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By Christine Benz | 10-04-2012 02:00 PM

Merk: Inflation Is Coming

Recent Fed action has laid the foundation for an inflationary environment in the U.S., and those looking to protect their portfolios should take a hard look at currencies, says Axel Merk of Merk Investments.

Christine Benz: I am Christine Benz, and I am here at Morningstar's ETF Invest Conference. I am joined today by Axel Merk. He is the president and chief investment officer of Merk Investments, and he also runs a number of currency-focused funds.

Axel, thank you so much for being here.

Axel Merk: Great to be with you.

Benz: Axel, you recently wrote a series of provocative pieces about inflation, really saying that you think the Federal Reserve's latest round of quantitative easing will be inflationary. Let's talk about your thesis there, why you think QE3 will lead to higher inflation in the years ahead?

Merk: Sure. First of all, I don't think it really matters whether we're right or not; it matters whether there is a risk that we're right. If you think there is a risk that not everything at the Federal Reserve will work according to plan, well, take it into account in your portfolio allocation. But more to the point, QE3 cuts the link between monetary policy and inflation and shifts the focus over to employment. What the Federal Reserve wants to achieve is that whenever we have good economic news come up, they don't want the bond market to sell off.

In the springtime, we had a couple of weeks of good economic data, and the bond market plunged. Those are headwinds that [Fed chairman Ben] Bernanke doesn't want. He especially wants mortgage rates to stay low. He wants long-term bond rates to stay low. The way you do it is you promise to keep buying Treasuries for an unlimited amount of time until things improve, and particularly, you shift the focus over to employment, and we'll see more of that.

We just had the Federal Open Market Committee minutes that said, well, how about some numeric targets. The reason they don't publish it right away is because you have the unemployment rate and the labor participation rate. But importantly, as you shift from fighting inflation to trying to lower unemployment, you want to have inflation. You want to push up the price level to bail out homeowners, and so if people don't pay off their debt, if you don't want those foreclosures, you have to push up the price level. That's what Bernanke wants. Don't fight the Fed. Inflation is here to come.

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