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ECB Will Do Whatever it Takes to Save the Euro

Currencies / Euro Dec 02, 2010 - 01:14 PM GMT

By: Axel_Merk

Currencies

The one thing worse than a fire in a building is a fire in a building when emergency exits are bolted shut: a panic in the market is exacerbated when liquidity dries up. It appears the European Central Bank (ECB) embraces this view: in today's press conference by ECB head Trichet, he re-iterated a number of times that non-standard measures are there to permit appropriate transmission of standard measures. In plain English, this means that whatever emergency support is given to the market is a) temporary in nature and b) designed to allow monetary policy and thus economies to function.


Some observers are disappointed that the ECB "only" announced an extension of its full allotment refinancing facilities until Q1/2011. However, that's incorrect: Trichet went out of his way to state that the ECB will do "whatever it takes" without using those words: the measures taken will be "commensurate to what we observe any time to what we see as disruption." Policy will be "back to functioning normally when we are back to normal functioning." When asked specifically whether the ECB would do whatever it takes, he indicated there is no limit on the the bond purchase program (Securities Market Program, SMP), although he emphasized that any bond purchases are always sterilzed.

By not giving a specific target on the bond purchase program, the ECB is as pragmatic as possible. If the ECB were to have a "bazooka" type of announcement as demanded by some market participants, such a bazooka would be bound to fail as any limit might be tested. Instead, by merely stating the ECB will adjust to the acuteness of the situation, the ECB has the flexibility to choose the water pistol or bazooka, as may be applicable. In our assessment, Trichet feels very strongly that price stability is best maintained by not explicitly threatening with a bazooka.

It's also apparent that Trichet doesn't see a quick and easy fix. To restore confidence, governments must show that they mean business. As such, the ECB, in our assessment, is most reluctant to intervene too heavily in the markets, as that would take the pressure off policy makers to follow through with reform.

It's also worthwhile pointing out that Trichet did not say the risk spreads in the markets are too high. Trichet continues to respect the market, well aware that a small group of economists do not know better than the market as a whole. If peripheral countries want to pay less for their debt, they have to pursue credible policies.

While there were no specific announcements on further monetary easing, Trichet mentioned that the risks had shifted somewhat to the downside with regard to economic growth. We see this also as laying the foundation to justify further intervention in the markets.

In the meantime, there were questions raised about the cost imposed on strong countries, such as Germany, to bail out weaker ones. Without a doubt, there is a price to be paid for solidarity. We assess the dynamics playing out as healthy, even if the process at times creates shockwaves in the markets.

In action beyond the ECB press conference, what we see as very positive is that Southern European countries in particular continue to sell bonds even in this environment. To attract buyers, bonds must be issued during good and bad times, otherwise we may see a replay of what contributed to Greece's downfall: when bonds are only sold during good times, the buyers of such securities are bound to lose money and lose interest in participating in the next auction. Spain issued bonds today at a high yield, but with very high demand; that's the sort of activity required to restore order to the markets.

In summary, central banks throughout the world are showing that they will do whatever it takes. It's just the ECB has a more restrained approach than the Fed; the ECB approach may lead to comparatively weaker economic growth in the short-term, but possibly to more structural reform and a stronger euro.

Please make sure you sign up to our newsletter to be informed as we publish updates on our analysis. We manage the Merk Absolute Return Currency Fund, the Merk Asian Currency Fund, and the Merk Hard Currency Fund; transparent no-load currency mutual funds that do not typically employ leverage. To learn more about the Funds, please visit www.merkfunds.com.

By Axel Merk

Manager of the Merk Hard, Asian and Absolute Return Currency Funds, www.merkfunds.com

Axel Merk, President & CIO of Merk Investments, LLC, is an expert on hard money, macro trends and international investing. He is considered an authority on currencies. Axel Merk wrote the book on Sustainable Wealth; order your copy today.

The Merk Absolute Return Currency Fund seeks to generate positive absolute returns by investing in currencies. The Fund is a pure-play on currencies, aiming to profit regardless of the direction of the U.S. dollar or traditional asset classes.

The Merk Asian Currency Fund seeks to profit from a rise in Asian currencies versus the U.S. dollar. The Fund typically invests in a basket of Asian currencies that may include, but are not limited to, the currencies of China, Hong Kong, Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand.

The Merk Hard Currency Fund seeks to profit from a rise in hard currencies versus the U.S. dollar. Hard currencies are currencies backed by sound monetary policy; sound monetary policy focuses on price stability.

The Funds may be appropriate for you if you are pursuing a long-term goal with a currency component to your portfolio; are willing to tolerate the risks associated with investments in foreign currencies; or are looking for a way to potentially mitigate downside risk in or profit from a secular bear market. For more information on the Funds and to download a prospectus, please visit www.merkfunds.com.

Investors should consider the investment objectives, risks and charges and expenses of the Merk Funds carefully before investing. This and other information is in the prospectus, a copy of which may be obtained by visiting the Funds' website at www.merkfunds.com or calling 866-MERK FUND. Please read the prospectus carefully before you invest.

The Funds primarily invest in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Funds own and the price of the Funds' shares. Investing in foreign instruments bears a greater risk than investing in domestic instruments for reasons such as volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. The Funds are subject to interest rate risk which is the risk that debt securities in the Funds' portfolio will decline in value because of increases in market interest rates. The Funds may also invest in derivative securities which can be volatile and involve various types and degrees of risk. As a non-diversified fund, the Merk Hard Currency Fund will be subject to more investment risk and potential for volatility than a diversified fund because its portfolio may, at times, focus on a limited number of issuers. For a more complete discussion of these and other Fund risks please refer to the Funds' prospectuses.

This report was prepared by Merk Investments LLC, and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advice. Foreside Fund Services, LLC, distributor.

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