On Tue, 25 Oct 2005, Doug Henwood wrote:
> I just read a WSJ story that says the bond mkt sees [Bernanke] as an
> inflationist. I don't get that.
You probably saw the article below in today's NYT from your old pal James "Permabear" Grant. It seems to shed light on how such people think. It seems to be a combination of:
(1) Almost incredibly, bond holders don't think deflation is such a bad thing, and hold against Bernanke a famous speech he made in 2002 elaborating the many tools the Fed might use to combat it if it ever arose;
(2) the background of a debt that has enormously increased, and will continue to do so, inspiring in bond holders a fear that inflating will inevitably become the irresistable logical solution to any central banker who hasn't pledged their first born against it; and
(3) a background belief that uncoupling the dollar from gold has made faith the ultimate basis of value (as if the gold standard was different, an ultimate reality on which value could be more securely based). And that this makes absolute orthodox fealty the only guarantee, and every heretical gesture a sign of coming doom.
What a bunch of weird ducks. Some people have said the only difference between a cult and a church is success. It seems to hold also of economic orthodoxy -- that if rich bondholders believe it, that makes it not crackpot.
But the weirdest thing of all is that Grant is a really smart guy and writes wonderfully well. The relation of the mind and its worldviews is weird.
Michael
==============
http://www.nytimes.com/2005/10/26/opinion/26grant.html
The New York Times
October 26, 2005
Future Shock at the Fed
By JAMES GRANT
PRESIDENT BUSH's choice to succeed Alan Greenspan as chairman of the
Federal Reserve Board has raised a roar of approval. Economist,
scholar, presidential counselor and former Fed governor, Ben S.
Bernanke is a nominee from central casting.
But there is one rub. The man with the gray beard and the perfect
résumé - winner of the South Carolina state spelling bee, Ph.D. from
the Massachusetts Institute of Technology, former chairman of the
Princeton economics department - professes to believe the impossible.
He insists that the Fed can keep the economy chugging and prices
stable just by pushing a single interest rate (the so-called federal
funds rate) up and down.
Alan Greenspan, of course, has long espoused the same impossibility,
as have other Federal Reserve officials and many private economists. A
little thought experiment will reveal their error.
Let us say that Mr. Bernanke's field of expertise was energy prices
rather than interest rates, and that the president named him to the
Department of Energy rather than the Federal Reserve. If Mr. Bernanke
then ventured a long-term oil-price forecast, would anyone even bother
to write it down? Would anyone expect him, once confirmed, to actually
fix the price?
Those who did would have to call the idea by its discredited name -
price controls - and would have to explain why the secretary-designate
knew better than the market at which price the supply of oil would
meet the demand for oil. They would also have to explain why this
episode in price controls would turn out better than the long series
of flops that preceded it. The world would laugh.
Yet we seem to accept, and even desire, exactly such ludicrous claims
of foresight from a Fed chairman. It follows that anyone who is
willing to take the job as Fed chief is, by that reason, unqualified
to hold it.
Wall Street, of course, has other ideas. Thus the rally in stock
prices following word of Mr. Bernanke's nomination was no vote of
confidence that the presumptive chairman would settle on the right, or
true, federal funds rate. It was, rather, an expression of hope that
he would do his all to ensure a speculatively appropriate (meaning
very, very low) rate.
Perhaps. But Mr. Bernanke's history shows he is not so much a believer
in easy money as in the capacity of the Fed to take the right
anticipatory action. Is the rate of inflation too high? Not high
enough? With a twist of the monetary-policy dial, the problem is on
its way to being solved. Let the Fed announce its target for inflation
- say, 2 percent a year - and juggle its interest rate to cause that
desired inflation rate to materialize. In so many words, the nominee
contends, policymakers control events, rather than the other way
around.
We are all susceptible to believing an impossible thing. Mr. Bernanke
has the special susceptibility of the straight-A student. The economic
world he sees is his to command. He can comprehend it, even measure it
(no small achievement given the subjective, even arbitrary, nature of
statistical sampling and compilation). And he expresses his supreme
self-confidence in some of the bluntest language ever spoken by a
central banker.
