Inflation or deflation? The man with the dollar printing press says “inflation”

Tuesday, October 20th, 2009 | Economics |

People are debating whether the United States is going to experience inflation or deflation. Ben Bernanke, the chairman of the U.S. Federal Reserve bank, has always intended to fight any hint of deflation with a massive dollar printing campaign. It’s hard to see how he can avoid overshooting attempts to stop deflation and crossing over into inflation.

Bernanke’s plan is a matter of public record since his time as a Federal Reserve governor before taking the reins of the Fed from Alan Greenspan in 2006. This speech is available from the the Federal Reserve archives (my emphasis in bold):

Remarks by Governor Ben S. Bernanke

Before the National Economists Club, Washington, D.C.
November 21, 2002

Deflation: Making Sure “It” Doesn’t Happen Here

As I have mentioned, some observers have concluded that when the central bank’s policy rate falls to zero–its practical minimum–monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken. Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.

The Fed has targeted and maintained an effective zero percent interest rate since December, 2008, forcing itself into a liquidity trap. Continuing from the 2002 speech:

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. 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? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

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.

Gold has risen from $300 in 2002 when Bernanke gave this speech to $1050 today. Gold prices rise when there is public mistrust of government fiscal and monetary policy, and when people expect the money supply to be inflated on a large scale.

Issuing more dollars makes each dollar worth less. It isn’t so much that gold is going up, but that the value of and demand for dollars is falling. This is a difficult idea for most people: we tend to think of prices of things going up and down in dollars. You also have to realize that the price of dollars goes up and down in terms of things - gold, land, stocks, etc. During inflation dollars are worth less so it takes more of them to buy those things. Continuing from the speech:

Each of the policy options I have discussed so far involves the Fed’s acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices.

And in fact the Fed is now engaged in a massive open market purchase of U.S. Treasury and agency debt. Without those purchases the U.S. would be at the mercy of domestic purchasers and foreign governments to buy the $7 trillion in debt we sold in fiscal 2009, which included $1.4 trillion in new debt. All is going according to Ben’s plan. See Federal Reserve has bought 100%+ of 2009 mortgage market. Continuing:

Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers.

Which fits well into the theory that today’s high stock prices are caused - not by fundamentals or earnings, which are in the toilet - but by an excess of dollars floating around and chasing those stocks. See More on the Federal Reserve’s effect on stock markets.

And if you’ve ever wondered why people call him Helicopter Ben:

A money-financed tax cut is essentially equivalent to Milton Friedman’s famous “helicopter drop” of money.

Previously - Inflation or deflation? How about hyperinflation

Tags: bernanke, inflation, the fed

1 Comment to Inflation or deflation? The man with the dollar printing press says “inflation”

Leave a comment