Bernanke, The Inflator

by: John M. Mason

Well, the short-term market response is in for the Friday speech of Fed Chairman Ben Bernanke.

The stock market is up, the price of gold reached a five-month high, and the value of the dollar weakened.

On could argue that all three of these responses centered on the possibility that the Federal Reserve would engage in some additional monetary easing in the near future, especially at the next meeting of the Fed's Open Market Committee meeting on September 12 and 13.

John Paulson, the hedge fund operator, apparently anticipated such a move as regulatory filings have already indicated that he has re-arranged his portfolio, increasing the proportion of gold in the portfolio.

The value of the dollar declined relative to other currencies Friday as the expectation of a greater amount of inflation in the future tends to weaken the price of the inflating currency relative to other currencies.

And, the stock market rises on the prospect of increasing cash flows into corporate coffers as the price of goods sold in an inflationary environment tend to increase more rapidly that the cost of producing the goods…especially in a situation where there is substantial un- and under-employment.

This immediate response of the markets just underscores the whole problem with the Bernanke viewpoint. If the economy is facing some structural problems that must be resolved before more substantial economic growth can be achieved, forcing additional money into the economy will just…sooner or later…go into prices and not into an increase in economic activity. (For more on this see my post "Mr. Bernanke Has it Wrong".)

Obviously, the above analysis points to three possible investment opportunities for those that want to take advantage of the prevailing economic policy being followed by the United States government at this time…a policy of credit inflation. First, like Mr. Paulson, one could begin allocating more resources into areas that benefit from inflation, physical assets like gold or other assets that historically have actively responded to rising prices.

Second, one could certainly take a position against the dollar. There are, of course, a lot of other things going on here, like the turmoil taking place in Europe. Over the longer-run, I am still bearish on the dollar. The value of the dollar relative to the Euro and other major currencies had been declining for most of the decade of the 200s, up until the events of the financial crisis in 2008.

Since then the weaknesses in other currencies has over-shadowed the weakness of the dollar. The dollar has not become stronger over the last several years; it is just that the problems in other countries, especially in Europe, have overtaken the weakness that exists in the dollar.

Thus, I am still looking for the value of the dollar to decline…at some time. Market responses like the one following Mr. Bernanke's speech indicates to me that investors are cognizant of this situation and will take the value of the dollar lower…sooner or later.

The stock market has been very sensitive over the past two or three months concerning the possibility of another round of easing on the part of the Federal Reserve. I believe, that the reasoning goes something like this. The economic growth being experienced in the United States is mediocre…at best. No one is at home at the White House or in Congress…leadership is totally absent. The Federal Reserve is the only game in town. Therefore, if there is any chance for the economic situation to improve, even if it is only experienced as a rise in inflation, it is going to come from the Federal Reserve doing something more.

So, pick stocks that are going to benefit from a bounce in inflation.

There is a political reason for the Fed not to do anything more at this time. This reason is the election. If the Federal Reserve is too overt in taking action in September or soon after, it could be argued that the Fed was taking the action to help the President. However, the only benefit that might accrue to the President would be the Fed taking the action because anything the Fed might do in this fall would certainly not achieve anything before the election as far as economic growth and unemployment is concerned.

The difficulty for the investor in all this, however, is timing. Greater inflation, I believe, is on the horizon. However, greater inflation has not surfaced yet. The possibility of greater inflation is not high on the list of most investor's priorities. And, if is the case then it seems premature to rush assets that will benefit from an inflationary environment.

I have recently mentioned the interview that Jack Schwager published in his new book "Hedge Fund Market Wizards" with Colm O'Shea, a global macro hedge fund trader. O'Shea gives some advice in this interview that I believe is very pertinent to the situation discussed in this post. We can believe that the will be more inflation in the future but if "no one cares" there will not be a trend to the markets reflecting that belief. We still need to trust our belief, but we need to be careful and not "jump on the bandwagon" before others start to care the way we do.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.