Late in 2002, the Fed started to warn against the risk of deflation,
that is, of broadly falling prices. Now, deflation is no bad thing if
you find yourself at the cash register with a shopping cart full of
groceries. But Mr. Bernanke did not have the shopper exclusively in
mind. "When inflation is already low and the fundamentals of the
economy suddenly deteriorate," he said in a speech that November, "the
central bank should act more pre-emptively and more aggressively than
usual in cutting rates."
Some modicum of inflation is a must, he said. Let prices start to sag,
and they could go right on sagging, as they had done in Japan for
years. The solution: print money. The counterarguments for sitting
tight (Are not falling prices a natural and, on balance, benign
consequence of the incorporation of China and India into the global
economy? By printing extra money to prop up the American inflation
rate, wouldn't the Fed distort a whole host of prices and interest
rates?) found no sympathy with him or Mr. Greenspan.
So Mr. Bernanke, then one of seven Federal Reserve governors, sought
to assure the world that United States monetary policy would stop
deflation before it started. Yet here was a tricky assignment, for the
post-1971 dollar is purely faith-based. Not since the Nixon years has
a holder of dollars had the privilege of exchanging them for a
statutory weight of gold. Rather, the dollar is a piece of paper, or
electronic impulse, of no intrinsic value. It is legal tender whose
value is ultimately determined by the confidence of the people who
hold it.
In the Greenspan era, the United States became an immense net debtor.
A prudent American central banker, it might seem, would therefore be
at pains to spare these overseas accumulators of greenbacks any
unnecessary anxiety about inflation damaging the shelf life of their
money. Not Mr. Bernanke. In that 2002 speech, he said that because the
currency is intrinsically worthless, the government can (and in
certain circumstances should) print up as much of it as it wants. And
it should not be stymied in the work of restoring the rate of
inflation to a decent minimum even if interest rates fell to zero.
The Fed could, if necessary, buy up all the Treasury's debt, using
dollars created specially for the purpose. Or, for a double-barrel
stimulus, it could also buy up private debts (mortgages, car loans,
bonds and the like). And as a last resort, the Fed could figuratively
put in place an idea that the economist Milton Friedman once theorized
for illustrative purposes: It could drop money out of helicopters.
Approbation for Mr. Bernanke is not quite universal on Wall Street;
after that speech some took to mockingly calling him "Helicopter Ben."
Many were the blessings, real and imagined, of the Greenspan era: low
inflation, falling interest rates in a growing economy, a pair of
notably mild recessions and a succession of financial crises nipped in
the bud by an activist Federal Reserve. Stock prices were bubbly
(until the bubble burst), and Wall Street prospered. But debt grew and
grew, and the gulf between what the United States consumes and what it
produces - the trade deficit - widened to break all records.
Now Mr. Bernanke stands to inherit what Mr. Greenspan and he, among
others at the Fed, wrought. Certainly they have whipped deflation. But
by pressing down interest rates to the floor, they have pushed housing
prices to the sky. And they are the uneasy witnesses to an unscripted
climb in the Consumer Price Index, which, in September, registered a
4.7 percent increase over last year.
Don't worry, many counsel. The seemingly alarming inflation data are
the statistical tracks of a boom in energy prices caused by the Iraq
war and the Gulf Coast hurricanes. It will pass.
But what if it doesn't? What if a new cycle of rising prices has
already begun - as I happen to believe it has? Mr. Bernanke, as sure
of himself as he is of the future, won't soon be changing the way the
Fed operates. Rather, it will be the world's dollar holders who will
change the way they operate.
If America's creditors sense that inflation is robbing them of their
wealth and that the Bernanke Fed is too slow to raise its interest
rate, they will sell their dollars and dollar-denominated securities.
Such an exodus would, among other things, tend to increase the costs
of imported goods and drive up dollar-denominated interest rates. In
other words, events would control the Fed.
Since each of the world's major currencies is a scrap of paper of no
intrinsic value, some of these disaffected dollar investors may buy
gold. Mr. Bernanke doesn't talk much about that barbarous relic. What
would he make of a flight from a rationally managed currency into an
inert precious metal? I will guess that it would astonish him.
James Grant, the editor of Grant's Interest Rate Observer, is the
author of "John Adams: Party of One."
* Copyright 2005 The New York Times Company