Friday, October 15, 2010

Bernanke: I'm Going Nuclear

Economic Policy Journal


Federal Reserve Chairman Ben Bernanke, at his speech this morning before the Boston Federal Reserve, made it extremely clear that the Fed is about to embark on a major money printing scheme. His justification is the current high unemployment:

Although output growth should be somewhat stronger in 2011 than it has been recently, growth next year seems unlikely to be much above its longer-term trend. If so, then net job creation may not exceed by much the increase in the size of the labor force, implying that the unemployment rate will decline only slowly. That prospect is of central concern to economic policymakers, because high rates of unemployment--especially longer-term unemployment--impose a very heavy burden on the unemployed and their families. More broadly, prolonged high unemployment would pose a risk to consumer spending and hence to the sustainability of the recovery...
...we see little evidence that the reallocation of workers across industries and regions is particularly pronounced relative to other periods of recession, suggesting that the pace of structural change is not greater than normal. Moreover, previous post-World-War-II recessions do not seem to have resulted in higher structural unemployment, which many economists attribute to the relative flexibility of the U.S. labor market. Overall, my assessment is that the bulk of the increase in unemployment since the recession began is attributable to the sharp contraction in economic activity that occurred in the wake of the financial crisis and the continuing shortfall of aggregate demand since then, rather than to structural factors

Bernanke showed no concern for the inflationary consequences of Fed money printing. Indeed, he chose to completely ignore the current soaring commodity prices and falling dollar. He took the stance that a little inflation is a good thing:

Let me turn now to the outlook for inflation. Generally speaking, measures of underlying inflation have been trending downward. For example, so-called core PCE price inflation (which is based on the broad-based price index for personal consumption expenditures and excludes the volatile food and energy components of the overall index) has declined from approximately 2.5 percent at an annual rate in the early stages of the recession to an annual rate of about 1.1 percent over the first eight months of this year. The overall PCE price inflation rate, which includes food and energy prices, has been highly volatile in the past few years, in large part because of sharp fluctuations in oil prices. However, so far this year the overall inflation rate has been about the same as the core inflation rate...the FOMC has found it useful to frame our dual mandate in terms of the longer-run sustainable rate of unemployment and the mandate-consistent inflation rate.... the mandate-consistent inflation rate--the inflation rate that best promotes our dual objectives in the long run--is not necessarily zero; indeed, Committee participants have generally judged that a modestly positive inflation rate over the longer run is most consistent with the dual mandate.
This is the most stunning speech that I am aware of that a central banker has ever given.

He is blaming the current high employment rate almost entirely on the Keynesian notion of a lack of aggregate demand. Which, by the way, ignores the conclusion of the recent Nobel winners, who in a convoluted manner, reached the obvious conclusion that the more you pay people not to work, the longer they don't work. Further, he ignores completely the Robert Higgs observation that regime uncertainty plays a role in high unemployment, i.e., firms don't hire when they don't understand the regulatory and tax structure ahead.

On the inflation front, he is ignoring the best indication of inflation, real prices. He is ignoring record high prices for gold, corn. cotton. etc.. etc. Instead, he is looking at questionable indexes assembled by employees of the regime.

It is, of course, important to monitor how much actual printing is going to be done, but all indications are that Bernanke is going all in. He is going nuclear.

The longest-serving chairman of the Federal Reserve Board, William McChesney Martin, famously said that the function of the Fed is to “take away the punch bowl” when the party gets too exuberant. Bernanke is doing the opposite, he is calling ahead to the party and announcing his car is loaded up with gin, vodka, whiskey and tequila. This in itself is bizarre, since by so loudly broadcasting QE2 in advance, he is building in huge anticipation of QE2. To keep the momentum of this mad program, he will have to print more than the expectations that he has built to high heaven, otherwise QE2 will crash out of the gate. Given Bernanke's speech today, it is clear that Bernanke is fully ready to exceed expectations.

What does all this mean, if Bernanke does indeed follow through on his money printing scheme? A very quick turn upward, in a manipulated way, for the economy. Inflation will explode at a rate far in excess of what most expect. Remember, we are for the most part in a period where the desire to hold cash balances is still very high. This will reverse itself at the same time as Bernanke's money printing. Bernanke wants an increase in "aggregate demand", he is going to get it in the form of huge inflation.

Borrowers should lock in long term rates now. Although, Bernanke may start buying long term bonds, and temporarily push down rates, eventually inflation concerns will overtake Bernanke's bond buying.

We are truly headed into uncharted territory. If Bernanke follows through on the statements in his speech today, I fully expect inflation in the United States greater than what was experienced in the 1970's. It will be devastating to any one on a fixed income and it will destroy savers. It will benefit debtors at all levels, including, not coincidentally, federal, state and local governments that are in hawk across the board.

I repeat: It appears we are heading into a period of major inflation. All assets (aside from bonds) will soar in price, especially gold and silver. The billionaire hedge fund manager David Tepper had it right when he said a few weeks ago, "Buy assets, any assets."

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