Mr Bernanke's First Crisis

May 8, 2006 - It was only two short months after Alan Greenspan was appointed chairman of the Federal Reserve that he faced his first crisis. The October 1987 stock market crash ended his brief honeymoon.

Newly appointed Fed chairman Ben Bernanke's honeymoon has already lasted nearly two months longer than that enjoyed by his predecessor, but it looks like he is now facing his first crisis. The difference is that Mr. Bernanke himself may have been the trigger that started this current crisis. He appears to have shot himself in the foot.

In an exclusive interview last week with CNBC commentator Maria Bartiromo, Mr. Bernanke reportedly said the market had "misunderstood" his views on monetary policy by incorrectly inferring from the written announcement released after the last meeting of the Federal Open Market Committee that the Fed was nearly done raising interest rates. When that news hit the tape, several markets were roiled.

The issue was not so much what he said, but the fact that he said anything at all. Actually, it would normally be bullish for the dollar by indicating that interest rates could go higher and that the Fed may not be stopping at a 5% fed funds rate. What happened is that the market was unnerved by the fact that he said anything because it was perceived that his statement reflected uncertainty, and the last thing markets want is uncertainty.

There is another important difference between the crisis facing Mr. Bernanke from that of his predecessor. While Mr. Greenspan had to deal with a one-day stock market crash, Mr. Bernanke has to deal with a crash in the dollar, which has only begun to fall off a cliff and looks as if it is going to continue falling for a very long time.

The dollar over the last few weeks has collapsed against gold, silver, other commodities and most of the world's major currencies. It is clear that the year-old bear market rally in the dollar has ended, and that it has now resumed its multi-year downtrend.

To be fair to Mr. Bernanke, the dollar began its recent downtrend before his gaffe. As noted in these letters and in my alerts on the GoldMoney website, the dollar has been looking pretty feeble since the beginning of the year, even before Mr. Bernanke assumed the Fed chairmanship.

What's more, the recent slide in the dollar picked up momentum after the G7 meeting in April. The announcement after that meeting by treasury and finance Pooh-Bahs of the G7 nations made it seem clear that a new effort was beginning to weaken the dollar in an attempt to tackle the soaring U.S. current account deficit. So perhaps Mr. Bernanke only added fuel to a fire that was already burning. But there is no doubt that what he said also extended that nascent fire into other markets.

No matter what market you look at, everything is now rising against the dollar. Gold, euros, commodities are all up. Even the stock market is rising, the theory being that one is better off holding stocks than dollars because equities are a claim to real producing assets and the dollar is but an illusion. It is simply a promise, the value of which can easily be eroded by politicians and their appointed bureaucrats who are not serving the best interests of dollar holders, but are instead serving blatant vested interests - like those who donate big bucks to politicians' campaign coffers. After all, everyone knows that the value of the dollar is being eroded away, and that the current account deficits and federal government budget deficits are unsustainable.

So Mr. Bernanke places foot in mouth and starts a panic. And it promises to be a big one.

Yield on 10-Year Treasury Note - May 2006

Take a look at the above chart of yields on 10-year treasury notes. Yields are slicing through a twenty-five year downtrend line. That is not good news for the US economy. Perversely, this time rising interest rates is also not good news for the dollar.

I've written before (see my article "Economic Suicide") how the dollar is at a the tipping point. The interest on the federal debt is approaching the point where the US government does not have the cash flow to maintain any pretence that continued government borrowing will not hurt the dollar's value. So rising interest rates will only worsen the federal government's budget deficit, with the result that the Federal Reserve will have to create even more dollars out of thin air to fund the government's growing appetite for dollars. And that of course is very bad news for the dollar, but very good news for gold and other tangible assets.

They'll probably trot out treasury secretary Snow this week to make some statement about the US wanting a 'strong dollar policy'. But of course it's just propaganda to try keeping people from bolting from the dollar into something safe, like the precious metals.

The so-called "speculators" are no doubt going to be made a scapegoat for the government's reckless spending and a monetary system that is broken. A May 2nd article in the Financial Times provides an example of this point. It reported a copper industry group as saying: "This market, where speculators can buy what does not exist, is doing serious damage to our industry and will bring into question whether the LME copper price should continue to be the recognised reference price."

First of all, an industry group is hardly going to give unbiased advice, but look at the statement itself. Please re-read the quote while keeping in mind that for every buyer there must be a seller. If speculators "can buy what does not exist", who is selling it to them but other speculators? And if there are more speculators buying than selling, why don't the copper producers sell their copper to bring prices lower? Maybe it doesn't exist. It could just be that the problem is not one caused by speculators.

So get ready for more propaganda. But Snow, Bernanke and everyone else is going to find it impossible to keep the dollar from sliding, and the crisis now beginning looks set to deepen in the days ahead.

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