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Dr. Fraenkel: Or How I Learned To Stop Worrying and Love Inflation

April 27, 2007 

Stanley Kubrick was my favorite director of all time. Peter Sellers was one of my favorite actors. Dr. Strangelove is high on my favorite movie list, so it’s not that unusual for me to look at today’s unfolding worldwide war on recession against the comic backdrop of Dr. Strangelove. 
Our government is fighting the recession war with weapons of economic mass stimulation  that have become necessary because of the cold war waged against inflation since the early 1980’s. None of the policy makers realize that targeting low inflation as the singular goal of economic policy has created the problems we are living with today. 
Most of today’s senior policy makers grew up during several business cycles characterized by inflation between the 1950’s and 1970’s.   Paul Volker and Ron Reagan’s team conspired to crush inflation with the double dip recession of 1980-1982 and it worked. They employed the nuclear option of driving interests very high to induce a double dip recession.   We won the inflation war. However, policy makers continued to fight that war for the next twenty five years. It was widely accepted that maintaining inflation in a low tight range was the end all and be all of protecting our economy. This was both too simplistic and wrong. 
Free market, entrepreneurial capitalism goes through cycles. The cycles can be slightly affected by policy makers but they play out largely on auto-pilot. As Bob Barbera, points out in his book, “The Cost of Capitalism” part of the this natural cycle relates to participants taking more and more risk as they become more and more comfortable with the environment. 
Central banks focus on keeping inflation low resulted in markets driving interest rates low. Very low interest rates supercharged the greed witnessed on Main Street, Wall Street and Washington DC.   The greed that cheap money stimulated coupled with the longevity of the last business cycle made the participants in the economy comfortable with taking more and more risk with their investments and business strategy.  
The investment banks created doomsday devices by employing obscene leverage in search of higher revenues that would be paid out 50% in bonuses. The funny part is that they didn’t realize that the mutually assured destruction they built wasn’t being used as a deterrent. The business cycle had its finger on the red button, and when the pre-emptive strike came and housing prices plummeted, explosions went off around the world. 
My mind conjures up a certain Wall Street CEO riding on a missile labeled CMO wearing a cowboy hat and plummeting to earth. The difference between our current movie and the movie that Kubrick made is that there is nothing wrong with our current world that a little inflation won’t fix. 
The debate, at high levels between luminaries, about whether we are about to experience deflation or Weimar Republic inflation is misguided. The amount of money created by world central banks has already prevented a depression. Employment recovery will lag the upcoming economic bottom by several quarters. This will prevent any wage price spiral in the near term. Workers will not demand higher wages while their friends and neighbors remain unemployed. There is the likelihood of a new inflation cycle starting in a year or two. The inflation will emerge first in commodities as world demand rebounds. It will slowly start build into a new inflation process, and that will be exactly what the good Dr. ordered. 
Fred S. Fraenkel
Fred S. Fraenkel
Vice Chairman and
Chairman of Investment Policy
Beacon Trust Company


Fred S. Fraenkel, Beacon Trust Company
Vice Chairman of the Board of Directors,
Chairman of the Investment Policy Committee
    • Chairman of Millennium 3 Capital Venture Fund
    • Vice Chairman and COO  of ING Barings Furman Selz
    • Managing Director and Director of Global Research at Lehman Brothers Inc.
    • Board of Directors and  Director of Research at Prudential Securities
    • Five Years Barron’s Year End Rountable
    • Chief Investment Strategist EF Hutton
    • Bank Analyst Goldman Sachs
    • University of Pennsylvania - Wharton School, M.B.A.
    • Lehigh University, B.S. – Beta Gamma Sigma, Omicron Delta Epsilon