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Ben Bernanke, The World Thinks You’re Nuts

By Jim Fink on November 9, 2010

U.S.-based investors should consider allocating more funds to emerging markets, paying special attention to opportunities in Asia ex-Japan. The region remains undervalued relative to global markets, but it won’t be overlooked for long given its strong fundamentals.

— Yiannis Mostrous, Silk Road Investor

What do Sarah Palin and the Finance Minister of Germany have in common? They both think Fed Chairman Ben Bernanke is nuts to print an additional $600 billion (on top of the $1.7 trillion already printed) via U.S. Treasury purchases over the next eight months.  Normally, I cringe whenever Sarah Palin says anything because she is a complete moron, but her Monday speech in front of the Specialty Tools & Fasteners Distributors Association actually made sense. Sure, she falsely states that grocery prices have risen significantly over the past year (they haven’t), but otherwise the speech sounds a lot like the views of Stanford University economics professor John Taylor, a reputed Palin economic advisor. 

In essence, Palin (er, Taylor) argues that interest rates are already low. Business lending is down not because interest rates are too high, but because the economy is weak and potential borrowers are already heavily indebted, making bank lenders worried about repayment.  Printing more money won’t reduce borrower indebtedness, but will simply cause inflation through higher commodity prices (like oil) which will act like a tax on the economy and slow spending further. 

Germany and China Mouth Off Against Bernanke

Germany’s finance minister Wolfgang Schäuble made a similar argument last Friday (Nov. 5th), saying undiplomatically that Bernanke was “clueless:”

They have already pumped an endless amount of money into the economy via taking on extremely high public debt and through a Fed policy that has already pumped a lot of money into the economy. The results are horrendous. For them now to pump even more is not going to solve their problems.

He also said that QE2 will “create additional problems for the world” by devaluing the U.S. dollar against other currencies, which will hurt the exports of U.S. trading partners and threaten their economic recoveries. He added that this unilateral action violated U.S. commitments at the G-20 meeting last June to act in a coordinated manner with the rest of the world to restore global economic balance.

China, which holds a whopping $1.7 trillion in U.S. dollar denominated debt, has also joined the international chorus of criticism. Worried that QE2 will cause China’s U.S. dollar holdings to lose value, Vice Finance Minister Zhu Guangyao called QE2 “the biggest risk” to the global economy and stated that the U.S.:

does not recognize, as a country that issues one of the world’s major reserve currencies, its obligation to stabilize global capital markets. As long as the world exercises no restraint in issuing dollars then the occurrence of another crisis is inevitable.

Commodity Inflation is the New Rage

The Fed’s money printing is already causing commodity prices to explode, the first step to broad-based inflation. Just look at some examples from this past week:

  • Gold hits an all-time high of more than $1,400 per ounce
  • Silver hits a 30-year high of more than $28 per ounce
  • Illinois farmland hits record high of $4,650 per acre
  • Crude oil hits two-year high of $87 per barrel
  • Raw sugar hits 29-year high of 32.74 cents per pound
  • Arabica coffee hits 13-year high of $2.144 per pound
  • Cotton hits highest price since U.S. Civil War of $1.46 per pound.

British Criticism of Bernanke

Two British periodicals sum up the world’s anger. The Economist says that QE2 will spur inflation, which will make it easier for the U.S. to pay its debts to foreign creditors like China:

The U.S. is a debtor nation. It has committed to borrow money from other countries in the form of dollars. Printing money to repay those debts (which is what the Fed is doing by creating money to buy government bonds) is, in essence, a partial default. It is as if you tried to pay your supermarket bill with Monopoly money.

The Telegraph says that this “crazy money-printing” has caused the U.S. to lose all credibility as a world financial leader:

The United States decided to drop all pretence of being interested in leading – or even being part of – a coordinated global policy response to the most serious economic crisis in more than 70 years.  America is now isolated and the rest of the world is furious. The widespread use of capital controls and even a lurch into 1930s-style protectionism are both far more likely than just a few days ago.

Do the Right Thing

Of course, all of this foreign criticism would be irrelevant if QE2 succeeded in reviving the U.S. economy. Stronger domestic U.S. growth would increase U.S. demand for imports, which would strengthen foreign economies. President Obama is defending QE2:

The Fed’s mandate, my mandate, is to grow our economy. And that’s not just good for the United States, that’s good for the world as a whole. And the worst thing that could happen to the world economy, not just ours, is if we end up being stuck with no growth or very limited growth.

