Fed Wants Even Higher Inflation

By: Axel_Merk

Today, the Federal Reserve Open Market Committee (FOMC) announced it will continue to purchase government securities as previously announced ("QE2"), including reinvesting principal payments from its holdings.

The FOMC downgraded its economic growth forecast, acknowledged inflationary pressures have moved from commodity inflation to core inflation, yet insists inflation remains too low. The Fed considers inflationary pressures to be transitory, but monitors the evolution of inflation and inflation expectations.

We may need to revise the meaning not only of the word transitory, but also of what "inflation expectations are anchored" actually means. Forward looking inflation expectations as priced into the markets have moved up significantly since Fed Chairman's Bernanke Jackson Hole speech last August, when he lamented inflation was too low.

It appears to us that the headwinds caused by higher food and energy prices may be answered with more accommodating monetary policy given that the Fed confirms its accommodating policy may persist for an extended period. In that context, it should be noted that the phasing out of "QE2" is not an exit, but a pause. The banking system will remain awash in money as seen in the extreme levels of excess reserves. The trouble is that commodity inflation, and now core inflation, may well be fueled by the policies pursued in the first place.

Fed Chairman Bernanke argues that only equity prices rise because of his policies and that global demand and other factors are largely responsible for food and inflationary pressures. With due respect, while the Fed cannot be blamed for all the ills in the world, the Fed must not deny that it plays a role in fostering inflation, all the more since the Fed's explicitly stated policy is to raise inflation.

As the Fed continues to ease, as all other major central banks ex Japan are tightening, it would not be surprising should the U.S. dollar continue to weaken. It turns out that this may be exactly what Bernanke wants, as he is firmly embracing the dollar as a monetary policy tool.

When a central bank wants higher inflation, that wish is likely to come true. Bernanke has referred to the "slack in the economy" and high unemployment as to why inflation will remain contained. We hope he is right, but cannot base our investments on hope.

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.

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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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