The Candy Man
By cutting interest rates to the bone and pumping the markets full of liquidity, Ben Bernanke may have saved the U.S. financial system from incurring even greater damage than it has already suffered. In the process, the U.S. Dollar has been degraded to levels that have not been seen in decades. After all the damage that has been done, last week's action has traders wondering if the man who has been feeding candy to the markets is now about to sing a different tune.
At least that's the hope of the many analysts who believe that the weak U.S. Dollar is generating high energy prices and global inflation. In Barcelona on June 3rd, Fed Chairman Bernanke shocked the currency markets by indicating that the weak greenback is damaging, not helping, the U.S. economy. The U.S. Dollar shot higher in response to his comments, and commodities prices fell sharply (see figure 1).
Figure 1: Euro falls nearly 200 pips vs. USD after Bernanke comments. Source: Saxo Bank
"We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations," said Bernanke. Maybe this doesn't sound like much, but coming from Helicopter Ben, a man with a reputation for easy money who has overseen a 10% decline in the US Dollar, these comments are absolutely stunning.
First, let's take a look at the context of his remarks; it is extremely rare for any Fed representative to comment directly on the U.S. Dollar, other than to repeat the empty phrase, "we support a strong dollar policy" (something that has not been true for years). Actually, the U.S. has supported a weak dollar policy for some time now. While this has benefited U.S. exporters, it has hurt individuals, who now must pay for food and gas with devalued dollars. Because the dollars have been devalued, we need more of them to buy a tank of gas or a meal at our favorite restaurant.
Voices in the Wind
It's not as if voices haven't been crying out for years against this weak dollar policy. Readers of this column might recall the recent article Coincidence? I Think Not, which examines the past ten years of Fed-created bubbles – first in the stock markets, then in housing, and now in commodities. Luminaries such as Warren Buffet, Malcolm Forbes, Jim Rogers and Ron Paul have been shouting from the mountaintops about the damage the U.S. weak dollar policy is causing. Here are a few quotes:
Warren Buffet: "If we have the same policies, the dollar will go down." (Forbes, Jan. 2005)
Jim Rogers: "There are serious problems in the U.S. with the U.S. dollar. I wouldn't own U.S. dollars if I were you." (Stock Interview, 2007)
Malcolm Forbes: "I want to hear that Bernanke and Paulson are going to shore up the dollar. Eventually the markets will force them to." (World Economic Forum in Davos, Switzerland, Jan. 2008)
Ron Paul: "The fact that our money supply is rising significantly cannot be hidden from the markets. The response in time will drive the dollar down, while driving interest rates and commodity prices up." (Before the U.S. House of Representatives, April 25, 2006)
It's interesting to note that hours after Bernanke's comments hit the newswire, oil dropped to a three week low and copper fell to its lowest point in more than two months. What a shock! I guess there's a link between the U.S. Dollar and commodities prices after all. But only actions, not words, will cause a sustained dip in prices. Bernanke has just begun to talk the talk; the question in the mind of every trader is this - will he walk the walk?
Props for Volcker!
The following day, I saw Bernanke giving a speech at Harvard to an audience adorned in plastic raincoats. Ben talked at length about the effects of the oil shock in the 1970's, and how U.S. monetary policy had been ineffective in dealing with the resulting inflation until Paul Volcker became the Fed Chairman.
What's that? Bernanke is praising Volcker??? But…Volcker is the guy who raised interest rates into double digits in the early '80s…he fought inflation, even at the expense of growth…meaning that he was the EXACT OPPOSITE OF BEN BERNANKE!!! OH MY GOD!!! WHAT'S HAPPENING??? This can't really be Ben Bernanke, I thought. Conspiracy theories crept into my mind, and the room began to spin.
As he neared the end of his speech, Bernanke said to the students: "At this point, you may be asking yourself, "Is it too late to book Ali G?" That was the last straw. Now the imposter was cracking jokes. Who is this guy, and what has he done with the real Ben Bernanke?
The New Guy
But in the end, it doesn't matter. See, I like this guy, the new Ben Bernanke. I just hope he's the real Ben Bernanke. I wasn't fond of the old Bernanke, with his bubble-causing, inflation-stoking low interest rates. I much prefer the new Bernanke, who publicly praises a man who raised the Fed Funds Rate well into double digits. This is a guy I can trust to fix the weak US dollar and tame inflation, even if the medicine is bitter. Not like the other guy, who like his predecessor Alan Greenspan seemed to exist on a treadmill that consisted of creating bubbles and then cleaning up the resulting mess when the bubbles finally burst.
The cure that Alan and the Old Ben came up with was often worse than the disease, as each bubble sprouted a successive, more dangerous bubble. The Nasdaq bubble injured stock traders and investors, people who at least had enough excess money to be involved in the markets. When that bubble burst, and Greenspan subsequently lowered the Fed Funds Rate to 1%, we saw the creation of a new, more harmful bubble in housing. More harmful because when it finally popped, people were not losing their investment portfolios, they were losing the roof above their heads. Now we're experiencing a commodity bubble that, through higher energy and food costs, has already deprived some people of their ability to eat on a regular basis. The New Ben seems to understand this, and even shows a willingness to put a stop to this nonsense. Too bad he's only been around for one week.
Eat Your Veggies
The moral of the story is this – eat your vegetables. Remember when you were a kid, and you wanted chocolate cake and candy for every meal? Sure seemed like a good idea at the time, right? But what happens to children who try to exist on such a diet? Well, the situation with interest rates and excess liquidity is similar. The Old Ben would shout, "Candy for everyone!" and toss cakes and sweets to the markets. The sweets took the form of low interest rates and excess liquidity, and no matter how much Old Ben threw their way, the markets always seemed to need more.
Then one day, Old Ben was gone and suddenly New Ben was telling the markets, "No more candy for you! Eat your vegetables!" The stock market fell, because it loves candy, but the weak, battered US Dollar rose up, anticipating the badly needed vitamins and minerals from the vegetables. The stock market doesn't realize it yet, but it too will benefit from better nutrition – but for now it is sulking, because like a child, all it knows is that it wants candy. Don't give it to them, Ben!
Have a question about Forex trading? Send an email to eponsi@tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.
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Ed Ponsi is a globally recognized name as a lecturer and teacher and is the former Chief Trading Instructor for Forex Capital Markets. An experienced professional trader and money manager, Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ed has appeared on CNBC, CNN International and TheStreet.com, and has recently written his first book for Wiley Finance, "Forex Patterns and Probabilities" (which you can purchase through 