The recovery is an iffy thing, according to Axel Merk, president and CIO of Merk Investments. As Federal Reserve Chairman Ben Bernanke keeps interest rates low to combat the possibility of a depression, says Merk, he’s inviting inflation—which may not be as easy to fight as Bernanke may believe.
In his latest Insight newsletter, Merk says that the deleveraging that followed a period of extraordinary leverage has led to a “money creation process” that has taken on “a life of its own.” Calling the current apparent trend toward recovery “the latest chapter in the tug of war between inflationary and deflationary forces,” Merk says that Bernanke’s present policy of maintaining low interest rates lest the market be spooked into a full-scale depression is erring on the side of inflation, in a mistaken belief that inflation is easier to control than it actually is.
“The extraordinary policies that have been pursued,” says Merk, “have not only planted the seeds of inflation, but have reintroduced leverage into the system.” Not only that, he says, but there is too much leverage now to be able to combat inflation as readily as Bernanke hopes.
What does this mean? While deflation has helped the dollar and driven gold downward, Merk says that markets may price in monetary tightening before the Fed is ready to act. Such a reaction may be based on hawkish comments from the Fed’s lone dissenter against continued monetary easing, the Richmond Fed president and Federal Open Market Committee member Jeff Lacke.
If the Fed reacts to any market perception of tightening, Merk says, “a flight into the dollar out of gold might be an opportunity to diversify out of the dollar into a basket of hard currencies, including gold.” In addition, a too-calm period in bonds could presage a return to volatility, with “fast money chasing yields.”
Currency, he says, thanks to its historically lower volatility than domestic or foreign equities, could provide an opportunity to “take advantage of the risks and opportunities provided by our policy makers without taking on the equity risk.”