Bernanke Rejects “That ‘70s Show” Comparison

Federal Reserve Chairman Ben Bernanke told the Senate Banking Committee Thursday that he does not believe inflation poses a threat to the economy.

The Fed Chairman displayed his usual nervousness in his semi-annual testimony to Congress. However, Bernanke became somewhat testy when asked by several Senators if the economy is experiencing the s-word: stagflation. Bernanke kept reiterating that “I don’t think we’re anywhere near a 1970s-type situation.” This is because “our anticipation is inflation will come down later this year.”

Bernanke attributes the rise in food and energy costs (core inflation) to investor speculation. While that is partially true, commodity and energy prices have been on a tear since the FOMC began lowering rates last September. The FOMC’s monetary policy has resulted in the U.S. dollar at record lows, causing commodity users to spend more dollars for those materials.

Bernanke mistakenly believes the FOMC has a “monoline mandate”: to focus only on economic growth. Even some members of Congress along with a few Permabulls are getting angry that he refuses to acknowledge his other mandate of price stability as enacted by Congress under the Full Employment & Balanced Growth Act. Ironically, this mandate came into being in 1978 - the last period of stagflation.

It is clear that the only beneficiary of the Fed’s lower rates is the banks. Mortgage rates have risen since the rate cuts (and lending requirements are tighter). This morning’s release of January Personal Income and Spending shows consumers are spending more than they are earning. Even the Fed’s favorite, the Core PCE Index, was 2.2% - once again above the Fed’s so-called “comfort level.” As Friday’s Wall Street Journal editorial rightly points out, “The people who aren’t being fooled by all this are the American people. They don’t pay their bills with “core” dollar bills, and they know those dollars buy less with each passing month.”

Because consumers can no longer tap into their home equity to offset the higher cost of living, demands for higher wages are about to arrive. Companies will have no choice but to acquiesce to higher wage demands as the low hanging fruit of productivity and outsourcing has already been picked.

Sir John Templeton once said: “The four most expensive words in the English language are ‘this time it’s different’.” Cycles repeat themselves, but this time it is different. This time is worse than the 1970s, as we have stagflation AND a housing and credit crisis like the world has never seen.

Allan Meltzer, an economics professor at Carnegie Mellon, wrote an outstanding op-ed piece (entitled “That ‘70s Show") in the Wall Street Journal, which Bernanke was asked about at Thursday’s hearing. Bernanke stated he disagreed with the piece. In the piece, Meltzer warns of the repercussions of not taming the inflation beast:

A country that will not accept the possibility of a small recession will end up having a big one when the politicians at last respond to the public’s complaints about inflation. Instead of paying the relatively small cost of a possible recession, the public pays the much larger cost of sustained inflation and a deeper recession.

If Bernanke wants to bring back “That ‘70s Show”, we need Paul Volcker in the starring role.