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Bernanke’s Grand Strategy to Let the U.S. Dollar Fall

Currencies / US Dollar Sep 28, 2009 - 01:43 PM GMT

By: Larry_Edelson

Currencies

Best Financial Markets Analysis ArticleBy now it should be abundantly clear to you that my warnings are coming to pass. Gold is acting firm, having made a new 12-month high above $1,000 an ounce, and within a whisker of a new record high.

And while it might not fully blast off yet, in time, it will — to well over $2,000 an ounce … then even higher to $3,000 … and ultimately, probably by the middle of the next decade, even to $5,000.


Meanwhile, the U.S. dollar has sunk to a new 12-month low and is a mere 7 percent above its record low reached in July 2008.

It won’t take much for the dollar to start plunging, almost out of control. A brief rally here and there, yes. But the long-term trend for the dollar isdown, down, DOWN.

Why am I so sure of it? Well, in addition to all of the reasons and all of the material I’ve already written on the subject, consider the press release issued from last week’s Federal Open Market Committee Meeting (FOMC).

The Fed signaled that the emerging signs of life in the U.S. economy are simply not enough for it to stop printing money.

So instead of letting market forces unfold naturally, the Fed will continue to engage in “asset purchases” to help the economy “return to higher levels of resource utilization.”

That’s Fed-speak for printing money … monetizing debts … and reinflating asset prices. The Fed is also extending its (largely phony) end-date for printing money, from December to March.

It also acknowledged that it will keep its Fed Funds interest rate in the range of zero to 0.25 percent for an “extended period.”

If you think extended period means a few more months, or even six months before the Fed raises rates, think again.

And if you think the Fed is worried about the sinking value of the dollar as a result of all this, then you’ll be even more surprised.

In fact, let me tell you a few things about our Fed Chairman. Every move he is making is part of his grand strategy to avoid the policy mistakes he believes were made in the 1930s that caused the Great Depression.

Bear in mind, I have read every paper ever published by Mr. Bernanke. I’ve studied him more thoroughly than I have any U.S. central banker in history, including his predecessor Alan Greenspan.

So what I am about to tell you can serve to help guide you in the months and years ahead to understand how Bernanke thinks and what kind of policy decisions he will likely be making.

Let’s get started …

Bernanke Belief #1: Monetary Policy Was Overly Tight at the Outset of the Great Depression. Ergo, Keep Interest Rates Low Today to Avoid Another Depression.

Bernanke believes that in the spring of 1928 and in the absence of any signs of inflation, the Federal Reserve unjustifiably raised its discount rate from 4 percent to as high as 6 percent in 1929 with the explicit aim of deliberately pricking the stock market bubble.

While it succeeded, ultimately the tight money move backfired. Instead of the stock market bubble bursting naturally of its own weight and overvaluations, the stock market imploded.

Naturally, once the stock market bubble burst in 1929, the Fed started lowering rates, all the way down to 1.5 percent by October 1931. But then the Fed made yet another tight money blunder, doubling rates within the next four months to 3 percent by February 1932, and in the absence of any signs of an economic recovery.

In Ben’s mind, the Fed engaged in overly tight monetary policy from 1929 to 1932, turning what would otherwise have been a fairly normal recession into a depression. The tight monetary policy had two effects …

1. It killed off any possibility of a recovery, by raising short-term rates above market rates.

2. Importantly, the higher rates artificially boosted the value of the dollar in international markets, importing deflation.

So what is Ben’s thinking today? Keep rates as low as possible and don’t even dare think about raising them until there are plenty of signs of a rock solid economic recovery. Furthermore, don’t dare make any moves that will strengthen the dollar, for fear of importing deflation.

Keep that latter point in mind because it’s going to re-emerge in Ben’s thinking when we look at how he viewed the latter stages of the Great Depression, and particularly, the dollar.

Bernanke Belief #2: Encouraging Bank Failures Was A Disastrous Policy During the Great Depression. Ergo, Do Not Encourage Failures Today.

In the aftermath of the 1929 Crash, not surprisingly, as dollars were being cashed out of stocks, bonds, and many other dollar-denominated assets (excluding gold, which was hoarded), the supply of money and credit in the U.S. began to implode, and banks began to fail.

