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Bernanke Put: Beware of Easy Money

September 26, 2012

Ultimately, the Fed may have reached too far, bringing risks to economic stability and elevated levels of volatility; the full implications of its actions may be somewhat dire down the road.
-Alex Merk, president and chief investment officer, Merk Investments

Central bankers around the world may be providing a backstop to the financial markets in much the same way Greenspan did during the "Goldilocks" years, but when the short-term euphoria wears off, will the negative repercussions be even more severe? Bernanke's Federal Reserve (Fed) appears to specifically target equity market appreciation as part of its offensive in bringing down the unemployment rate; expectations are high: every time the market sells off, the Fed might simply print more money. We fear central bankers have overstepped their reach, and the implications of their actions may be much worse than the anticipated benefits.

To an extent, the effects of today's monetary policies resemble the "Greenspan Put" (named after former Fed Chair Alan Greenspan) in the years leading up to the crisis. Today's central bankers have been quite straight forward in communicating their stance: they appear willing to step in with evermore liquidity should the global economy show any signs of further weakness. Bernanke's Fed has gone even further: the Fed has stated it's accommodative policies will "remain appropriate for a considerable time after the economic recovery strengthens". In other words, financial markets will be awash with liquidity for an extended period, even if we see signs of a sustainable economic recovery.

At first glance, this may appear a positive development for investors holding stocks and other risky assets. After all, Bernanke appears willing to underwrite your investments over the foreseeable future. Indeed, Bernanke appears to specifically target equity market appreciation, on many occasions noting one of the key benefits of quantitative easing (QE) has been to increase stock prices. Notably, while he believes the Fed's QE policies have had a positive impact on stock prices, he considers it has not caused increases to inflation expectations or commodity prices. We disagree, which we elaborate below. Ultimately, the Fed may have reached too far, bringing risks to economic stability and elevated levels of volatility; the full implications of its actions may be somewhat dire down the road.

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