Ruminations, February 10, 2013
When the Fed’s only tool is a hammer, every problem looks like a nail
*** and the Fed has been hammering currency manipulation with a vengeance. You might think that after almost five years of hammering the currency, hoping to create a strong jobs market, Bernanke and the rest of the Fed would admit defeat and concentrate on strengthening the dollar. But rather than admit defeat, they keep on banging away.
And things get worse for the Federal Reserve Chairman. Over the past year, we’ve documented the effects of the Fed’s programs on the economy.
• Creating inflation
• Distorting the market through artificially induced lower interest rates
• Creating economic bubbles in the stock, commodities and real estate markets through these artificially low interest rates
• Driving the country further into debt so that when the Fed can no longer control the interest rates, the government’s cost of borrowing will reach new highs
• Creating currency wars with other nations, resulting in a drop in international trade.
Through it all, the Fed keeps up the pretense that they will be able to put the brakes on inflation if it gets out of control. According to the Bureau of Labor Statistics, inflation has averaged about 2.4 percent over the past 10 years. Which was not too bad – or was it? If you put $100 in the bank and left it there for 10 years at the current interest rates (that Bernanke’s Fed effectively sets -- 1.25 percent) – and discounted for inflation -- your deposit would be worth $89. So, in effect, Bernanke is taxing you $11 plus interest to help pay for the Federal spending.
But that’s not enough. Liberal economist and New York Times columnist Paul Krugman says that the Fed should loosen the controls and let inflation increase to maybe 4 percent – which would make your $100 deposit worth $75. Hmm.
Why would Krugman want to do that? Does he hate retirees and savers? No, he’s looking at jobs and the debt. During times of economic recession, he seems to say, we cannot reduce wages due to minimum wage laws, labor contracts and, more important, the psychological effect that wage cuts would have on the population. So if we allow a higher rate of inflation, we will cut the purchasing power of existing wages, which is an effective cut in wages. Lower wages means lower unemployment.
As far as the debt is concerned, when we reduce the value of currency through inflation, we end up repaying the debt with cheaper dollars. It’s sort of like a tax on savings: your theoretical deposit of $100 dollars loses $25 in value due to inflation, and that is a stealth tax of 25 percent that has been placed on your deposit.
It’s an interesting theory. The problem of economic theories is that there are far too many unpredictable variables in the marketplace and, therefore, it can lead to unanticipated and uncontrollable problems. If the inflation rate accelerates as Krugman suggests, labor unions will demand pay increases and legislators are likely to ratchet up minimum wages – resulting in higher inflation and no new jobs -- reminiscent of the stagflation of the 1970s.
Does Bernanke have inflation under control – or is he starting to lose it? Last week, The Wall Street Journal’s Brett Arends evaluated the Treasury Department’s Treasury Inflation Protection Securities – TIPS. TIPS, according to the Treasury Department, “provide[s] protection against inflation. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater.” Sounds like a good conservative investment. So good, in fact, that the Fed says that there are now some $850 billion worth in circulation. But given the current machinations of the Fed, a 30-year TIPS could lose an investor 7 percent.
Whoa. You buy a government-protected security and the Federal Reserve, through its quantitative easing and other inflation generating monetary programs eats away at your principal? That doesn’t make any sense.
But the insidious part of inflation is that the real culprits – those who are responsible for most of inflation -- don’t get blamed. If the price of cereal goes up, we blame the cereal manufacturers, the grocery stores, advertisers or the middlemen – not the Fed. If the price of gas goes up, we blame big oil, speculators and Arab sheiks – not those who control the currency printing presses.
Bernanke is trying to increase jobs. However, as chairman of the Federal Reserve, he has few tools with which to work – except increasing the supply of money and holding down interest rates. But hold on a sec: this is a financial downturn (requiring a longer recovery period) and the recession is structural and not cyclical. How is the world reacting to Bernanke’s nostrums? Morgan Stanley has said that it will lay off 1,600 financial workers, UBS bank will lay off 10,000, Lloyds is eliminating 15,000 jobs, Barclay’s Capital will lay off 275 and Deutsche Bank laid off 1,500.
Bernanke’s response? He will create a little inflation that will permit banks to borrow more money. How will that help? It won’t – but what else can Bernanke do? So he keeps using those same tools over and over and over again – and he has little effect on the jobs market. But he has had an effect on currency
Quote without Comment
Economists Milton and Rose Friedman, writing in their 1979 book, Free to Choose: “… [T]o our knowledge, there is no example in history of a substantial inflation that lasted for more than a brief time that was not accompanied by a roughly correspondingly rapid increase in the quantity of money; and no example of a rapid increase in the quantity of money that was not accompanied by a roughly correspondingly substantial inflation.”