STAFF NEWS & ANALYSIS
Ben and Barry's Inflation Problem
By Staff News & Analysis - March 17, 2011

Inflation caused by Bernanke's "Quantitative Easing" may doom Obama's re-election. Here's a political equation that ought to furrow the brows of everybody working to get a second term for President Obama: QE1+QT1=DEFEAT. For those not cursed to be economists, QE1 stands for Quantitative Easing, while QT1 means "Quantitative Tightening. According to Ralph Benko, writing in Forbes, Federal Reserve Board Chairman Ben Bernanke may be about to doom the Obama re-election effort with that equation. – SF Examiner/Forbes

Dominant Social Theme: The president may be doomed by factors beyond his control. It is a kind of Greek tragedy.

Free-Market Analysis: There seems to be no doubt that Barack Obama is obsessed with gaining a second term as president of the United States. But this article (excerpted above) makes some very good points about how monetary policy plays into presidential politics. We will examine them further, below.

Ben Bernanke's monetary stimulation has been pervasive and ongoing; it has also been historically massive. Never before has a central bank dumped US$20-$50 trillion into the marketplace within a two year time-span as the Fed under Bernanke seems to have done.

And Bernanke, it should be noted, is not the only one following these policies. Other central banks have been printing as well to ameliorate the lingering effects of the 2008 economic crisis.

The argument of the above article, which first appeared in Forbes, is that sooner or later the money that has been printed and shoved into bank coffers will start to circulate. This will happen when people wish to spend more, thus gradually increasing the velocity of money and allowing banks to lend if they wish to. As banks begin to respond to consumer demand – having rebuilt their own balance sheets – the dollars that are lingering in bank vaults will be injected into the larger economy causing price inflation.

The thrust of the article – the analysis and ultimate conclusion – is that price inflation should begin to peak as the US presidential campaign begins in earnest. At that point the Fed and Bernanke will be faced with several unpalatable alternatives. Either price inflation expands (risking hyperinflation) or the Fed begins to raise rates in earnest, eventually choking off the "recovery" (which always happens as the business cycle turns) and the economy lapses back into recession.

The article acknowledges all this and has the good sense, as well, to point out that slowing monetary velocity (as we have often mentioned) is not a scientific endeavor. Here's the salient quote: "In the grim reality of the world dollar system, this is virtually impossible. Vivek Ranadivé, the smartest guy in Silicon Valley you've never heard of, astutely wrote in 2007, 'If you applied the Federal Reserve approach to ensuring a suitable temperature in your home, you would turn the heater on and off every three months, overheating or under-heating your house.'"

This is not idle speculation anymore. For months, even years, people have been warning that one cannot dump trillions of dollars into the American economy, and the world's, without creating significant price inflation. At the beginning of March, Bloomberg reported that commodities reached a two-year high; cocoa reached a 32-year high (though there are political reasons why cocoa has soared having to do with the current political turmoil in the Ivory Coast).

Cotton prices have climbed "above the price reached during the cotton embargo of the American civil war in the 1860s," the Financial Times reported. And of course the price of oil continues to rise, and will go even higher because of the Japanese nuclear disaster. Commodity price hikes have an impact on price inflation in the broader economy. One is speaking, the article notes, of months, however, not years. By the end of 2011, or certainly sometime in 2012, price inflation will become a major challenge to the Federal Reserve and, thus, eventually, to the administration itself.

Bernanke has given several extraordinary interviews of late in which he has maintained almost defiantly that he is "100 percent" confident that the Fed can reduce liquidity at the appropriate time and do so with the efficiency. This flies in the face of both history and logic. Historically, central banks do NOT do a good job of controlling price inflation. Afraid of ruining the recovery, they tend to be timid which gives rise to even higher prices. Then, afraid suddenly of hyperinflation, central bankers over-react and tend to push the economy back into recession with a series of pre-emptive rate hikes.

This pattern can be seen most clearly in the US itself in the late 1970s. The Fed initially was not aggressive enough with price inflation, which spiked into the double digits. When Paul Volcker took over as Fed Chairman he wasted no time in raising interest rates aggressively while apparently throttling back on money creation itself. The result was an aggressive diminishment of price inflation, but also a terrible recession that came close to bankrupting a slew of Western money-center commercial banks.

