Why Bernanke's Paranoia Will Lead to High US inflation
Lots of folks scorn the idea of inflation coming down the road, the argument goes as follows “money printing wont work, banks are hoarding liquidity, savings rates are rising, credit is being paid back, the output gap and unemployment will make deflation stay with us”. While I believe this argument is right for the next year or two it isn’t right for period after that, why?
Because in that scenario that world would end and since the world won’t end that means we will have high inflation. Its a bit of a exaggeration to say that world would end but that scenario implies downright dangerous deflation rates, the US simply cant survive with a 3-5%+ deflation rate, standards of livings would be smashed, debt and deflation is a deadly poison, the minimum wage would go up every year under deflation, debt burdens would go up, foreclosures, defaults all would soar and borrowers suffer the ‘pay option ARM’ effect of their real debt burdens going up every year and being more insolvent as the day goes by.
If sustained that kind of deflation would lead to something worse than the great depression since leverage is higher and global trade/flows are getting hit harder, thats what I mean by the world would end. Bernanke's paranoia is justified
The US central bank will simply not tolerate any kind of sustained deflation and those who think the fed is 'all-in' because of 0% central bank rates and money printing are mistaken. Bernanke is printing money like mad yet he continues to make apologies for it, he keeps assuring the markets they have a 'exit strategy' and it 'wont be inflationary in the end', he does this to prevent the 10y and 30y treasuries from tanking and also because inflationary expectations are still reasonably anchored as show by the TIPS market.
So in the US currently deflation is still not an issue, the core CPI and core PCE are still well into the fed's comfort zone, if they do take a nosedive and TIPS tumble its very likely the fed will change their tone, they wont just print huge money they will also try to convince people that their dollars are garbage. If people get convinced their money will lose purchasing power tomorrow they will spend it today creating a self-fulfilling prophecy of inflation. The fed have just began this process by creating a long-term inflation target of 2% but they are still waiting for the core indexes to go down
Japan had 1% deflation rates even though their central bank is headed by incompetents, had they pursued better policies instead of being paranoid about losing face they quite likely would have had positive inflation and better growth
What about the output gap and unemployment?
In 1933 when FDR devalued the dollar against gold, took the US off the gold standarad and allowed the fed to print its way out of the problem(the 30's version of quantitative easing), the unemployment rate was at 25% and GDP way bellow its potential having dropped 27% from its 1929 peak every single year, talk about output gap and deflationary forces. Yet the Producer Price Index jumped 25% y-o-y a little after the devaluation then averaged 7% up to 1938, the CPI jumped 6-7% then avg around 2.5% up to 1938. GDP then grew 30% from 33 to 38, the unemployment rate dropped from 25% to 15%. M1 grew something like 40% from 1933 to 1936
Yes, monetary policy works, when FDR screwed dollar holders overnight through devaluation that induced people to be worried their dollars were going to be worth less tomorrow and people spent today as a result(higher velocity of money), that shows in the private consumption data(83% of GDP) that jumped 25% during that period and private investment(2.7% of GDP) that jumped 80%, government spending(20% of GDP) jumped 20%, so it wasn’t FDR public spending that bottomed out the economy, it was his monetary policy inducing personal consumption(although effects on consumer sentiment from his programs probably account for some of the improvement, an additional positive factor was stabilization of banks)
The higher velocity coupled with money printing(higher supply) lead to a rise in prices stopping the debt deflation collapse and that showed up in the improvement in GDP and employment, prices rose even though the unemployment rates was still well above the Non-Accelerating Inflation Rate of Unemployment(NAIRU, in this case being above the NAIRU should create deflation). Why didn’t I considered the data from 1938 and on? Because in 38 the US suffered a government induced recession lead by higher taxes, higher reserve requirements for banks and cut back on public spending, its unlikely that mistake will be made again
Bottom line is the fed will not tolerate deflation, and to think that prices are outside the fed's control is to think that what the central bank says won’t have an impact, Bernanke has crashed the dollar twice with QE announcements, those were huge moves much bigger then what the Geithner comments on SDR ever made. That is because Bernanke not Geithner sets US dollar policy and gigantic levels of deficit monetization coupled with manipulating people into thinking the Fed doesn’t care about inflation is quite likely to make US inflation rates to be quite high after the recession/depression is over.
If by some oddity money printing stops working the fed will literally pay the entire national debt and finance the federal government forever, of course in equilibrium that is not possible because inflation would soar and this should end up being the Bernanke plan just in a smaller more cautious scale
I can only imagine what the gold market will behave like when Bernanke tries to fool people into thinking they will print money and 'drive the dollar down', that wont be true of course, the fed will pullback when inflation goes up alot but the gold conspiracy theorists will be puzzled when one of the bigger verbal supporters of higher gold becames Ben Bernanke
sources: The Recovery from the Depression of the 1930s
Inflation figures are from economagic
- ▼ April (8)