‘Helicopter Ben’ will fly again

2011-DEC-12

European equities have fallen this morning, following on from losses on Asian exchanges and declining commodity prices. Precious metals have once again been caught in the cross hairs of this commodity selling and general risk aversion, with gold falling back below $1,700 per ounce and silver falling below $31.5. Aside from the on-going problems in Europe, bad news about falling Indian industrial production (now down at levels last seen in Q1, 2009) has also hit traders’ confidence.

Though last week saw news that the European Central Bank will lower reserve requirements and loosen collateral requirements for three-year loans to European banks – a camouflaged method of quantitative easing – ECB chief Mario Draghi is still insisting that the bank will not engage in mass debt-monetisation beyond the roughly $210 billion’s worth of sovereign debt it has already bought.

Standard & Chartered has also predicted that the UK economy will fall back into recession next year – an unsurprising prediction when one considers the money supply growth trends in the UK recently. New analysis from the Bank for International Settlements also casts doubt on the Bank of England’s quantitative easing policies, noting in a study into the QE programmes in the UK and US that they “had a significant impact on financial markets when the first stages were announced, but the effects became smaller for later extensions”. This is another way of saying that QE can only be “effective” insofar as the injections of new money get larger and larger, with the central bank’s balance sheet growing larger and larger and its leverage spiralling ever-higher. Taken far enough, this will lead to hyperinflation.

Add to this growing concern that major continental banks could be at risk of failure (something James Turk discussed in a recent KWN Blog interview) and it’s no surprise that we are seeing hedge funds once again running to the perceived “warm embrace” of the US dollar and Treasuries. The Dollar Index (USDX) is now over 79.10, with the EURUSD now at 1.326 as of 12.24GMT.

As can be seen from a five-year chart of the EURUSD, lows in this exchange rate in the autumn of 2008, late February 2009, and during the summer of 2010 have preceded major money printing moves by the Federal Reserve. The present strength in the dollar relative to other currencies – as seen by the rising USDX – thus makes it far more likely that the Fed will engage in more quantitative easing, as the Fed is looking to weaken the dollar against other currencies in order to encourage US exports.

Thus, relative dollar strength begets QE, which in-turn begets higher gold and silver prices. If the USDX moves much above 80, we will likely Ben Bernanke and other Fed officials starting to “talk down” the dollar. If these psychological ploys fail, the likelihood of “QE3” will increase significantly.

Stand by folks: “Helicopter Ben” could be about to climb back into the cockpit.