Making Sure Inflation Happens

Ben Bernanke says the United States has plunged into a deflationary depression.

Really, that's what his Fed announcement from last week made plain. His deflation-defying policies have clearly failed to date on Bernanke's own metrics. Because he's now moved to applying the cure instead.

The US government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many US dollars as it wishes at essentially no cost.

So said the Maestro's apprentice when still merely a governor, rather than chairman, November 2002, speaking to the National Economists Club in D.C.

You may recall that Consumer Price Inflation, on the official measures at least, had just sunk to a 38-year low, hiking the cost of living barely 1.0% per year. The asset-price deflation hitting tech stock investors, meantime, had just found its floor (not that anyone knew it) some four-fifths below the peak of 31 months before.

And caught amid the first true "deflation scare" since the Great Depression of the 1930s – his own specialist subject, remember, if not quite worthy of a Trivial Pursuit collector's edition – Dr.Bernanke didn't shy away from stating his policy options.

Deflation Prevention

1. Target annual Consumer Price Inflation above zero, say from 1-3% per year;
2. Ensure financial stability, by lending freely to banks whenever trouble hits;
3. Act "preemptively and more aggressively in cutting rates when inflation is already low and the fundamentals of the economy suddenly deteriorate."

Deflation Cures

1. Print money;
2. Get fresh ink and paper;
3. Repeat.

You see, "Deflation is always reversible under a fiat money system," as Bernanke announced, claiming that his conclusion "follows from basic economic reasoning." To wit, "a little parable may prove useful:

Today an ounce of gold sells for $300, more or less [or three times more in early 2009]. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days.

What would happen to the price of gold?

Fast forward six-and-a-half years, and it's not gold which Ben Bernanke has produced in unlimited amounts at no cost, but US dollars. But given his obsession with the Great Depression – and given that money was gold seven decades ago – you get the point.

Presumably, the potentially unlimited supply...would cause the market price...to plummet. Indeed, if the market is to any degree efficient, the price would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce.

Look at the chart, and you can see what the Fed chairman meant. It shows what he did for gold and the Euro with last Wednesday's $1.25 trillion devaluation of the greenback. Both shot higher on the news. Neither has given back too much of their jump yet.

But while the Euro had already been ticking higher, the gold price vs. the dollar had been falling. Looking back over the last seven year, in fact, the nine weeks starting mid-Jan. were something of an aberration. The Euro and gold moved in opposite directions. Whereas, seeing how committed to dollar devaluation the Federal Reserve clearly remains – especially now deflation avoidance has failed – both should really move together.

"As I have stressed already," Bernanke explained back in late 2002, "prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation."

Trouble is, if the dollar falls then other currencies must rise. We've already had clear devaluations from the UK, US and Swiss authorities. The Japanese can't be far behind; they sold their own currency all through mid-decade, desperate to apply Bernanke's "deflation cure" vs. the dollar.

Once the Bank of Japan fires up its "quantitative easing" again, that would leave only the Euro still to devalue.

Maybe gold and the single currency will soon diverge again. Because in curing deflation now the US believes prevention has failed, making sure inflation happens looks the only sure goal of global monetary policy.

Disclosure: Author is invested in physical metal, not ETFs

Comments

[DONE_SONZ:]

Gold is the only true currency.Especially these days.

Mar 24 07:11 AM

[kelm:]

There is talk going around about a plan by Brazil, China, India, and Russia to use an IMF instrument as a new global, non-national, reserve currency as the current owners of the world's three main reserves haven't exactly been great stewards of their responsibilities. I think it is quite likely that gold and perhaps some other commodities will find their way into the basket that defines that new construct. Further, I would not be surprised if a re-valuation (higher) of gold occurs as has been done in the past.

Mar 24 09:24 AM

[Jason Rines...:]

Please review my below post on the article: seekingalpha.com/artic... dated August 8th 2008.

"Fellow investors and friends. History rhymes. Two quick important things to note:

1) 1908, 1929. What do they have in common with global conflicts a few years later.
2) It's about the money, always about the money. Mankind is down to one final conflict of West and East. Useful puppets such as radical Islam (may as well call Al Queda, Iranian and Syrian leadership as high paid mercenaries). The East uses them often and has done so for 40 years. It's about who gets the power of the globe by nations pegging currency. Oil is the new global currency but by meaning new I mean last 40 or so odd years.
3) The West now knows Russia's temporary Fascism to fix there nation is permanent to major military confrontation on a global scale. Google Adolph Hitler and his decision-making in Europe when he came to power in the 1930's. Man at this period of history can only make so many choices, we are in a box until we fix our genetics which causes permanent mental imbalance to leaders abuse of money causing national or global suffering. This was becoming apparent in 2004 with Putin, I said it all along he is KGB for life but many investors ignored the signals and viewed things with rose colored glasses. KEEP AWAY.
4) Russia is going to be the temporary new monetary peg for a short time as the USA recovers.

All of this is sounding Revelations-esque. It is, but remember that this is a correction to mankind restoring broken genetics and perfection. The time period of all the bad stuff is short but tremendously painful. Protect your investments and life accordingly gentlemen. Aug 08 11:47 AM"

Mar 24 03:22 PM

[Vox Rationalis:]

"Look at the chart... It shows what he did for gold and the Euro with last Wednesday's $1.25 trillion devaluation of the greenback. Both shot higher on the news. Neither has given back too much of their jump yet."

Yes, we were all almost knocked over by that 3.5% "shot higher."

"Looking back over the last seven year, in fact, the nine weeks starting mid-Jan. were something of an aberration. The Euro and gold moved in opposite directions."

No. The aberration started in August-September, and the link is silver, not the euro. In late summer, following years of extraordinarily correlated movements, gold and silver suddenly diverged. Silver, along with virtually all other commodities, fell dramatically, and has continued its strong long-standing negative correlation against the dollar. Gold, however, reversed direction, as its destination for the fearful led to increased demand at a time when all other assets classes (except Treasurys) were falling in a way few can recall.

Gold is still overvalued relative to other commodities.

"Whereas, seeing how committed to dollar devaluation the Federal Reserve clearly remains – especially now deflation avoidance has failed – both should really move together."

Deflation avoidance has failed? We've had three months of falling prices, and you're ready to announce a meaningful deflationary environment?

Anyway, here's a reason for you: fear of a deflationary depression led to increased demand for gold. With the Fed's announced actions, a deflationary depression is pretty much off the table. If fear has fallen, fear-driven demand for gold has probably also fallen. Just as gold moved in opposition to silver as fear increased, so may it move as fear decreases.

The currency moves seem inevitable - the gold move does not.

Mar 24 10:30 PM

[Plan B Econ...:]

Deflation is easy to prevent. Just print money. And that's what is happening all around the world.

Of course, the risk is that central banks will be under pressure to keep running the printing presses...even when inflation starts. This happened in the 1970s...instead of a real solution to inflation, Nixon tried implementing price controls and rationing. It took 10 years before someone was allowed to step in and really jack up rates.

Here's a look at the difference between 6% and 12% inflation rates...more than meets the eye:

www.planbeconomics.com.../

Apr 04 01:30 PM