Based on his recent public comments, Fed Chairman Bernanke seems
determined to give the U.S. dollar the reputation of Egypt's Hosni
Mubarak: an unwanted relic of the past that everyone agrees must
go, but stubbornly clings to a privileged position. The dollar is
currently the world's ruling
currency, but, as with Mubarak, I believe that
growing public discontent will spur regime change quicker than
most pundits expect.
Clearly, the most significant problem facing central bankers
around the world is the recent eruption of inflation, which is sparking
unrest in Asia and the Middle East. With respect to this issue, Bernanke is
alternating his responses through two different personas.
Sometimes he chooses to act like Baghdad Bob,
the Iraqi Information Minister who, in the opening days of
the 2003 invasion of Iraq, continued to deny the presence of
American troops even as U.S. tanks rumbled behind him. The parallel to
Bernanke's testimony to Congress today is striking.
Speaking to the House Budget Committee, Baghdad Ben not only
claimed that there is no evidence of overall inflation in the U.S., but that
even food and energy prices are rising less than 1% annually. This is
simply not true. He then claimed that the Fed's massive QE purchases of U.S.
Treasuries do not distort the yield curve, despite the fact that he has
stated repeatedly that the program was specifically designed to
lower long-term rates.
The reason behind these lies should be evident. Acknowledging
inflationary threats would force him to raise rates. But Baghdad Ben knows
that the current economic "expansion" is a lie built on a weak
foundation of ultra-low interest rates. He knows that even marginally
higher rates will trigger a savage return to recession. In his view, the only
choice is to sell us an elaborate fiction - even when it obviously conflicts
with the facts.
At other times, Chairman Bernanke assumes the persona of Marie
Antoinette by professing regal indifference to how his own actions negatively
impact the great unwashed. In a rare Fed press conference last
week, Bennie Antoinette showcased this "let them eat cake"
attitude by declaring that U.S. monetary policy is solely designed to
benefit the U.S., and that any adverse consequences in other countries are
not his problem. As a result, he broadly absolved the Fed of any blame for
global inflation, putting it instead on foreign governments for not allowing
their currencies to appreciate and for keeping their interest rates too low.
It is this type of attitude from our top monetary policy maker -
to either deny inflation or to lay blame elsewhere - that will accelerate the
day of reckoning for the dollar.
Amazingly, for all its flaws, the buck remains the world's
reserve currency. So, for now, the U.S. continues to enjoy all the rights and
privileges that come from that status, including lower consumer prices and
lower interest rates. But along with those benefits comes the great
responsibility of not conducting monetary policy in a vacuum. Since the
dollar is the benchmark currency, when it is debased, other currencies must follow
suit. Because of the massive printing effort underway for some time now, the
dollar has gone from an instrument of stability to an instrument of
A reserve currency must not go on in perpetual decline.
Since abandoning the dollar as a reserve implies radical change with unknown
consequences, governments have been very reluctant to take the chance. So,
they are acting to preserve the status quo. But, in so doing, they're
creating inflation in their own countries. Unfortunately, this strategy may
prove more risky in the end.
Other factors are also influencing foreign central bankers to
stick with the devil they know. For one, as emerging markets compete to
export to the United States, no one wants to surrender what it perceives to
be its competitive advantage. None of these governments yet understand that
if the dollar were to collapse, new customers would be instantly created in
those countries whose currencies appreciate against the dollar.
Emerging markets also feel obligated to protect the value of the
trillions of dollars that they already hold in reserve. Like traders throwing
good money after bad, their instinct is to average down their cost of their
position. The reality is that the more dollars they buy, the more they will
ultimately lose. Once they realize that the rise in their own currency will
more than offset their dollar losses, they will cut their losses and run.
When emerging-market governments decide they do not want to eat
Bennie's cake, but rather keep their own bread prices from rising, they will
have to pursue the tighter monetary policies. When that happens, the dollar
will lose its reserve status.
When the rest of the world no longer links their currencies to
ours, the Fed will truly not have to worry about fueling global inflation.
Instead, all of its inflation will burn through our banks accounts right here
at home. And that blaze, so concentrated, will burn a lot hotter than the
fires we see abroad.
Peter D. Schiff