Quantum Pranx


Bernanke’s inflationary binge could spark a currency war and ruin the dollar

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by Gerard Jackson
Posted originally Dec 20th, 2010

BERNANKE’S MONETARY SHENANIGANS ARE BUILDING UP a host of problems, domestic and international. In the next 8 months or so he plans to pump nearly $900 million dollars into the US economy with the intention of lowering interest rates to the point where business borrowing and consumer spending will be sufficiently stimulated to trigger a recovery. (If only it were that simple.)

This policy amounts to criminal negligence. If Bernanke were a surgeon he would be doing jail time. To get a grip on the magnitude of Bernanke’s folly let’s go back to 2007 when the Fed’s balance sheet stood at $900 million. By 2009 it had jumped to $2.3 trillion, an increase of 136.7 per cent. The excuse was that a massive monetary injection was needed to prevent an economic collapse. I for one never believed that the US was in danger of a deflation-driven implosion. I also warned that the consequences of any rescue package would be to slow if not prevent the necessary economic adjustments from taking place.

So what did America get for Bernanke’s swift monetary rescue? Unemployment stuck at 9.6 per cent with the broader measure standing at 17 per cent. His response is not to reason why but to once again step on the monetary accelerator. Brilliant. Absolutely brilliant.

Let’s see what “Helicopter” Ben’s vulgar Keynesianism might mean for Americans. Short-term debt used to be the Fed’s main monetary instrument. Thanks to Bernanke most of the Fed’s Treasurys are now long long-term with about half exceeding five years. Bernanke has to know that in the current situation holding long term securities involves great risks. At the moment the rate stands at just over 4 per cent. You don’t have to be an expert in finance to realise that a rise to 6 per cent would slash the value of these holdings, wiping out several times over the capital on the Fed’s balance sheet.

But why should this happen? Because Bernanke — the architect of this policy — has implemented a monetary strategy that must eventually drive up interest rates if not checked. And right now, there is nothing checking him. Flooding the economy with dollars is bound to arouse inflationary expectations. This will lead to rises in the yield of long-term bonds which in turn will drive down bond prices (there is a strict inverse relationship between the yield of a bond and its price) turning the Fed’s balance sheet into an ocean of red ink.

It has been suggested that before inflationary expectations can take root the Fed could soak up the “excess liquidity” by selling bonds. But this would have the effect of raising rates by pushing down bond prices.

But the above is only part of the Fed’s sordid tale of gross monetary incompetence. Bernanke has two objectives: one is to raise prices at home and the other is to devalue the dollar. Running down the dollar is bound to have severe international ramifications and this why Bernanke’s policy provoked global outrage with the Germans calling him “clueless” and China warning that it might have use capital controls to protect itself. As Guido Mantega, Brazil’s finance minister, said: “Everybody wants the US economy to recover, but it does no good at all to just throw dollars from a helicopter.” I do not know of a single country that has supported Bernanke’s rabid inflationism.

The fear is not that driving down the dollar — “exchange dumping” — will inflame world-wide inflation (this is not the ’60s when a flood of Eurodollars ramped up European money stocks) but that it will greatly disrupt international trade by sparking a “currency war”. If Bernanke succeeds his victory will only be temporary. Other countries are not going do nothing while he uses inflation to price their producers out of US the market as well as other foreign markets, not to mention their own domestic markets. They have a number of weapons at their disposal, none of them good for international trade.

Everyone knows that inflation means a depreciating currency, with dollars buying less and less as prices continue to rise. But if rising prices put people back to work so would cutting real wage rates. After all, one of the effects of inflation is to widen profit margins and cut the real cost of labour, therefore make it cheaper to hire. But like just about everything else in economics, it’s not quite this simple. Unfortunately for Americans — and the rest of the world — Bernanke doesn’t know that: he is still wrapped up in the Keynesian multiplier, the Phillips curve and LM-IS analysis. No wonder he cannot get it right.

Bernanke does not stand alone. Olivier Jean Blanchard, the International Monetary Fund’s chief economist, recently stated that it wouldn’t be the “end of the world” if the Fed stimulated the rate of inflation considering the threat of deflation. Bernanke’s printing greenbacks like crazy and this twerp warns about deflation. As expected, Blanchard is another Keynesian.

No one with a decent knowledge of the history of inflation denies that loose monetary policy can create a boom. On the contrary, this is precisely why we have booms and busts, as explained by the Austrian school. If Bernanke succeeded in using inflation to slash unemployment and expand production, the victory would be short lived. Accelerating inflation would see interest rates eventually climb as the price premium increased, and the dollar would start falling even faster than Bernanke could tolerate. Sooner or later the Fed would once again have to slap on the monetary brakes.

Inflation does not create real wealth and jobs — it destroys them. This is a fact that Keynesians seem genetically incapable of grasping.

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