Friday, May 12, 2006

A Flea in Bernanke's Ear

Hi. KatyDee Gadfly here. I wish I could turn myself into a flea for just a moment, so I could skitter on over to the Fed to slip a little idea or two into Bernanke's ear.

[Thanks to for the image.]

The FOMC (Federal Open Market Committee that determines how our monetary system will function) reminds us regularly that they are keeping a very fatherly eye focused on the Economic Data, so as to be able to adjust the Fed rate up or down appropriately and keep the American -- to wit the world -- economy on an even keel. From their statements, we can conclude that they are mainly concerned with inflation and employment.

In order for CPI inflation to rise, it is not enough for there to be excess purchasing media in circulation. That media must reach the US marketplace -- and not just any marketplace; it must reach the CPI items (cars, electronics, food, etc.)

Now, from the data we can assume that somewhere between 1.5 to 5% annual inflation (depending which flavor of inflation figures you prefer, core or regular) must correspond to that portion of the increased circulating purchasing media that is reaching those items. But I can see three reasons why there might be some, or even a lot, that is not reaching them.

1. With the exception of Holland, the US has a trade deficit with all of its major trading partners, and as we all know, our current account "deficit" [CAD] is at a record all-time high. This means that our trading partners have chosen to use our dollars to buy something other than those products that are included in CPI calculations. We know this to be true, because the CAD proves this. They are (or were until recently) buying treasury bonds and other financial assets that are encouraging inflating of asset prices in the US, assets like real estate, the stock market, derivatives and CLOs (collateralized loan obligations like mortgages.) This must mean that our other CPI products are not of interest to them, probably because the unwarrantedly high exchange value of the dollar (which they themselves have maintained through their purchase of dollar instruments and assets) renders most of our manufactured CPI products too expensive.

2. Because the US Fed has chosen to turn a blind eye to the inflated prices of assets other than CPI, or even worse, the more limited core CPI, they have unfortunately chosen to ignore the symptoms of excessive circulating purchasing media that the inflated dollar-asset prices represent. By doing this, they had -- at least up until recently -- assured continuous credit pumping, which both foreign and native investors have been syphoning off into more real estate and interest-chasing instruments like derivatives. Why? Because there is no other capital market for their money, being as general US consumption and foreign trade dollars buying US CPI products have not increased those specific prices enough to warrant production expansion in those industries, reducing the demand for capital-investment dollars in those industries.

3. There is a third element of tragedy here. By watching the wrong figures, the Fed is insuring America's workers that their salaries remain stagnant, not even keeping pace with the CPI until this year. Salaries presently have at least a four-year lag. Obviously, producers are not going to hire (i.e. raise wages) if they're not seeing a rise in prices to justify expanding production. They're now starting to, but why now? Because (1) the derivatives and other risk capital markets are saturated, (2) credit had nowhere else to go but to over-expansive consumer credit that was sustaining production, and (3) finally, the dollar exchange is coming down, which they may be calculating will make US products more interesting to foreigners.

But now is too late. The horse is out of the barn. The Fed has indeed been the creator of a huge business cycle distortion that they will not be able to cure without throwing the world economy into chaos.

Professor Bernanke, this has fallen upon you, and you're not the guy for the job of biting the bullet. Get out while the getting's good if you don't want to take the blame for Greenspan's mess. Either you have to take this excess liquidity out of the system (and when you do, you'll cause an investment crisis involving many banks), or you have to allow the situation to get worse by not doing so (and you'll have CPI inflationary pressure that will conflict with your methodology, messing with your calculations and with your mind, never mind ours.)

Now, I'm just a gadfly. So, if there are any economics gurus reading this, please translate the above into academic jargon and pass it on to Professor Bernanke and his buddies. After all, they'll never listen to someone as one-cellular-brained as I, but you -- now that's a different story.


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