Bernanke’s problem

Alasdair Macleod – 8 December 2010

Ben Bernanke in a recent interview on CBS said the following:

Well, this fear of inflation, I think is way overstated. We’ve looked at it very, very carefully. We’ve analyzed it every which way. One myth that’s out there is that what we’re doing is printing money. We’re not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way. What we’re doing is lowering interest rates by buying treasury securities. And by lowering interest rates, we hope to stimulate the economy to grow faster. So, the trick is to find the appropriate moment when to begin to unwind this policy. And that’s what we’re going to do.

This statement will probably go down in history as a greater folly than Gordon Brown’s justification for the disposal of half of Britain’s gold reserves right at the bottom of the market. Bernanke is printing massive quantities of money, which he here denies, and expects us to believe that the inflationary consequences are “way overstated”. If this is true, why ever bother to unwind the policy?

I cannot find one statement, even one phrase in Bernanke’s quote above which is true or likely to be justified even with the benefit of hindsight. It is pure delusion, but Bernanke is no fool, he must realise there are inflation risks so there have to be greater priorities, or undeclared reasons for printing money in such unprecedented quantities.

The two that spring to mind are the parlous state of government finances and the potential for a second banking crisis. These problems are on a collision course, with the US economy and its tax base stalling on the edge of an economic abyss, and the banks trapped between rising domestic insolvencies and the consequences of the approaching Euroland banking implosion. The Fed is nervously watching broad money, which has been contracting for about two years in spite of zero interest rates. Bernanke confuses money with credit: he is expanding money supply to counteract the contraction of credit and hopes we will not understand the difference. So we can conclude that Bernanke is more frightened by systemic problems today than by inflation tomorrow.

If so, he has a point. The American public is in no mood to support a second rescue of the banks, so such a failure cannot be allowed to happen. So to do its job The Fed needs for itself and the financial system to have as low a public profile as possible: like a swan, serene on the surface while paddling furiously below. However, the Fed has come under public scrutiny, having been recently forced to disclose to whom it leant money to resolve the first banking crisis. The yet-to-be-confirmed appointment of Ron Paul[i] to the chairmanship of the Financial Services Sub-committee, which oversees the Fed, can be expected to force more disclosures and make Bernanke’s life more difficult, more high-profile.

Cynics might observe that Ron Paul will be brought to heel, because with the financial system on the verge of collapse he will not want to be associated with bringing it down. There is nothing like giving a critic responsibility to shut him up. But whatever policy position Ron Paul takes as chairman of the Financial Services Sub-committee, we are faced with a money-printing Fed that has inflation low in its priorities.

Inflation is already picking up rapidly, with energy and agricultural commodities rocketing in value. Food manufacturers in particular will have bought their raw materials by forward contracts to match production schedules, but these transactions are rarely more than six months forward, perhaps ensuring supplies to next spring at the latest. Given the scale of these wholesale price rises there are significant retail price rises in the pipeline for next year. Increasing food and energy prices will be wrongly dismissed by the Fed, since they are not regarded as core components of the CPI figures, due to their volatility.

Anything more core to human existence than food and energy it is hard to imagine, but central bankers and politicians spin non-facts into facts with surprising felicity, so much so that they themselves become muddled between reality and fantasy. Ergo, “trust me, there are more important things to worry about than inflation but I shall not tell you what they are”. It is this approach to the job that will ensure that Bernanke will preside over accelerating inflation, obtaining a Brownite reputation in the process. It is the nature of inflation that the more it progresses the harder it is to bring to an end. If it was too hard to raise interest rates on the last credit cycle when there was less debt around, it is virtually impossible today. Forget Bernanke’s threat to “unwind the policy” at the appropriate moment: it will never happen.

The truth is that inflation is already out of control, and the Fed is on the run. It cannot stop the US economy from sliding into the second dip, because zero interest rates do not generate the real savings required for economic regeneration. The Fed cannot stop the banks going bust, because enough of them are bust already to bring down the others; but it can delay recognition of the fact by pressing the button marked “Print”, and keeping it pressed for as long as it takes. And that is what will surely happen.


[i] Ron Paul is a Republican Congressman who promotes sound money policies.

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Alasdair started his career as a stockbroker in 1970 on the London Stock Exchange. In those days, trainees learned everything: from making the tea, to corporate finance, to evaluating and dealing in equities and bonds. They learned rapidly through experience about things as diverse as mining shares and general economics. It was excellent training, and within nine years Alasdair had risen to become senior partner of his firm. Subsequently, Alasdair held positions at director level in investment management, and worked as a mutual fund manager. He also worked at a bank in Guernsey as an executive director. For most of his 40 years in the finance industry, Alasdair has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapon governments use against the common man. Accordingly, his mission is to educate and inform the public in layman’s terms what governments do with money and how to protect themselves from the consequences.

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