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In a Wall Street Journal op-ed on
Monday, and in congressional testimony later in the week, Fed Chairman Ben
Bernanke reassured all that thanks to his accurate foresight and deft use of
the Fed's policy toolkit, he could maintain near zero percent interest rates
for an extended period without creating inflation. With supernatural powers
such as these, one wonders if Ben would be better employed by the Justice
League rather than the Federal Reserve.
Ben's game plan is apparently
simple: once he determines that the economy is on solid ground, he will use
the monetary equivalent of Superman's laser vision to strategically evaporate
all the excess liquidity that he has recently created without endangering the
recovery. Don't try this at home, kids.
In other words, as he did just a
few years ago when the subprime fiasco began to emerge, Bernanke is assuring
us that inflation is contained. He is just as wrong now as he was then.
The idea that the inflation genie
can be painlessly rebottled has no historic precedent. Even mainstream
economists, who've never met a fiscal stimulus they didn't like, agree that
central banks must act preemptively with regard to inflation. Bernanke is
making the case that the new set of liquidity tools, hastily developed in the
panic of late 2008, will act just as well in reverse. But liquidity is a lot
like liquid, it's a lot easier to spill than to un-spill. The Chairman
believes that his new gadgetry will allow him to perform a feat of monetary
magic no other central banker has managed to pull off. But given his history
of getting it wrong, why should we assume that this time he will get it
right?
The bottom line is that Bernanke
has no exit strategy. He can talk about it all he likes, but when it comes
time to actually pull the trigger, his nerves will buckle. The current
communications campaign is simply an attempt to calm the markets. I doubt few
citizens or members of Congress had any hope of understanding the exit
strategy mechanisms that Bernanke described. Many likely place their faith in
his seeming mastery of financial minutiae. Sadly, as with the mythical
“strong dollar policy,” confident talk may be the sum total of
the Chairman's strategy.
He senses that the villagers, in
the form of currency traders and bond market vigilantes, are becoming a bit
restless. To sooth their concerns, he must pretend that he has the situation
under control. Like Jack Nicholson in A Few Good Men, he knows full well that
markets simply “can't handle the truth.”
But make no mistake, in order to
mop up all the excess liquidity, the Fed will need to raise interest rates
substantially to attract buyers for all the bonds that the Treasury must
sell. Fed officials know that our economy is completely dependent on cheap
money and limitless government credit, and can't tolerate the loss of either.
Of course, the longer the monetary spigot remains open, the more addicted to
low rates we get, and the harder it will be to kick the habit. If the Fed
could not remove the punch bowl during the years before the bust, how will
they do so while the economy is far weaker? Even if they do start the
process, the minute the “recovery” seems in jeopardy, look for
the Fed to turn the showers back on.
Also, paring down the Fed's
bloated balance sheet will require selling hundreds of billions of dollars of
toxic assets, such as bonds backed by subprime mortgages, credit card debt,
and auto and student loans, back into the market. Finding buyers for such
sludge without crushing the market is a trick that Houdini himself would be
reluctant to attempt. The Fed's assumption that the assets will no longer be
toxic by the time it sells them is farcical. The economy at large has not yet
suffered the full weight of the recession because these assets have been
largely quarantined at the Fed. Reintroduce these toxins back into the
economy and the reaction could be lethal.
Bernanke also mistakenly expressed
optimism that a strengthening global economy would aid our recovery.
Unfortunately, a global resurgence will force Bernanke's anti-inflation hand,
and will thereby cause more pain to the U.S. economy.
Few appreciate how the global
panic of 2008 actually benefited the U.S. by causing a flight into U.S.
dollars and Treasury bonds. The resultant flows put a lid on consumer prices
and kept interest rates low. As growth overseas resumes, and these flows
reverse, both consumer prices and interest rates will rise.
Further, as current policy
prevents the structural imbalances underlying our economy from being
corrected, U.S. unemployment will continue to rise. Combined with higher
interest rates and rising consumer prices and the Misery Index (inflation +
interest rates + unemployment) will be a big issue in the 2010 mid-term
elections, and an even bigger one in 2012.
Peter D. Schiff
President/Chief Global Strategist
Euro Pacific Capital, Inc.
20271 Acacia Street, #200 Newport Beach,
CA 92660
Toll-free: 888-377-3722 / Direct:
203-972-9300 Fax: 949-863-7100
www.europac.net
pschiff@europac.net
Also
by Peter Schiff
For a more in
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and mortgage markets, and U.S. dollar denominated investments, read my new
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