Bernanke Fed Strikes Out

US$ Plunges, Gold Soars, T-Notes Sink

by Gary Dorsch, Global Money Trends. September 20, 2007

"Under a fiat money system, a central bank has a technology called a printing press that allows it to produce as many US$'s as it wishes at essentially no cost. By increasing the number of US$'s in circulation, or even by credibly threatening to do so, the US government can reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices of those goods and services."

Those infamous words uttered by Ben Bernanke nearly six years ago still haunt the Fed chief today, whose nickname "helicopter" Ben just doesn't seem appropriate anymore. Instead, "B-52" Ben might be a better fit, considering the huge bombshells of cash that have been dumped into the bond and stock index futures market by the central banker over the past five weeks. The Fed has pumped $320 billion of temporary cash into the banking system since mid-August.

As the chart above shows, Fed chief Ben "B-52" Bernanke has been massively inflating the US money supply at a record pace in the past few weeks to prevent a major bear market in the stock market. It's frightening to contemplate, but the US M3 money supply was already growing at a 14% annualized rate, its fastest in 35-years, even before the latest rounds of Fed injections of monetary steroids.

Then on Sept 18th, Fed chief Ben "B-52" Bernanke finally showed his true colors, exposing himself as a radical inflationist by slashing the fed funds rate a larger than expected half-point to 4.75%. The Bernanke Fed panicked, lost its cool in a desperate attempt to bailout Wall Street brokers, who peddled toxic sub-prime US mortgage slime around the world, and saddled banks and hedge funds around the world with losses to their balance sheets that can exceed $150 billion.

To defuse the credit crunch and still fend off inflation, Bernanke could have chosen a wiser path by simply lowering the discount rate by a half-point. Instead, Bernanke chose the most aggressive action by slashing the fed funds rate a half-point. Most ominously, Bernanke left the impression that more rate cuts are in the pipeline, which in turn has touched off a major speculative attack against the US dollar.

The Fed's decision to slash the fed funds rate to 4.75% was very dangerous, considering the US dollar is skidding to a 15-year low, gold is climbing to 28-year highs, crude oil is zooming above $82 per barrel, soybean and wheat prices are spiraling to record highs, and the Baltic Dry Freight Index is jettisoning into the stratosphere. Signs of hyper-inflation are sprouting all around.

"We took the action to try to get out ahead of the situation and try to forestall potential effects of tighter credit conditions on the broader economy," Bernanke told a congressional hearing today. "The resulting global financial losses have far exceeded even the most pessimistic estimates of the credit losses on these loans," he explained. Yet in trying to defuse one crisis, the rookie Fed chief might be touching off a crisis of confidence in the US dollar, whose stability is so important for the world's largest debtor nation, saddled with $750 billion /year of external deficits.

And in a land far away, currency traders are probing the Saudi Arabian central bank's determination to defend the riyal's peg to the US dollar at 3.75, after Saudi Central Bank Governor Hamad Saud al-Sayyari said the oil kingdom would hold back from matching the Fed's half-point rate hike earlier this week. That's led the speculation the kingdom may ditch its peg to the dollar, which pushed the US currency to 3.7405 riyals, its lowest level since December 1986.

There have been similar speculative attacks against other pegged currencies such as the Hong Kong dollar, but each time, the HK central bank defeated the speculators with massive intervention. Riyadh has close ties with the Bush administration, and depends upon the US for military support to keep Iran at bay. Therefore, it might be premature to bet on a US dollar devaluation vs. the Saudi riyal.

Still, in order to keep the US dollar stable at a time when the Federal Reserve is inflating the US M3 money supply at a 14% annualized rate, the Saudi central bank must also turn up its money printing machines to keep the dollar peg stable. Saudi Arabian annual money-supply growth surged to 21.5% in July. M3, the broadest measure of money supply, was 725.71 billion riyals ($193.5 billion) on July 31, compared with 597.39 billion riyals on July 31 last year.

Lowering Saudi interest rates to match the Fed's rate cut could accelerate the growth rate of the Saudi M3 money supply and send inflation soaring. Thus, at some point, if the Fed continues to lower the fed funds rate, Riyadh would come under enormous pressure to devalue the US dollar against the riyal, or face sharply higher inflation at home. With the US dollar plunging against the Euro, Saudi imports from Europe are becoming much more costly.

But Saudi princes already saw the hand writing on the wall, and have been buying gold to protect the purchasing power of their Petro-dollars for the past few years. Gold demand in Saudi Arabia rose 30% to 42.5 tons in the second quarter of 2007 from 32.6 tons the year earlier, before the yellow metal zoomed to a 28-year high of 727 riyals/ounce today. With crude oil climbing above $82/barrel today and more Fed rate cuts on the way, Middle East demand for gold should remain strong.

Yesterday, Kuwait’s central bank matched the Fed rate cut by lowering its repo rate by 50 basis points to 4.75%, adding to its 25 basis-point cut last week. But inflation in Kuwait is at a 12-year high of 5%, and its M3 money supply hit 18 billion dinars at the end of July, up 22.5% from a year earlier. Matching Fed rate cuts to defend an artificial peg to the US dollar is like throwing gasoline onto a fire. Kuwait’s central bank has blamed rising inflation on the dinar's peg to the US dollar, which is raising import costs. Kuwait pays for about a third of its imports in Euros.

Canadian Dollar hits Parity with US$, 31-year high

The Canadian dollar reached parity with the US greenback for the first time in 31 years. The US dollar's slide is linked to a narrowing of the spread between US and Canadian interest rates after the Fed's rate cut to 4.75%, bringing it closer to the Bank of Canada's 4.50% overnight rate. Also, Canada is a major oil producer and soaring oil prices buoys support for the Canadian Petro-dollar. It's a virtuous cycle for the Canadian dollar, since a weaker US$ inflates world oil prices.

Since the beginning of the year, the US$ interest rate advantage over the Canadian dollar has shrunk from 110 basis points to 30 basis points today. On Sept 12th, the Bank of Canada chief David Dodge indicated he would not match future Fed rate cuts. "Our objective for monetary policy is to keep inflation at target and that is the best contribution that we can make to stability of financial markets," he added.

In fact, no other central banker seems to be panicking over the sub-prime mortgage debt crisis, except for Ben "B-52" Bernanke. Last week, the Swiss National Bank actually hiked its 3-month Libor target a quarter-point to 2.75%, and some European Central Bank officials are suggesting that higher Euro interest rates might be necessary to control explosive money supply growth in the Euro zone.

Is there a limit to Fed Money printing?

Bernanke's money printing machines can run at full speed, as long as the bond market vigilantes remain asleep at the switch. But earlier today, the benchmark 10-year US Treasury note's price plunged 1-½ pt, lifting its yield by 16 basis points to 4.70% amid worries that a mix of easy money and record high agricultural and oil prices could be a dangerous formula that could spark hyper-inflation. The 30-year long bond plunged 2 full points in price today.

Oh, what a tangle web Mr. Bernanke finds himself in today. Since his bold decision to slash the fed funds rate by a larger than expected half-point, the yield on the Treasury 10-year Note has actually jumped 25 basis points higher. Would more Fed rate cuts send long term mortgage rates higher, worsening the current US housing slump?

Gary Dorsch

Contact Information

Gary Dorsch | Editor and Publisher, Global Money Trends
Observations | FSU Editorial Archive | E-mail