Bernanke's Math - Does It Add Up?

By: Axel Merk | Wed, Jun 3, 2009
Print Email

The current account deficit is down as we are less reliant on foreigners to finance our deficits; the government's deficit is increasingly covered by the domestic private sector as private sector borrowing is down. -- These were the approximate words of Fed Chairman Bernanke in testimony to the House Budget Committe. This statement is so troublesome, let's examine it a step at the time.

The current account deficit reflects the amount foreigners need to buy in U.S. dollar denominated assets to keep the currency from falling. As the trade deficit shrinks because of weaker global trade, the current account deficit came down a bit last year. However, external financing is part of the current account and as the U.S. government has to raise trillions in the markets this year, it is difficult to imagine that the current account deficit will be down this year from last. It would imply that over $2 trillion in new U.S. government debt will be financend entirely domestically. Two main ways this may be achieved:

More realistically, the dip in the current account deficit was temporary as foreigners will continue to play a major role in financing U.S. deficits. However, because there is less trade and foreigners could use the money in their own countries, it will be an uphill battle to attract the massive amounts needed. The task is made more difficult by U.S. policies that are at risk to leading to unsustainable deficits. The reference to unsustainable deficits come from Mr. Bernanke himself who is well aware of the challenges.

In our assessment, the cost of borrowing should increase substantially as the supply of new debt may simply dwarf the demand - in that context, it is not particularly relevant whether the demand is domestic or international; plunging bond prices in recent weeks may be a pre-cursor of what is to come. Lower bond prices imply higher costs of borrowing not just for the government, but everyone. A nascent recovery could easily be stalled in the process. That in turn may tempt the Fed to monetize the debt, although at this stage Mr. Bernanke says the Fed will not pursue this path.

With regard to foreign appetite for U.S. debt, it may be noteworthy that foreigners have indeed continued to buy U.S. debt in recent months; however, foreigners have been bidding for short-term Treasury Bills at unprecedented amounts. That implies foreigners may agree with our assessment that long term bonds are overvalued and shift to shorter maturities to mitigate potential losses should inflationary expectations rise. While this may make sense from investors' point of view, it poses yet another challenge to the government that may struggle to issue longer dated debt. In our view, the government is digging itself into a hole that may not be very different from those of consumers that took out adjustable rate mortgages, only to be caught off guard as interest rates eventually rose.

 


 

Axel Merk

Author: Axel Merk

Axel Merk
President and CIO of Merk Investments, Manager of the Merk Funds,
www.merkfunds.com

Axel Merk

Axel Merk wrote the book on Sustainable Wealth; peek inside or order your copy today.

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.

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 www.merkfunds.com.

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 www.merkfunds.com 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. Merk Investments LLC makes no representation regarding the advisability of investing in the products herein. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advice and is not intended as an endorsement of any specific investment. The information contained herein is general in nature and is provided solely for educational and informational purposes. The information provided does not constitute legal, financial or tax advice. You should obtain advice specific to your circumstances from your own legal, financial and tax advisors. As with any investment, past performance is no guarantee of future performance.

All Images, XHTML Renderings, and Source Code Copyright © Safehaven.com

SEARCH





TRUE MONEY SUPPLY

Source: The Contrarian Take http://blogs.forbes.com/michaelpollaro/
austrian-money-supply/