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Stop the Fed!?

Interest-Rates / US Federal Reserve Bank Jun 17, 2015 - 12:30 PM GMT

By: Axel_Merk


We are concerned the Fed causes both economic and political stability to deteriorate. And, no, this is not about discouraging the Fed to hike rates. This analysis is about pointing out that the road to hell may be paved with the best of intentions. For the economy to prosper, we need a re-thinking not just at the Fed, but also with some Fed critics. Let me elaborate...

What’s wrong?

Central banks have been ever more engaged in the markets. More than seven years after the onset of the financial crisis, we are still arguing whether we can afford interest rates above 0%. Asset prices have been inflated, benefiting those with assets, but doing little for the working man and woman. Governments from the U.S. to Europe and Japan appear to ever more rely on central banks to provide them with cheap money to keep their deficits sustainable (at zero percent interest, at least in theory, any deficit appears sustainable!).

Generally, when asset prices are distorted, we are all but certain to get capital misallocation. This isn’t simply bad for investment managers that chase the Fed rather than invest on fundamentals- it can also be bad for real investments, as it is difficult to discern what real projects are worth investing in.

The easy money can also be bad for the social fabric of nations. Without rambling too much about the socio-economic implications of extraordinarily low interest rates, in our assessment, the rise of the Occupy Wall Street movement; the rise of the Tea Party; the success of Abenomics; as well the success of various populist parties in Europe are all a byproduct of monetary policy that’s gone astray. Central banks may not be solely responsible for all the ills of the world, but they have played and continue to play a catalyst.

Many may be thankful for the Fed to have “saved the day” in 2008, but the Band Aid approach imposes a heavy toll.

The Fed must get out of politics
The Fed ought to focus on monetary, not fiscal policy. That is, the Fed may set interest rates, but shouldn’t be in charge of who gets a loan. The Bernanke-Fed crossed the Rubicon when it first started buying Mortgage-Backed Securities (MBS). By choosing to favor the housing market over other sectors of the economy, the Fed started to meddle on fiscal turf. Fiscal policy is a messy, well politicized affair. In our humble opinion, anything pertaining to fiscal policy shall be left to elected politicians. Once central bankers start veering away from monetary policy, they are asking for trouble. Because politicians want to have a say in how credit is allocated (through tax and regulatory policy), they now want to have a say over what the Fed is up to. It’s no surprise to us that, as a result, there’s been a movement to “audit the Fed.”

The Fed’s role has expanded vastly over time; be that by adding a full employment mandate in the 1970s; be that by adding responsibilities for consumer protection; or a mandate for overall financial stability.

One doesn’t need to be an expert in central banking to have realized that the Fed isn’t particularly good at most, if not all, of these tasks. At the same time, the more dysfunctional a government appears to be, the higher the expectations rise for the central bank; we have seen this in the U.S. since the onset of the financial crisis; in Japan where the Bank of Japan plays a key part of ‘Abenomics’; or the Eurozone where European Central Bank (ECB) President Draghi had to ‘promise to do whatever it takes.’

What about going back to basics. In reverse order of the below list outlines how radical one might want to be. Let me say that by describing them I am not necessarily endorsing any of these initiatives.

Eliminate the Fed (and central banks altogether)
Let’s be honest about money and have the government, not the Fed print money. From today’s perspective, this may sound extreme, but it’s not impossible. To have such a move be viable, one should address one of the main reasons why we used to have many panics and bank runs until the introduction of the Fed: fractional reserve banking.

Eliminate fractional reserve banking
Modern finance is based on fractional reserve banking, but it does not need to be. For those interested in learning more about ‘full-reserve banking,’ the Wikipedia entry on the topic is a good starting point.

Re-introduce a gold standard
Some love it; others hate it. The gold standard takes away the power from policy makers to print money. And that’s the reason why it hasn’t survived. Even if we went back to a gold (or other metallic) standard, odds are that, sooner or later, politicians would once again find ways around it. As such, anyone interested in the gold standard should consider building their personal gold standard, rather than rely on a government to take care of it for them.

Eliminate the Fed’s ability to make fiscal decisions
The Fed should be allowed to hold nothing but Treasuries. If the Fed were to get stuck with something other than Treasuries, for example, when collateral needs to be seized upon the failure of an institution to which collateral was provided, such collateral should be swapped for Treasuries with the Treasury. Any political decisions on how to administer them would then be shifted to a political body.

Have the Fed solely focused on inflation
If one resigns to the likely fact that the Fed is going to be around, let’s have them try to be good at least at one thing: inflation. Let them not try to hide behind 1001 excuses why they can’t raise interest rates.

If the mandate were clear, it would be easier to communicate, easier to implement.

Oh, and should one mention that low inflation when oil prices fall isn’t necessarily bad (Sweden’s central bank has of late been heavily leaning on that excuse to keep rates low).

A sole focus on price stability isn’t perfect, but should go a long way towards allowing price discovery to take place with fewer distortions, if combined with a ban for the Fed to make fiscal decisions.

Hold the Fed accountable
No, this isn’t the #AuditTheFed movement, but this would be a Taylor-type of rule as a benchmark. The Fed wouldn’t be required to set policy according to the benchmark, but would need to elaborate on deviations from it. This may sound boring, but, in our opinion, would be huge progress versus the tea leaf readings that take place now where policy makers appear to be running in circles, looking for clues from the market as to what they may do next.

All of these ideas have one thing in common: simplify monetary policy, realize its limitations.

Why is any of this important?
If central banks don’t reverse course, it’s more than money that is at stake. The Great Depression ended in World War II- we don't think that’s a coincidence. When central banks help to prop up systems that are unsustainable populist leaders come to power. Because if there’s one thing that hasn’t changed in history it is that policy makers rarely ever blame themselves for the challenges they are facing.

To continue this discussion, please register to join us for an upcoming webinar. If you haven’t already done so, ensure you don’t miss it by signing up to receive Merk Insights. If you believe this analysis might be of value to your friends, please share it with them.

Axel Merk

Manager of the Merk Hard, Asian and Absolute Return Currency Funds,

Rick Reece is a Financial Analyst at Merk Investments and a member of the portfolio management

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

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 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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