Kingmaker of the Universe

We have a sneaking suspicion --perhaps based on a few choice words by Fed Gov. Ben Bernanke over the weekend-- that the Fed wouldn't mind boosting prices as it administers its next all-sugar suppository.  "The only thing worse," we imagine Ben sitting back at his desk and musing, "than a consumer who thinks prices will even get better if he waits to make a purchase is a guy who hasn't taken out a loan on his house to get back in the market.  No," he goes on, "if those cunning Asians insist on sticking to the dollar standard, we'll, well, hmmm, we'll show them some IPO's that will suck the wind out of everybody's sails." "Sooner or later, they'll all see what stocks and awe really means.  We will inflate! we will inflate!"  He bangs his loafer on the desk for emphasis, further crumpling the latest warning on America's finances hot off the presses from the IMF, and gazes up on the wall at an engraved plaque with quotes from a speech he made last year, mumbling to himself, "they just don't understand; carved in bronze it reads:

Although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value. ...........

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

In the story books I read as a kid, central bankers were an austere lot, who never wore loafers, and from their Olympian heights used to throw bolts of wisdom down on the madding crowds.  "Trade deficits, they'd admonish, trade deficits mean we are living above our means, buying more than we're selling."  Budget deficits got the same intonation: "no country can continuously spend more than it takes in in taxes; that's tantamount to passing down our profligate ways to our children and grandchildren."

The role of the central banker back in those days was to make sure that things didn't veer too far out of control so we wouldn't all end up in a ditch. They knew from a long history that the politicians in pinstripes and kings in ermine left to their own devices would invariably let their self-serving ambitions bring everyone to ruin.  For most of monetary history, the cost and natural scarcity of precious metals, principally gold, has served as a greater brake than any stern banker or moneylender's admonitions.

Throughout history, whenever the good faith and credit of the issuing country has been the only thing backing the currency, there has been first a great bubble and then when the realization finally dawned on the paper's major holders, a terrible crash.

Here's a somewhat more scary thought:  inflation wipes out savings and erases debts!  Is Ben, the dauphin, dreaming that the Fed will resurrect all those American consumers now weighted down by an avalanche of plastic and other mortgage and non-mortgage debt for yet another go round?  Well, when Mr. Bernanke talks about a little inflation, he imagines a managed inflation target of several percent a year. We, of course, wonder just how he's going to get everybody else, including the debt holders, to hold still like a turn of the century family being photographed while the Fed keeps an underlying stagnant economy at a slow boil.

Well, tomorrow for starters we'll find out whether the Europeans are readying themselves to drop their interest rates.  It's expected that an actual rate drop may not be in the cards but instead the problem will be fought by words at a press conference given by Jean-Claude Trichet, the ECB central bank president.  In other words, will that sucking sound coming out of the Fed start to move the European bureaucrats ever closer to the fire?  Or, are they just trying to slow the inevitable down a bit?

In Detroit over the weekend, Volkswagen, Europe's largest automaker announced that the strong dollar was going to hurt their earnings in 2004.  This was certainly not good news for an economy that has been in the doldrums for years.  Meanwhile the stock markets back in the US keep heating up.  If you looked at your 401K lately, you'll know that your net worth is probably up.

There's an inevitability to the downward march of the dollar.  There will be blips, moves up and down but there are no blinking red tail lights on at the Fed in an election year, the bubble will continue to inflate and the piper will be paid ..... but later! When Alan Greenspan looks in the mirror, he only sees as far as kingmaker of the universe.

rmb

dymaxionweb@verizon.net

Copyright 2003 Richard Mendel-Black All Rights Reserved

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