Helicopter Ben Plants Seeds for the Next Bubble: Gold

Ben Bernanke has long been known by a friendly nickname, “Helicopter Ben”, due to a speech he gave in November 2002 before he became Fed Chairman on the Federal Reserve’s response to deflation.

He said, basically, that the U.S. government could print as much money as it wants:

“But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.

By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

He became known as “Helicopter Ben” because of the image of the government dropping money from the sky into the economy.

What is more interesting about his speech on that November day was his discussion of what would happen if the Fed had to drop its interest rate to zero to combat deflation:

“Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it’s worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt’s 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation.

The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.

The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt’s devaluation.”

The rest of the speech is worth reading as well.

Deflation: Making sure “It” Doesn’t Happen Here, November 21, 2002, Before the National Economists Club, Washington, D.C.

Helicopter Ben is doing what he said the Fed could do in 2002. And without actually “intervening” to affect the exchange value of the dollar- the Fed’s actions are doing just that as the dollar has weakened considerably since the Fed’s last interest rate cut.

With all the free money again flooding the system, it will inevitably lead to distortions in the economy.

Many analysts believe the housing bubble will bloom again- as mortgage rates decline to their lowest in the last 40 years.

But that ship has sailed. Never before in history has a bubble that has burst (or is bursting) been halted and re-inflated. This time will be no different.

So where will the distortion show up?

We’re already slowly seeing the results of the events of the last year in the gold market. While gold is off its 2008 highs by about 17%, it is one of the few asset classes that is actually higher for the year. Through Sunday, Dec 21, it was up 5.13% for the year.

Maybe it won’t hold its recent gains going into the end of the year. Or maybe it will.

Gold is up 14% in the last 30 days. Not surprisingly- it rallied sharply after the Fed cut rates to zero.

Everyone is looking for the next bubble but it is already staring us in the face. The precious metals will rally hard as the free money moves through the system and pushes inflation higher in the second half of 2009.

Yes- I said “inflation”- not deflation.

Nearly 30 years after its last boom, gold is poised to again be a mania.

The best ways for an investor to catch the upside are:

1. Owning the metal itself either through gold coins or gold bars (but then where do you store it?)

2. Buy the iShares Gold ETF (GLD)- which actually holds gold in London and trades closely with the gold price.

3. For a more speculative play- buy gold stocks. You can buy a basket of them in the Gold Miner ETF (GDX). This ETF also holds a few silver stocks (which should move higher along with gold.)

GDX is a much more volatile play- as the gold stocks don’t always behave the same as the underlying metal. But in a gold bubble, gold stocks have the potential for the most upside.

As always, be diverse. In this kind of market environment, it pays to be invested in several asset classes (stocks, bonds, precious metals etc.).