Tuesday, June 13, 2006

What Is Bernanke Up To?

I don’t know what has gotten in my food supply, but something is definitely amiss. As you all know, I’m generally a pretty easy goin’ guy. Ok, I’ve got a temper; I’ll admit that, but the good thing about being a bit mercurial is that I can vent and move on.

So, I’m a bit troubled that, after a lovely week off from blogging, I find my self back and pissed. First, there was Daniel Schorr, a man whose name I spit from my mouth like the vilest of explicatives. Now today…..well today….. our new Fed Chairman has got me a bit ticked off.

Why has Uncle Ben Bernanke got me riled? Cuz the man is talkin’ non-sense folks; it’s as simple as that. Even worse, the man is talkin’ stupid non-sense and in the process he is scarring the markets, which by definition is damaging the net worth of one Mr. Pursuit and this makes me a very unhappy man.

So today I’d like to talk about Uncle Ben’s incessant chatter about the threat of inflation; why it is driving me nuts, and how deeply disturbing it is to find that he very well might be driving Fed policy from this wildly incorrect view. Now stay with me here because while I know its economics, I promise not to be dull and hopefully can provide some food for thought for the next time you see a talking head on one of the cable business shows.

So let’s start with a bold proclamation. If there is one thing that is absolutely certain about today’s market it is this:

There is no threat of any inflation in either the near or medium term in today’s U.S. economy.

There, I’ve said it, go ahead and print it, save it to disk and hold me to that statement. Oh I’m aware that the popular business press likes to talk about the threat of inflation due to “oil prices” or our “growing economy that may be overheating” but anyone, who knows anything about economics knows that neither of these factors has anything to do with inflation. Think I’m wrong? Well then let’s get a definition for what inflation is:

Inflation: “Inflation is an increase in the price of a basket of goods and services that is representative of the economy as a whole.”

Actually that definition, provided by About.com is wrong, or at the very least over simplified. Let’s try again with wordreference.com:

Inflation: a general and progressive increase in prices; "in inflation everything gets more valuable except money"”

Hmm…..well still a little too simple, but the idea regarding the steady devaluation of money is getting us a little closer to the truth. Let’s try Wikipedia:

Inflation: is a fall in the market value or purchasing power of a money. This is equivalent to a sustained increase in the general level of prices. Inflation is the opposite of deflation. Typically the term is applied to a given economic region in which a currency is used, however it may apply to smaller or larger regions also.”

Ta daaaa! Frankly the last place I’d expected to find the truth turned out to provide the most succinct, accurate definition. To put a fine point on it, inflation, as Mr. Bernanke and friends discuss it, is purely a monetary phenomena that is separate and distinct from price changes that arise from the laws of supply and demand. So, when we hear in the popular press’s reporting on inflation due to oil price rises, commodity price rises or our economy’s high rate of growth, the proper reaction is not to hide in fear but to mock these foolish dolts with every last ounce of our vastly superior intelligence!

Well, mock and cringe that is. I know I may seem a bit wonkish to be concerned about what could be viewed as a purely academic issue, but this stuff is important because of the impact a wrong policy choice can have on our lives. As I stated above inflation is purely a monetary problem; specifically it is a problem of having too much money available in the marketplace, which is typically the result of a “loose money” policy by the Fed. The presence of too much money in the economy leads to a devaluation of the purchasing power of the money so prices rise specifically because money is worth less. There is only one known cure to inflation, and that is for the Fed to restrict money supply.

The problem is that when prices rise because demand for a good out strips supply, as is the case with oil today, the temptation is to blame inflation. This is wrong because there really is no reason to blame anything at all; The rise of the price of a good in response to increased demand is not a bad thing. In fact it is quite assuredly a good thing in that it is the market’s reaction and recognition that an adjustment in the good’s value is necessary. As that good becomes more valuable as a result of this adjustment, more investors are encouraged to make, discover or create more of that good (or substitutes for that good) for the general use.

With this perspective it becomes clear that misreading a market based adjustment such as inflation is quite a bad mistake; tragic even. For if Uncle Ben and his pals at the Fed continue to raise interest rates to fight non-existant inflation, they are only serving to slow the economy down – possibly pushing it into recession even – and punishing the market mechanism that is working as it should be!

So I wonder what in the world Mr. Bernanke is thinking. Could it possibly be that some jamoke in Chicago with a keyboard and an internet connection knows more about the workings of our economy than he does? Well, I suppose anything is possible, but we probably can say that this is unlikely.

In the extreme!

More likely is the possibility that Mr. Bernanke and his fellow Fed Governors are proving their “street cred” with investors and politicians in the wake of Alan Greenspan’s retirement. You see, one of the absolutely worst aspects of fighting inflation in an economy is breaking participant’s expectations of future price increases. For the Central Banker who wants to leave a legacy of stable prices and a growing economy, rule number one is to ensure that these expectations never get started.

Looking at the economic circumstances that Uncle Ben has taken office in, his talk of fighting inflation begins to make a little more sense. We have had a huge, and very visible increase in the price of a major input into our economy – oil – and we’ve had much inaccurate talk in the press about how this could lead to inflation. Uncle Ben, fearful that people’s expectations of inflation will get started is anxious to prove he is in control and eager to ensure that we maintain a stable value in our currency. In other words proving his ‘street cred” in much the same way the new kid in the neighborhood has to beat somebody up to demonstrate the dangers of pantsing him at recess.

Let’s hope Uncle Ben can keep this fine balance in tune. Otherwise it may be us who must endure the swirly.

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