For the Bernanke Fed, the devil of hyper-inflation is preferable to the specter of a bear market for the Dow Jones Industrials and weaker home prices. Exercising the “Bernanke Put” means the Fed will slash the federal funds rate further below the US inflation rate next month. But that’s a frightening prospect for foreign holders of $2.3 trillion of US Treasury debt, who must contend with negative interest rates, which in turn, could severely weaken their US dollar denominated investments.
It was shocking to hear Federal Reserve officials insist this week that inflation in the United States is under control, before telegraphing another tidal wave of liquidity injections into the US banking system. “It is important to recognize that downside risks to growth remain,” said Fed Chief Ben Bernanke before the House of Representatives. “The Fed will act in a timely manner as needed, to support growth and to provide adequate insurance against downside risks,” signaling a rate cut at its next meeting on March 18th.
The Fed has entangled the US economy into the “Stagflation” trap. On the one hand, slumping home prices and a softer jobs market could increase foreclosures on many sub-prime home borrowers, and blow huge craters in the balance sheets of banks and brokers worldwide. US consumers will have less home equity to convert into cash, which could lead to a big pullback in spending. With consumers struggling with high energy costs and a softening jobs market, the drying up of home equity could usher in a recession.
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On the other hand, the Fed is signaling aggressive rate cuts at a dangerous time. Inflationary pressures in the US economy are elevated at multi-decade highs. US producer prices are up +7.5% from a year ago, a 27-year high, consumer prices are up +4.3%, the highest in 17-years, compared with +2.5% for 2006. Thanks to the Fed’s cheap dollar policy, US import prices are +11.7% higher, the fastest increase since 1987. The Dow Jones AIG Commodity Index has soared to an all-time high of 216.25, led by soaring agriculture, softs, energy, base and precious metal sectors.
Foreign investors are rapidly losing faith in the Fed’s anti-inflation credibility, and it will complicate the central bank’s ability to put a safety net under the stock market. “Increases in the prices of energy and other commodities, and the latest data on consumer prices, suggest slightly greater upside risks to both overall and core inflation. Any tendency of inflation expectations to become unhinged, or the Fed’s inflation-fighting credibility to be eroded could greatly complicate the flexibility of the Fed to counter shortfalls of growth in the future,” Bernanke admitted.
The Fed’s aggressive rate cutting campaign is pushing investors into commodities as a hedge against higher inflation and a weaker US dollar, which in turn is driving up food and energy prices for US consumers already bruised by sliding home prices. As the Fed drops interest rates to stop a slide in the housing and stock markets, it’s simultaneously blowing an enormous bubble in the commodities markets.
Stephen Roach, chief economist for Morgan Stanley Asia, commented on Jan 24th, “Policy-makers are reaching back to the same play book that created this mess in the first place. They’re saying we are there to clean up after bubbles burst first rather than to prevent them. It’s a dangerous, reckless and irresponsible way to run the world’s largest economy. We have a market-friendly Fed injecting a lot of liquidity in the system which will set us up for another bubble economy. Excessive monetary accommodation just takes us from bubble to bubble to bubble.”
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Buoying the commodity markets across the board is the chronically weak US dollar, which has been stripped of its life support by the Bernanke Fed. After a double barreled rate cut of 1.25% in January, the largest monthly reduction in 25-years, Fed chief Ben “B-52” Bernanke signaled yet another rate cut in March as an “insurance policy” against an economic recession.
Since the Fed began its rate cutting campaign last August, soybeans have soared 90% to /bushel, wheat has soared 77% to .75/bushel, crude oil rose /barrel to 2/barrel, gold gained 50% to 0/oz, silver soared 62% to 19.50, and copper is trading at all-time highs of ,500/ton in London. Bernanke thinks these explosive trends will simply flatten out over the next 12-months, and the Fed can declare victory over inflation without tightening US monetary policy.
“We do have greater inflation pressure at this point than we did in 2001,” Bernanke admitted. “The current inflation is due primarily to commodity prices of oil and energy and other prices that are being set in global markets. I believe that those prices are likely to stabilize, or at least not to continue to rise at the pace that we’ve seen recently. If that’s the case, then inflation should come down and we should therefore have the ability to respond to what is both a slowdown in growth and a significant problem in the financial markets,” Bernanke told the Senate on Feb 28th.
However, such wishful and naïve thinking might not turn the speculative tide flowing into the commodities markets. The California Public Employees Retirement System, the largest US pension fund which has about 0 billion in assets, agreed at a Feb. 19 board meeting that it may increase its commodities investments 16-fold to .2 billion through 2010 as raw materials prices surge to records.
“We are excited about commodities, which have performed exceptionally well for us. We plan on ramping up the program by hiring additional staff,” said CALPER’s spokesman Clark McKinley on Feb 28th.
Commodities investment guru Jim Rogers said on Feb 25th, “The Fed is printing money and are trying to prevent the recession, they are putting on Band Aids,” he told an investor conference in Dublin, Ireland. Rogers added, “as long as the US central bank and the federal government keep making mistakes, you will have a longer period of slowdown, and it will be perhaps, one of the worst recessions we have had in a long time in America,” Rogers predicted.
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The Fed’s double barreled rate cuts in January, ricocheted into the foreign exchange market, weakening an already wobbly US$, which in turn put a floor under the crude oil market at /barrel. Nymex traders figured another half-point Fed rate cut could lift crude oil above 0/barrel, and boosted their net long oil positions to 60,873 contracts last week, compared with 39,933 in the previous week.
The United States imported a record 1 billion worth of crude oil last year at an average price of .25 per barrel. Ironically, if the US is forced to import crude oil at per barrel or higher this year, due to the Fed’s aggressive rate cuts, the import bill for 2008 could jump by roughly 0 billion and completely negate Washington’s upcoming 2 billion economic stimulus package.
Image cannot be displayed In other words, Washington is going deeper into debt to help American motorists pay for the higher cost of imported oil, which in turn will flow into the hands of Iran’s Mahmoud Ahmadinejad, Saudi King Abdullah, Venezuela’s strongman Hugo Chavez, and the Kremlin’s FX reserves, already bloated at 0 billion.
“Soon we will not talk about dollars because the dollar is falling in value and the empire of the dollar is crashing,” said Venezuelan strongman Hugo Chavez last Nov 19th in Tehran. “Naturally, by the crash of the dollar, America’s empire will crash," Chavez said at a joint news conference with Iran’s Ahmadinejad.
After Fed deputy Donald Kohn threatened this week to use all the tools at the central bank’s disposal to help the economy, the US$ Index broke sharply below its November lows at the psychological 75-level. Then Fed Chief Bernanke roiled the FX market again on Feb. 27th when he said it doesn’t matter to the US economy which currency OPEC uses to price its oil sales. It might only be a matter of time until the wealthy Persian Gulf oil states decide to ditch their dollar pegs.
