's
balance sheet so the banks wouldn't have to face the
music.
The big banks are now flush with liquidity while the underlying trend is deflationary. This is the very definition
of the inefficient use of capital. As someone has said, we normally
see such travesties in
state capitalism: China gets
empty cities and
buildings; we get banks with state-repaired balance sheets.
Another danger inherent within central bank engineered bailouts is that
while monetary stimulus can cushion the worst of the impacts of a crisis,
eventually conventional monetary policy reaches its limits
and fiscal stimulus turns, sometimes
prematurely, to austerity.
As The Economist
recently observed,
“Federal stimulus is
steadily giving way to restraint. More drastic tightening looms at the end of the year if George Bush’s tax cuts, already
extended, expire, and a ‘sequester’
automatically slashes federal outlays.”
As the U.S. economy has
the appearance of a recovery
underway, the pressure is
already off the Fed to commence another
round of quantitative easing. Central banks tend to consistently underestimate the severity of
the long-term deflationary
trend which has been exposed
since the housing market crashed. It only takes a few months of central bank inaction
for deflation to rear its ugly head
again as we’ve seen already since 2009 (viz. the eurozone debt crisis and more recently China’s slowing economy). We’ve likely not seen an end to these periodic crises that will only
intensify as we head closer to 2014.
Until the deflationary 120-year Kress
cycle bottoms in 2014 there will be
strong deflationary
pressures in all the world’s developed nations and especially
in the U.S. If history teaches
us any lesson it’s that the world’s central banks will prove unequal
to the task of staying ahead of the deflationary wave still to come.
Gold
ETF
The iShares
Gold Trust (IAU, 16.01), our proxy for gold,
has been under selling
pressure in the weeks since
its Feb. 29 sell-off and made a slightly lower low on Thursday, Mar. 22.
As we observed in last week’s commentary, IAU now looks like it may test the critical 60-week (300-day) moving
average shown in the chart below. The 60-week moving average has turned back declines in the past, including most recently November-December 2011 correction.
IAU needs to show us that it has bottomed,
which it can do in the next few days by re-establishing support
above the technically significant 60-week MA, which intersects at approximately the 15.60 level
in the daily chart.
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