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The ECB Calls Bernanke's BluffGary Dorsch A new member of the British Parliament once solicited the advice of Benjamin Disraeli, the nineteenth century British prime minister, on whether he should speak up on a controversial issue. "Do you have anything to say that has not already been said?" Disraeli asked him. "No," the man conceded. "I just want the people whom I represent, and the members of Parliament to know that I participated in the debate." Disraeli replied, "Then it's better to remain silent and have people say, I wonder what he's thinking, rather than to speak up, and have people say, I wonder why he spoke." On June 3rd, the super-dovish Fed chief Benjamin Bernanke, couldn't remain silent any longer, and shocked the global money markets, when he spoke out for the first time, about the need for the Fed to defend the US dollar in the foreign exchange market, before an international television audience. "The Fed is working with the Treasury to carefully monitor developments in foreign exchange markets," Bernanke warned. "We are attentive to the changes in the value of the dollar and inflation expectations. The Fed's commitment to price stability is a key factor, insuring that the dollar remains a strong and stable currency. The possibility that commodity prices will continue to rise, and lift inflation expectations are significant risks, that might ultimately become self-confirming," he said. A week later, currency traders were left wondering if Bernanke had undergone a brain transplant, and [been] re-programmed as a Bundesbank hawk, when he downplayed the biggest monthly surge in the US jobless rate in 22-years. "The risk that the US economy has entered into a substantial downturn appears to have diminished. The FOMC will strongly resist an erosion of longer-term inflation expectations. There are significant upside risks for inflation through commodities," Bernanke declared. Instinctively, foreign currency traders rushed to cover over-extended short positions in the dollar, as yields on the US Treasury's 2-year note, jumped by a startling half-percent in just two-days, to 2.90%, discounting the likelihood of 75-basis points in Fed rate hikes by year's end. Something must have changed, to cause "Helicopter" Ben to suddenly talk about switching gears, from inflating the US money supply at a 17% annualized rate, its fastest in history, to a more prudent course of defending the purchasing power of the dollar. 
However, after the initial shock wears off, if not backed up by concrete action, "jawboning" begins to lose its potency. If the economic landscape hasn't changed, then before long, quick-trigger traders could test the resolve of the central bank, by the attacking the beleaguered currency. Nowadays, it's the dollar's weakness against the Euro that is helping to elevate the agricultural and crude oil markets, and transmitting a major outbreak of hyper-inflation worldwide. But with the S&P Banking Sector Index plunging to its lowest level in 12-years, US homes prices sinking at their fastest clip since the Great Depression, and Lehman Brother's LEH.n stock losing 54% of its value in the past four weeks, the Fed's ability to defend the dollar with a tighter monetary policy is very limited. Just last week, Sheila Bair, head of the Federal Deposit Insurance Corp, warned that "weakening real estate markets could take down bigger banks than we have seen in the past," and would quickly exhaust the FDIC's paltry $58 billion cash reserve. Furthermore, the US jobless rate jumped a half-percent in May to 5.5%, its highest level in 3-1/2 years, underscoring the big recessionary risks that the US economy still faces. Some 49,000 jobs were cut from payrolls in May, the fifth straight month of job losses, further sapping consumer confidence, already at a 16-year low. "Weak economic conditions could extend defaults on consumer installment or credit card loans, as well as corporate loan portfolios," warned Fed deputy Donald Kohn.  Yet the 2% federal funds rate is pegged far below the inflation rate, and negative interest rates spawn speculation in the commodities markets. The US dollar remains weak against the Euro, because the yield on the 2-year US Treasury note is roughly -180 basis points below the German 2-year schatz yield. A year ago, the US 2-yr T-note was yielding +60 basis points more than the German schatz. On June 11th, St. Louis Fed chief James Bullard said the 2% fed funds rate is too low and could fuel inflation, unless the Fed takes action going forward. "The Fed's easing in January and March was very sharp, for insurance against the possibility of a very bad outcome from the financial crisis. The probability of a very bad outcome from the financial crisis is now receding, and we've still got the low level of interest rates. I see inflationary consequences of that going forward, if we don't take action and stay on top of this situation," Bullard warned. Since the Fed began its easing campaign in August 2007, the year-over-year increase in the Dow Jones AIG Commodity Index, has soared from a -5.5% to a record +33% today, led by a near doubling in crude oil and grain prices, and pushing the global inflation rate to its highest in three decades. Yet until this month, the Bernanke Fed refused to weigh food and energy prices in its inflation calculations, and instead, solely focused on bailing out Wall Street banks. To read the rest of the article, click on the hyperlink below: http://sirchartsalot.com/article.php?id=88 Jun 12, 2008 321gold Ltd |
But if "Helicopter"
Ben is just bluffing about his determination to defend the US
dollar, then it would have been better, had he remained silent
last week. Foreign currency traders know the first line of defense
for a currency in the $3.2 trillion per day FX market is "jawboning"
- or trying to alter trader behavior and psychology with words
alone. Initially, "open-mouth operations" are cost-free,
and might even achieve the central bank's objective without more
expensive remedies. 