Axel Merk, April 18, 2005

Last year, Paul O'Neill in his book on his days as U.S. Treasury Secretary wrote that he had the TV business channel CNBC running all day in his office. There is nothing wrong with a Treasury Secretary observing the news, but he is the one who should be setting the news, not following it every minute of the day. His successor does neither, which is not particularly encouraging, either.

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In the meantime, the Federal Reserve Bank system has been working on greater "transparency" with the public; their goal has been to communicate more effectively what their intentions are. However, it has become apparent that good intentions do not necessarily lead to good results. An ever larger section of the the Fed's meetings (as apparent from the FOMC minutes) are devoted to what the Fed believes how the public will perceive their statements.

There are two implications: first, it signals an ever growing influence of governor Ben Bernanke, who mentions at every occasion possible that interest rate policy is best set with words, that the right signals at the right time is the most effective way to manage the entire yield curve. Traditionally, central banks mostly control short-term interest rates, whereas rates for debt with longer maturities is set by the markets; Bernanke believes the entire yield curve can and should be managed. For now, Bernanke will leave his post as Fed governor and become Bush's chief economic advisor; we still believe Bush will appoint him as successor to Greenspan, but even if not, it is clear that he will continue to be highly influential in both monetary and fiscal policy.

The other implication is that those in charge of preserving our monetary system are now guided by their perception of how the markets will perceive them. This is a recipe for disaster: it is no different from stock analysts recommending a stock merely because it is attractively priced "relative to its peers," not because of some intrinsic value or potential; it is also no different from real estate brokers claiming that housing prices wil never go down because they "always" rise in the long-term. This time around, the Fed and the administration have artificially kept the consumer afloat in the post dot-com era (U.S. consumer spending never declined after the tech bubble burst), and it may well be a falling dollar that will deflate this one. If the yield curve is put into a corset, some other valve has to give. When managing a fragile psychology is more important than fundamentals, we are in trouble.

Greenspan is scared because he knows inflation is building up, but he cannot aggressively raise rates without sending an overly leveraged, and thus interest-rate sensitive economy into a downward spiral. The latest FOMC minutes claim that recent inflationary warning signs are only temporary. Average salaries, which decreased in 2004 for the first time in a decade, may be tame as corporations continue to accelerate their outsourcing as a result of global imbalances. But inflation is creeping up everyhwere, no longer just in the cost of healthcare and education. The only reason to state inflation is at worst a short-term issue is if one wants to have an excuse not to raise rates aggressively; Greenspan needs that excuse to keep the consumer afloat.

In meantime, the strains of the global imbalances are becoming more apparent. General Motors and Ford, the ultimate consumer-sensitive companies, can no longer reach their sales targets, and credit agencies are downgrading the quality of their debt. On the trade front, disputes are escalating, ranging from the Boeing/Airbus subsidy dispute with Europe to the textile dispute with China. While the U.S. wants to re-impose quotas on textile imports from China, China is requiring technology firms to conduct their research and development in China if they want to sell to the Chinese government. For now, the U.S. may be winning the textile war, but losing the high tech war. Trade wars can cause unstable systems to collapse, just as the depression in the 1930s was exacerbated through trade disputes; this one certainly has the hallmarks of instability.

We manage the Merk Hard and Asian Currency Funds, no-load mutual funds seeking to protect against a decline in the dollar by investing in baskets of hard and Asian currencies, respectively. To learn more about the Funds, or to subscribe to our free newsletter, please visit www.merkfunds.com.

Axel Merk
Manager of the Merk Hard and Asian Currency Funds, www.merkfunds.com

Axel Merk, President & CIO of Merk Investments, LLC, is an expert on hard money, macro trends and international investing. He is considered the authority on currencies. His insight and expertise have allowed him to foresee major economic developments: As early as 2003, he pinpointed the macro trend of U.S. dollar volatility while warning about the building of the credit bubble. In 2005, Axel Merk positioned his clients to move out of real estate and protect them against a faltering U.S. dollar by investing in hard currencies and gold. In early 2007, he wisely cautioned that volatility would surge, causing a painful global credit contraction affecting all asset classes. He is a regular guest on CNBC, Fox Business, Bloomberg TV and frequently quoted in the Wall Street Journal, Financial Times, Barron’s and other financial publications around the world.

The Merk Asian Currency Fund invests in a basket of Asian currencies. Asian currencies the Fund may invest in include, but are not limited to, the currencies of China, Hong Kong, Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand.

The Merk Hard Currency Fund invests in a basket of hard currencies. Hard currencies are currencies backed by sound monetary policy; sound monetary policy focuses on price stability.

The Funds may be appropriate for you if you are pursuing a long-term goal with a hard or Asian currency component to your portfolio; are willing to tolerate the risks associated with investments in foreign currencies; or are looking for a way to potentially mitigate downside risk in or profit from a secular bear market. For more information on the Funds and to download a prospectus, please visit www.merkfunds.com.

Investors should consider the investment objectives, risks and charges and expenses of the Merk Funds carefully before investing. This and other information is in the prospectus, a copy of which may be obtained by visiting the Funds' website at www.merkfunds.com or calling 866-MERK FUND. Please read the prospectus carefully before you invest.

The Funds primarily invests in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Funds owns and the price of the Funds' shares. Investing in foreign instruments bears a greater risk than investing in domestic instruments for reasons such as volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. The Funds are subject to interest rate risk which is the risk that debt securities in the Funds' portfolio will decline in value because of increases in market interest rates. The Funds may also invest in derivative securities which can be volatile and involve various types and degrees of risk. As a non-diversified fund, the Merk Hard Currency Fund will be subject to more investment risk and potential for volatility than a diversified fund because its portfolio may, at times, focus on a limited number of issuers. For a more complete discussion of these and other Fund risks please refer to the Funds' prospectuses.

The views in this article were those of Axel Merk as of the newsletter's publication date and may not reflect his views at any time thereafter. These views and opinions should not be construed as investment advice. Mr. Merk is the founder and president of Merk Investments LLC and is the portfolio manager for the Merk Hard and Asian Currency Funds. Foreside Fund Services, LLC, distributor.