Get Ready for QEII: Bernanke Strikes Back

The Euro plunged to new 52 week lows against the US dollar today, as traders finally began to acknowledge that sovereign debt loads pose a severe threat to the viability of the young currency. The Germans bowed to widespread pressure and agreeed to bail out Greece, despite clear evidence that Greece will never pay off its debt. Also, the ECB chipped in to help by trashing EMU rules about allowing junk rated sovereign debt to be used as collateral for central bank loans. These actions, together with the general air of confusion and desperation emanating from EU authorities, have served to send the currency on a downward spiral against even the hapless dollar and British pound.

Now that the Europeans have proven themselves worthy adversaries in the game of Beggar Thy Neighbor, dollar holders should prepare for the American response. In March, Barack Obama pledged to double US exports over the next five years. It's an honorable goal, but the best way to do it would be to make America competitive by stepping on the toes of some key democrat constituencies. Like the trial lawyers, and the environmentalists, and the labor unions and the high tax, wealth redistribution, pro-regulatory left wing base. In short, Obama would have to turn his back on his party and that seems farfetched. The cheater's way to improve exports is to devalue the currency, which fits right in with our central bank's long held tendency toward ever cheaper money. The fact that we've taken interest rates to zero will not be a hindrance to Bernanke, because he has a printing press. But now Europe has raised the ante in this fiat race to the bottom, threatening Bank of Japan and the Fed's battle for title of most accomodative central bank in the world.

The Euro's drop is now impacting the US equity market, and that impacts the wealth effect so carefully nurtured by manipulating stocks inexorably higher over the last 14 months. Ben won't stand idly by and watch all his good work go down the toilet. If the S&P drops much more than a standard 10% correction, I look for Bernanke to once again flood the US economy with dollars, driving stocks back up and sending a message that no currency will be allowed to underperform the US fiatsco. It's possible that he'll resume buying government debt or mortgage securities from the primary dealers like Goldman Sachs and JP Morgan. They've proven quite adept at sending stocks to the moon if given enough free capital to play with. Or Bernanke could buy stocks directly. That seems less likely because it would raise fears of government ownership of private corporations (not that we haven't already headed down that slippery slope).

Either way, when the economy and the stock market dips, have no doubt that more free money is close at hand. It's been that way for 20 years and it would be folly to assume otherwise until proven to be the case.