Bernanke insists that printing money will spur growth by inflating stock market prices:

Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion. 

Creating an Asset Bubble Isn’t the Right Thing

In other words, Bernanke wants to artificially spur growth by creating another asset bubble! As I wrote in Stock Market Volatility: You Ain’t Seen Nothing Yet, the problem with asset bubbles is that they burst, leaving behind economic devastation worse than existed before the bubble. In this case, the bursting will manifest itself in either hyperinflation that vaporizes U.S. purchasing power or in sharply higher interest rates when the Fed tries to shrink its bloated balance sheet through debt sales. Neither end result is good for the U.S. economy. But that’s mañana, so why worry about it?

Even my favorite economic forecasters, the guys at the Economic Cycle Research Institute, are against QE2 because the economy is already in a sustainable economic recovery and printing more money risks boom-bust instability:

The car that is the U.S. economy is crawling uphill, slowing as its engine sputters. Determined not to let the car start rolling back disastrously downhill, yet unaware that the road is about to level off, the Fed is strapping an untested rocket onto the car in hopes of blasting it over the top.

The Fed, looking out the rear-view mirror to steer the car, won’t know when we’re approaching a bend in the road, though we’re now high up in the mountains, with a dangerous abyss below.

Bottom line, Obama and Bernanke are clueless. There is absolutely no evidence that QE2 will, in fact, result in sustainable long-term economic growth. Many economists I respect are very pessimistic about QE2.  Money manager and economics Ph.D John Hussman says that the problem with the U.S. economy is excessive debt, not a lack of liquidity.  Providing liquidity to encourage overleveraged small businesses and individuals to assume even more debt won’t get rid of their debt. Consequently, what the U.S. economy needs are fiscal policies that help reduce debt levels by encouraging productivity.

Real Economic Solutions

The U.S. needs to promote real economic growth rather than bubble-induced growth. According to Hussman, examples of effective fiscal policies would include:

  • extending unemployment benefits;
  • ensuring multi-year predictability of tax policy;
  • expanding productive forms of spending such as public infrastructure;
  • supporting public research activity through mechanisms such as the National Institute of Health;
  • increasing administrative efforts to restructure debt through writedowns and debt-equity swaps;
  • abandoning policies that protect reckless lenders from taking losses; and
  • expanding incentives and tax credits for private capital investment, research and development.  

David Stockman, President Reagan’s budget director and architect of the largest tax cut in American history, now says that the budget deficit is so out of control that tax hikes are critically needed. He recently appeared on the TV news magazine 60 Minutes and argued in favor of a one-time 15% surtax on the wealthy (defined as the top 5%) which would cut our national debt by half. Given that the wealthy have collectively increased their net worth five-fold in the past 25 years (from $8 trillion to $40 trillion), this proposal sounds reasonable to me. Stockman also recommended massive cuts in defense spending and a means-testing of entitlement programs.

Lastly, Nobel Prize-winning Columbia University economics professor Joseph Stiglitz argues that QE2 will cause global currency wars that will hurt the U.S. economy, just as the Smoot-Hawley Tariff of 1930 caused international tariff wars, prolonging the Great Depression. He recommends increased fiscal stimulus focused on investment, including extending unemployment benefits and promoting infrastructure spending.

Take Advantage of the Upcoming Asset Bubble with Silk Road Investor

The Republican takeover of the House of Representatives in the mid-term elections ensures that any proposal on Capitol Hill to increase fiscal spending will be dead on arrival, so Bernanke’s asset-bubble plan is the only game in town. 

Rather than pout, investors should take advantage of the impending QE2 tsunami by buying into the assets that will be inflated by the QE2 cash. Namely, emerging market stocks are primed to continue upward as cash looks for the highest returns. 

Yiannis Mostrous, editor of Silk Road Investor, the market-beating investment service focused on the highest-growth emerging markets, recommends focusing on Asian markets ex-Japan:

Asian currencies remain undervalued and will continue to inch higher, thus enhancing returns in U.S. dollar terms. When searching for investment themes, focus on emerging market consumer plays, infrastructure-related companies, agriculture, and firms that pay sustainable dividends.

For specific Asian stock ideas in Yiannis’ favored industry sectors, give Silk Road Investor a try today.

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