But the Fed and the Treasury did not want weak banks to stay in business. Treasury Secretary Andrew Mellon actually publicly called for weak banks to close their doors.

But that policy clearly backfired, causing a banking panic, which saw more than 11,000 banks go bust by 1932. And it also started to drain the country of its gold reserves, which — because of the gold standard at the time — further caused the supply of money and credit to contract, in a virtually non-stop freefall.

Bernanke thinks encouraging financial institution failures was the wrong policy, a major blunder — especially so since in the 1930s there were no safeguards in place for depositors — the innocent victims of bank failures. Not one. There was no depositor insurance whatsoever.

Today, we have FDIC insurance and other safeguards to protect innocent investors and savings. But Mr. Bernanke still believes that encouraging banks to fail is the wrong policy.

Why? Because he knows darn well that there is no way depositors can be protected, even today, if a mass banking panic were to spread throughout the country. Washington simply does not have the resources to control an all-out panic.

Bottom line: Do not expect to see Bernanke encourage bank or broker failures, other than Lehman Brothers last year. His views on this have not changed regarding today’s great financial crisis. Nor are they likely to change.

Bernanke Belief #3: Tight Money Policy Yet Again, in 1932, Was Disastrous for the Economy. Ergo, Keep Rates As Low As Possible for As Long As Possible Today.

In February 1932, after seeing the devastation to the economy that the high interest rate policy caused, the Fed suddenly reversed course and dropped the discount rate from 3.0 percent back to 2.5 percent in June, just four months after raising rates.

That was a smart move. But they botched it up again. Just nine months later, in March 1933 — under strong pressure from Congress — the Fed cranked rates back up one full point from 2.5 percent to 3.5 percent. Again, in the absence of any solid data that the economy was recovering.

The result? The economy immediately took yet another devastating plunge, taking down thousands more banks with it, and causing unemployment to soar past 25 percent.

What will Ben do today? It’s pretty clear: He’s not likely to raise interest rates for quite a long time, until well after the economy has cleared the crisis stage and is solidly back on firm footing. That could be a year from now, or, even longer.

Bernanke Belief #4: Vigorously Defending the Dollar — Via Protecting the Gold Standard Come Hell or High Water — Was the Biggest Mistake of All.

Bernanke’s major conclusion is that almost all policy initiatives taken by Congress and the Federal Reserve during the Great Depression were designed based on one underlying motive: To protect the dollar and its underlying gold reserves, at all costs. Even at the cost of causing a Depression and 25 percent unemployment.

But that policy, according to Bernanke, had devastating unintended consequences.

Foreign countries around the world — worried that they were going to lose gold reserves to the higher interest rates offered in the U.S. at the time — began to competitively raise interest rates to defend their own gold reserves, without any concern whatsoever for deteriorating economic fundamentals.

Hence, a worldwide race toward higher interest rates broke out in the early 1930s, causing the entire globe to sink into a major economic depression that became self-fulfilling and self-perpetuating.

Furthermore …

Bernanke Belief #5: The Longer a Country Defended Its Currency — Via Defending Its Gold Reserves — the Worse the Depression.

In one of his most important papers, published in October 1990 — “The Gold Standard, Deflation and Financial Crisis In the Great Depression: An International Comparison” — Bernanke puts all the cards on the table from his years of studying the Great Depression, with the following two conclusions …

1. Supporting the dollar via the direct and indirect actions taken to vigorously defend the gold standard was the single most important factor causing the Great Depression.

And …

2. The sooner a country abandoned the gold standard during the Great Depression — and effectively devalued its currency — the faster the economic recovery.

ERGO, TODAY, DO NOTHING TO SUPPORT THE DOLLAR AND INSTEAD, LET THE DOLLAR FALL AS QUICKLY AS POSSIBLE TO HOWEVER LOW THE FREE MARKET FORCES TAKE IT, NO MATTER WHAT.

You now know pretty much how Bernanke thinks. The only questions that remain are …

1. Will his policies work?

2. Or will they backfire?

3. What unintended consequences might there be?

4. How does one protect their wealth and profit from Bernanke’s views and likely actions regarding the economy, the dollar, interest rates?

I’d love to hear from you on the above questions, via my personal blog. Just click here to give me your comments!

And click here to become a savvy investor and to take advantage of these markets by becoming a member of my Real Wealth Report.

Best wishes,

Larry

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