This is history; but history in monetary terms is driven by logic of currency manipulation and its inherent difficulty. Logically, central bankers do not have the tools necessary to drain liquidity properly; and this is why they are always doing too little or too much. Central bankers claim that they can figure out the tendencies of an economy by watching various, broad money supply gauges. In reality, of course, such indices are both unreliable and backward looking.

This is the ultimate weakness of central banking. There are NO tools that really provide insight into what the economy is doing in real time. Inevitably, the central banker is looking into the proverbial rear view mirror, responding to what the economy has already done rather than what is actually taking place at the actual moment-in-time. This is also in fact, why central banking price fixing of the value and supply of money (for that is what it is) doesn't work. They know this.

Trying to slow down the economy is ultimately just as distortive as printing money. The difference is that while printing money usually causes a boom, draining velocity inevitably causes a bust – a recession or even a depression. This is why central bankers are much better, or certainly more enthusiastic, about adding money than subtracting it. The latter process has a good deal more political and economic risk involved.

Bernanke has maintained that, "the most important lesson of all is that price stability should be a key objective of monetary policy." But these are just words. Bernanke, despite his bravado, has no more tools at his command than any other central banker. He appears more powerful or at least more certain because he has presided over the single biggest injection of monetary material into an economy that has ever taken place. But creating a historical disaster is not necessarily proof of competence. The ability to create a massive monetary injury does not necessarily add to one's competence.

At some point, there will come a rupture between the Obama administration and Ben Bernanke's monetary regime. Perhaps what is to come has not yet occurred to Obama. But he is a thin-skinned and ambitious man. He no doubt sees a second term as vindication for what he has gone through and the extraordinary vilification to which he has been subject. In other words, it is an emotional issue for him. Likely, he will treat his monetary dilemma in the same fashion.

If this is a correct analysis, then Obama will surely pressure Bernanke (privately if not publicly) to restrain himself and the Fed when it comes to slowing the economy. If he is successful, the economy will move from price inflation to something approaching price hyper-inflation given the vast sums of currency that can potentially circulate. And the more successful he is, ironically, the worse the ultimate disaster will surely be.

Sooner or later, the Fed like all central banks in the face of price inflation will have to tighten. But if Obama puts enough pressure on Bernanke and is able to affect Fed policy then the US must probably face a kind of monetary whiplash. First price inflation will become a serious problem; then as panic sets in monetary tightening will be applied harder than it would have been otherwise and the economy will be constricted and severely damaged. This is the sad tale of the 1970s and there is no reason to believe it will not be repeated.

Obama is fond of saying that elections have consequences. Monetary policy, which is not hypothetical but which is acted on, has consequences, too. There seems no doubt that the US and the world are headed toward a bout of sustained price inflation. The only question is how bad it will be, how much chaos it will cause and how out-of-control it will become. The second question then is how fiercely central banks will react, and how deep a slump will be created as a result.

The betting here is that the second decade of the 2000s will be like the 1970s on steroids. The amount of money that it has taken to reliquify the dollar reserve system is truly unfathomable. People simply have no idea of the sheer magnitude of central banking irresponsibility in this regard. To salvage an unsalvageable system, central banks knowingly created the "mother of all price inflations." Now Bernanke et al. will have to deal with it. And in Bernanke's case, he will have to do so within the middle of an election cycle.

Bernanke actually wanted a second term, probably because he was frightened about what would be revealed if he stepped away from the helm. Also, having in large part created the problem, he no doubt believes he is in the best position to fix it, or at least ameliorate the worst of the excesses. It is obviously a delicate balancing act; though one could speculate (and we have) that Bernanke et al. are purposefully trying to destabilize the dollar reserve currency to generate conditions more sympathetic to a (non dollar) global currency, perhaps the IMF's SDRs.

We would venture to say that a tipping point may be closer than mainstream media commentators tend to believe. If the system dissolves before other arrangements can be made, then the money masters will effectively lose control and the global game will collapse. In such a case, it is perfectly possible, as we have argued on many occasions, that the world or at least the West might in some fashion default to a market-based gold and silver standard along with free banking.

After Thoughts

What is also clear, however, is that if chaos does overwhelm the current system and people truly lose faith, then Bernanke will likely come to regret that he campaigned so hard for a second term. He will surely become a most vilified individual, along with entire central banking priesthood. Obama will not regret a second term, as he probably will not have one.

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