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Investment News and Wealth Report

The Bernanke Fed:
Hawks or Doves?

Central banks across the globe are raising interest rates to stem the flow of cheap money into the economic system to fight inflation that is rising above comfortable 2-3% benchmark levels. The Federal Reserve Bank of the United States has raised interest rates 17 consecutive meetings to over 5%. Now, for the first time in nearly a decade, the Bank of Japan has raised interest rates a quarter point and has set the stage for further rate increases moving forward.

Federal Reserve Bank

At the same time, the governments of China, Canada, India, the European Central Bank and other countries across the globe are raising rates to slow economic growth and combat inflation.

The Trick Is Figuring out When Is Enough, Enough?

No country wants their currency to challenge the US Dollar as the global reserve asset because of what it would mean to their trade deficits. But, at the same time, the deficits and trade imbalances being run by the US government are eroding the overall worth of the greenback. The Euro and the Yen are not strong enough currencies to absorb all of the flight from a weakening dollar, which opens the door for gold to reassert itself as the fourth global currency.

“It is difficult, if not impossible, to recall a time when so many central banks were so crystal clear about their desire to withdraw liquidity from the system. As always when leveraged investors are invited to the party, everyone thinks they can be first out of the door when they hear the chimes at midnight.”
—Tim Price, a strategist at Union Bancaire Privee 6/20/06

Recent language by the Fed suggests that they are ready to end rate hikes or, at the very least, see the end coming soon. It is a fine line to be forced to walk. On one hand the Fed needs to sound hawkish on rising inflationary pressures (being led mostly by energy prices which will eventually flow throughout the entire supply chain), while at the same time being careful not to tighten too much and send the economy into a recession. The possibility of stagflation sits on the horizon should the Fed rate decisions not be able to combat macroeconomic trends.

“GOLD IS EMERGING AS A FOURTH GLOBAL CURRENCY. We regard gold as an essential barometer in the grand battle between hard and financial assets, which has strongly favored commodities and real estate over the past three years. Gold should be well positioned if the US economy slows sharply, given debt and dual-deficit strains that would likely emerge, or if the Fed attempts to reflate its way past near-term growth impediments. Citigroup economists remain concerned over global macro imbalances. Refreshingly, however, it no longer seems necessary to be a ‘caned food-and-crossbows’ gloom-and-doomer to believe in gold.”
Citigroup 1st quarter 2006

Up until the 1970s, it was generally believed that recession and inflation could not occur at the same time. A slowing economy was supposed to bring stable prices; so inflation just could not be a problem when the economy slowed. That belief gave central bankers, such as the US Federal Reserve, a sure-fire method for combating high inflation by employing tight monetary policies until inflation was choked off. The oil crisis of 1973 shattered that myth and resulted in a new word in financial circles: Stagflation.

Stagflation is a 4-letter word on Wall Street because, once it takes hold, it is very difficult to correct. Fiscal and monetary policies aimed at stimulating the economy only exacerbate the inflationary aspect of stagflation. Tight monetary policies, on the other hand, amplify the stagnating effect of high energy prices. For instance, manufacturing is currently falling into a recession, while the service sector of the economy is growing. This has the effect of showing some growth and some weakness while not giving government economists a clear picture of which direction the economy is currently headed.

“One of the most significant aspects of financial globalisation has been the extremely rapid expansion of international liquidity. The enormous increase in liquid assets available to international market participants is worrisome for several reasons: it erodes central banks’ ability to exercise monetary control; it triggers potential inflationary pressures that could easily be triggered if expectations change; finally, it facilitates the opening of speculative positions and may cause the quality of credit to decline. These last two channels can create instability in the financial and real markets.”
—Bank of International Settlements position paper on global liquidity by Fabio Fornari and Aviram Levy

Should the Fed stop hiking rates while other countries around the globe continue raising rates or, as in the case of Japan, have just begun raising rates, gold and precious metals will be in the ultimate sweet spot for rapid growth as we enter the third and fourth quarters of 2006. Uncertainty surrounding reserve asset allocation and competent monetary policy will lead to countries returning en masse to the ultimate reserve asset...GOLD.


Read More... The Return of Stagflation >

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Volume pricing over 25 oz
Current as of Sep 03, 2010 10:32AM CST.
Not for trading purposes.
Bullion prices above reflect volume pricing.

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