Gold News

Inflation Fire-Starter

Both fire chief and arsonist, Ben Bernanke points the way to beating inflation with Gold and natural resources...

PICTURE the FIRE CHIEF, Ben Bernanke, standing in a house, says Dan Denning of The Daily Reckoning Australia.

   Picture him setting the house on fire. Picture the house burning to the ground around him. Now listen to him as he tells you he's committed to fighting fires wherever he finds them.

You have to give the man credit. (Reciprocity demands it.) He knows how to put on a show. He gave another speech on inflation on Monday this week. It shocked the world currency markets and led to a US$3 drop in the price of oil.

Perhaps it was the audacity of the Fed Chair vowing to fight inflation. Isn't Bernanke vowing to fight inflation a little like an arsonist standing in the middle of a burning building and vowing to fight fire?

"Fire? What fire? Oh, I fight fires! And I light them too!

"Light and fight...Almost the same word really! Who's listening anyway?"

Bernanke said in his speech that "The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation."

Why would any investor take this statement seriously?

Yet judging by the action, and not least in the Gold Market, plenty of people are judging the Fed by what it says, not what it does. The US Dollar rallied against the Euro and the Yen and the Aussie, and commodity stocks took it on the chin.

Gold fell and the futures markets are pricing in a US interest-rate hike. But let's all just take a deep breath for a moment.

Do you really think the Fed will raise rates in an economy that just saw the sharpest increase in the unemployment rate for two decades? For the Fed to raise rates, it must be convinced that inflation is a bigger threat to the economy than recession. Is that the case?

One thing is for sure; high energy and food prices are panicking law and policy makers all over the planet. Our take is that the Fed, the US Treasury and George Bush want to talk the Dollar up because they think it will bring commodity prices down. With a strong dose of talk therapy, they hope to get all the benefits of a Strong Dollar without having to take any of the measures that would actually make the dollar stronger.

What would really make the US Dollar stronger? Higher interest rates, for sure. But with so many American consumers and companies still drowning in debt, raising rates would be akin to whipping a horse that's already frothing at the mouth.

Another route to boosting the Dollar would be an improved fiscal policy. But do you think the US government (or any government) is suddenly going to reduce spending and balance the budget?

Of course that won't happen. It's clear what HAS happened, instead. Global monetary policy makers have pursued a strategy of inflation to escape the consequences of the credit bust. Only now, the policy has gotten away from them, leading to out-of-control fuel and food-price rises, plus rising unemployment in energy-sensitive industries and a growing sense of panic among consumers that things are getting out of control.

Well, guess what? Things ARE out of control. That's what happens with unrestrained credit creation. A whole army of genies is out of a whole crate of empty champagne bottles, and now Bernanke wants to sober up and act sensibly.

Or so he says. That the Dollar rallied at all is a testament to how utterly oblivious investors are to what's going on. It has always been the policy of the Fed to inflate its way out of any crisis. But now the Fed finds that it's inflating its way into an inflationary crisis from which there is no easy exit.

If only it were easier. Somebody should pass a law banning inflation.

Still, what is an investor to do? If the scourge of epic, 1970s-style inflation is back, we'd still expect long, strong runs in precious metals – led by Gold – and energy.

If we're wrong about that, the US Dollar will rally instead, oil prices will fall back to, say, $110 per barrel, the credit crisis will just fade away, and the global economy will take its licks and keep on ticking this year, albeit at a slightly slower pace.

Either way, the odds are that this unfolding, slow-motion crisis will lurch from point to point, driven by increasingly shocked and panicked reactions by both investors and policy makers. Separate out the emotion of it all, focus on the underlying trends, and you should do okay.

And what are those trends?

The global US Dollar standard is ending. No other government currency is yet ready to replace it, leading to a great deal of volatility in currency markets. Meanwhile, in the real economy, the world's productive capacity (and capital) are migrating to the East, where a new class of cashed-up consumers will eventually begin consuming what comes from their own factories.

Australia's real economy should do just fine in this brave new world. Not that it will be all roses and chocolate kisses. Currency volatility will affect earnings forecasts for resource producers. But on the demand side, if you adjust for the occasional mini-crash in China, the long-term trend looks pretty bullish.

How to relax and keep smiling through this crisis? Breathe deeply. Meditate. Ignore Fire Chief Bernanke. Build a portfolio of assets correlated to natural resources, the growth of an Asian consumer class, and global energy prices.

Buying Gold looks a good enough place to start.

Best-selling author of The Bull Hunter (Wiley & Sons) and formerly analyzing equities and publishing investment ideas from Baltimore, Paris, London and then Melbourne, Dan Denning is now co-author of The Bill Bonner Letter from Bonner & Partners.

See our full archive of Dan Denning articles

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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