Monday, September 19, 2011

Paul Volcker Gets in Ben Bernanke's Face

Former Federal Reserve Chairman Paul Volcker is out with a stunning Op-Ed in today's New York Times, it is as anti-Paul Krugman as you can get and in a subtle praising of words uttered by Ben Bernanke, it is in Bernanke's face.

I have seen Volcker up close on a few occasions and he generally couches his views in a non-confrontational manner, though always stating what he thinks. He has a true diplomatic polish to his approach. But, aside from being polite to Bernanke in his Op-Ed, he has guns blazing warning about potential inflation:

IN all the commentary about Ben S. Bernanke’s recent speech in Jackson Hole, Wyo., little attention has been paid to six crucial words: “in a context of price stability.” Those words concluded a discussion by Mr. Bernanke, the Federal Reserve chairman, of what tools the central bank could consider appropriate to promote a stronger economic recovery....

we are beginning to hear murmurings about the possible invigorating effects of “just a little inflation.” Perhaps 4 or 5 percent a year would be just the thing to deal with the overhang of debt and encourage the “animal spirits” of business, or so the argument goes.

It’s not yet a full-throated chorus. But remarkably, at least one member of the Fed’s policy making committee recently departed from the price-stability script.

The siren song is both alluring and predictable. Economic circumstances and the limitations on orthodox policies are indeed frustrating. After all, if 1 or 2 percent inflation is O.K. and has not raised inflationary expectations — as the Fed and most central banks believe — why not 3 or 4 or even more? Let’s try to get business to jump the gun and invest now in the expectation of higher prices later, and raise housing prices (presumably commodities and gold, too) and maybe wages will follow. If the dollar is weakened, that’s a good thing; it might even help close the trade deficit. And of course, as soon as the economy expands sufficiently, we will promptly return to price stability.
Well, good luck.

Some mathematical models spawned in academic seminars might support this scenario. But all of our economic history says it won’t work that way. I thought we learned that lesson in the 1970s. That’s when the word stagflation was invented to describe a truly ugly combination of rising inflation and stunted growth.

My point is not that we are on the edge today of serious inflation, which is unlikely if the Fed remains vigilant. Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and “reasonable” 4 percent becomes 5, and then 6 and so on.

What we know, or should know, from the past is that once inflation becomes anticipated and ingrained — as it eventually would — then the stimulating effects are lost. Once an independent central bank does not simply tolerate a low level of inflation as consistent with “stability,” but invokes inflation as a policy, it becomes very difficult to eliminate.

It is precisely the common experience with this inflation dynamic that has led central banks around the world to place prime importance on price stability. They do so not at the expense of a strong productive economy. They do it because experience confirms that price stability — and the expectation of that stability — is a key element in keeping interest rates low and sustaining a strong, expanding, fully employed economy.

At a time when foreign countries own trillions of our dollars, when we are dependent on borrowing still more abroad, and when the whole world counts on the dollar’s maintaining its purchasing power, taking on the risks of deliberately promoting inflation would be simply irresponsible.

It is that conviction that underlies Mr. Bernanke’s six words. Let’s not forget them.
Since it is Bernanke who controls the money printing machine, make no mistake, Volcker's warning is right at Bernanke.

Remarkably, as Volcker's warning is printed in NYT, WSJ clues us in that Bernanke may be considering a move to ease monetary policy even further. This despite the fact that money growth is now well into double-digit rates. Three-month annualized money supply growth (M2) is at 23.3%. This growth is largely because some of the $1.6 trillion in excess reserves created during QE1 and QE2 is leaking out into the economy.

So what is WSJ telling us Bernanke is considering? Get this:
They [the Fed] also could try to encourage lending by cutting the 0.25% interest rate currently paid to private banks when they park money at the central bank.
Cutting the interest rate on reserves would cause money to move out of excess reserves even faster! It may very well be time for the 6' 7" Volcker to do more than just get in Bernanke's face. Perhaps Volcker should lift the pipsqueak up, throw him against the wall and ask the Fed chairman if 23.3% money printing is quite enough and that perhaps things should be slowed down quite a bit, rather than the Fed coming up with new ways to goose the money supply even more.

Volcker is no End the Fed advocate. He only comes around as the enforcer when inflation is about to get out of hand, or already there. We may know by Wednesday, when the Fed issues its statement following its FOMC meeting, whether Bernanke is going to calculate Volcker's warning into his thinking, or if he will ignore Volcker's warning and focus on further expansionary moves.

If Volcker is ignored, hug your gold coins, for, as Volcker says, to get business to jump the gun and invest now in the expectation of higher prices later, and higher housing prices, this will also raise
presumably commodities and gold, too.
It will in otherwords mean that all hell will break loose on the price inflation front.


  1. Bernanke knows he probably doesn't have a future job with any Republican other than maybe Mitt Romney or Jon Huntsman. With Fed actions always being a few months ahead of the "benefits," it wouldn't surprise me if they moved to a slightly negative interest rate on reserves to force them out into the economy. The short-term artificial "goose" to the economy would be an attempt to get Obama re-elected. The massive inflation might not be evident until shortly after the election.

  2. I don't believe Bernanke and company are capable of reinflating any bubbles at this point. Just as during the Great Depression, our current economy is so bad -- rendered permanently dysfunctional by endless booms and busts -- that more printing will fail to goose the economy. Only drastic, Volker-like measures -- combined with courageous slashing of taxation, spending, and regulation -- will save the country, but only at the expense of a harsh depression.

    Whatever the case, Bernanke is obviously courting disaster.