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The Big Slowdown?

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June 1, 2012

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As we approach the halfway mark of 2012, the optimism that characterised the beginning of the year—revealed by positive stock market performances around the world—has begun to falter. A steady stream of negative economic assessments is quickly turning into a chorus of bad news, which, increasingly, is becoming a self-fulfilling prophecy. Europe looks unresolvable without massive money printing. China and India are reporting significant slowdowns in growth. Even the US unemployment rate, after a few seemingly promising months, has ticked up from 8.1 to 8.2%. Commodity prices have been hammered, while bond yields have hit historic lows—particularly in the United States and Germany—as investors flee to the perceived safety of government debt. Consumer spending is down on a weak market and a decline in sentiment. All signs point to recession, but reality rarely unfolds in such a linear fashion.

On New Year’s Eve, Jim Rickards, author of the excellent book Currency Wars: The Making of the Next Global Crisis, explained in an interview on King World News that the reason the Fed never embarked on a new easing program in the summer of 2011—as many had predicted—was because of weakness in the dollar.

QE3, QE2, any of this quantitative easing, is a function of the currency wars. In other words, does the Fed look at domestic economic conditions? Of course they do, but that’s not the main driver. The main driver is to cheapen the dollar. The Chinese currency was going up, the Euro was maintaining its strength, despite all the storm and stress in Europe. So, in a way, the Fed was getting what they wanted, and they didn’t need QE3.

Conversely, Rickard predicted that the Federal Reserve would begin a new round of quantitative easing midway through 2012 because of dollar strength. And, sure enough, since September 2011, the US Dollar Index has risen from just below 74 to above 83 (view the chart). Meanwhile, the Euro has been under major stress, having recently dipped below $1.24 against the US dollar on concerns out of Greece and Spain (view live quote). If Rickard’s “currency wars” thesis is true, one would imagine a new easing program from the Fed is in the pipeline.

Furthermore, in a political context, Ben Bernanke’s window of opportunity is getting smaller considering the US presidential election will take place in November. In theory, the Fed is an apolitical institution, but this is Washington. As many commentators have pointed out, if Bernanke was to wait any later than June to hint at an announcement, the move would be interpreted—rightly or wrongly—as a political manoeuver that would unfairly help President Obama’s re-election campaign. There’s also the fact that the wisdom of the easing policy is highly controversial, in itself. Mitt Romney has publicly stated, if elected, he would actively seek to replace Bernanke as Fed Chairman.

I’d be looking for somebody new. I think Ben Bernanke has overinflated the amount of currency that he’s created. QE 2 did not work, it did not get Americans back to work. It did not get the economy going again … We’re growing now at 1 to 1 and a half percent.

A lot of people don’t like Bernanke, but I would argue—whatever one thinks of his policies—that he acts with conviction. In his heart of hearts, he may see this as his last opportunity to save the US economy from a deflationary depression, particularly if Romney is elected.

All to say, this time around, a significant money printing program from the Fed seem likely. But whatever happens, the course of action for investors is clear. Prepare your cash, and be ready to act quickly. Should there be a deflationary wave, it could disappear overnight with an announcement from the Fed. A date to keep in mind is June 19, when the Federal Open Market Committee begins a two day meeting in. This is where a hint for further easing would probably be announced. Dramatically, the Greek election will take place only two days earlier on June 17. Should an anti-bailout party win, one would imagine further declines in the world’s stock markets, as well as the Euro, while the US Dollar would strengthen, further increasing the likelihood of intervention from central banks.

But perhaps this scenario’s a little too perfect. We’ll find out soon enough. In the meantime, preparation is in order.

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