In contrast, in Thursday's press conference, the ECB President Trichet said "risks to the outlook for price developments are on the upside;" and that it "is paramount that the rise in [..] inflation does not lead to second-round effects." He then clarified that the ECB is "in a posture of strong vigilance," and that based on past experience, this suggests an increase in interest rates at the next meeting is possible. Indeed, in ECB parlance, "strong vigilance" has all but once been a codeword for an upcoming rate hike.
Given the most recent developments, the jump in the euro versus the U.S. dollar should not be a surprise, and may be exactly what Bernanke is trying to achieve. Bernanke, unlike his predecessor, embraces the discussion surrounding the dollar. Indeed, we believe Bernanke considers the U.S. dollar a monetary policy tool. Our assessment is based on both words and action by the Fed Chair. Bernanke has argued:
- Going off the gold standard allowed the U.S. to recover faster from the Great Depression than other countries. Our interpretation: if you devalue your currency, you may boost growth. Note that someone has to be on the other side of the trade: the Eurozone in particular may have lackluster growth because less money is being printed, but a stronger currency.
- Bernanke believes a weaker dollar may not be inflationary. We strongly disagree and point to the rise in the cost of import prices in the spring of 2008 that went well beyond the soaring price of oil and commodities at the time. Bernanke, however, points to work done by the staff at the Fed highlighting that, in the past, a weaker dollar has not necessarily been inflationary.
- Bernanke puts his words into actions by purchasing government securities. Those securities are now intentionally over-valued, signaling to rational investors to take their money abroad. As a result, when a central bank aggressively buys government debt, it tends to weaken a currency.
President and CIO
Merk Investments, Manager of the Merk Funds
This report was prepared by Merk Investments LLC, and reflects the current opinion of the author. 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 a solicitation or an offer to buy or sell any investment security, nor provide investment advice.