Axel Merk issued his thoughts on the Federal Reserve ahead of Chair Janet Yellen's testimony before Congress early Wednesday, when she hinted at a change of heart over plans for multiple interest rate hikes in 2016.
Merk, the president of Merk Investments who is bullish on gold, is critical of the Fed's thinking in light of former Chair Alan Greenspan's heavy emphasis on the "wealth effect," the idea that rising asset prices are beneficial to investment and economic growth.
THe next Fed chairman, Ben Bernanke, "went as far as mentioning in FOMC minutes rising equity prices as a beneficial side effect of quantitative easing," Merk says. In addition, when inflation expectations would drop toward 2%, Bernanke would talk about the need for QE.
As economists, investment analysts and others look at ways to improve the U.S. economy, Merk suggests that the Fed's short-term thinking, its quantitative easing and its tacit approval of rising asset prices may have created conditions that support populist politicians such as Donald Trump and Bernie Sanders, who won the Republican and Democratic primary elections, respectively, in New Hampshire on Tuesday.
Monetary policy is no answer to economic woes. "You cannot print your way to prosperity. That path risks destroying purchasing power and a destruction of the middle class," he said. "The result may be public resentment, the rise of populist politicians and reduced political stability, even war."
As he said in 2008, "The best short-term policy is a good long-term policy … Based on my analysis, the answer must be in monetary or fiscal policy to make debt sustainable as a percentage of gross domestic product (GDP)."
As for greater fiscal spending, a move advocated by Janus Capital's Bill Gross and hedge fund manager Ray Dalio, it can be argued that a huge amount of spending — at levels usually seen in wars — can break the deflationary cycle, according to Merk: "That's what we got after the Great Depression, and I don't look forward to a repeat."
The portfolio managers sees the extension of printing money as a form of default. "Some debt will need to be restructured, and indeed, I believe much of the work in the eurozone has been to get the financial system strong enough to stomach a sovereign default," he stated.
Second, fiscal policy can also entail austerity. "It works for Germany, but not for Greece. In Greece and many other countries, it causes popular backlash that can destabilize a country," Merk said.
But, the better way out could be fiscal policy that is both expansionary and sustainable.
"Fiscally sustainable policies are long-term pro-growth strategies that don't themselves blow up the debt," he stated.
This entails entitlement reform, on the one hand, to make deficits sustainable and cutting of red tape to unleash growth. "Over the past 15 years, I believe red tape has increased rather dramatically in many sectors, inhibiting growth," Merk explained.
He isn't overly optimistic on such shifts: Policymakers "are unlikely to pursue what I believe is necessary," and this means investors and advisors must cope "with the cards we are dealt."
Fed's Conundrum
Yellen has pointed to surveys that show long-term inflation trends "remain well anchored," he adds. But Merk adds that Yellen, as a labor economist, is "destined to look at stale data, as jobs data tend to be backward looking."
