We still see the glass as half full, given likely decent global economic growth, healthy corporate p...
Fed's Food Fight Is Making Us All Sick
03/01/2011 1:30 pm EST
The Federal Reserve’s plan to engineer inflation is working like a charm, and the extra costs other countries are paying will quickly implode our economy when—not if—those effects and international countermeasures are felt here, writes Axel Merk of Merk Investments.
In arguing food inflation is not the Federal Reserve’s fault, Fed Chairman Ben Bernanke points the finger at everyone but him.
Summarizing the greatest money printing experiment in monetary history, he stipulates that the program has been “effective”, because:
- "equity prices have risen significantly”; and
- “inflation compensation as measured in the market for inflation-indexed securities has risen."
Yet, when quizzed about whether his policies contribute to commodity and food inflation, Bernanke argues that they have only influenced equity prices to the upside, not commodity prices.
While that logic is unlikely to convince a preschooler, the Fed chief goes on the defensive to defuse the argument that his policies may actually be destabilizing the Middle East and Asia, where a high portion of disposable income is spent on food.
With regimes toppling left and right, Bernanke must feel he is carrying the weight of the world on his shoulders.
Why Bernanke Is Right
Bernanke argues that countries concerned about inflationary pressures from food and commodities have plenty of tools to address these. Among those tools are the ability to raise interest rates or allow their currencies to appreciate.
Indeed, we have long argued that Asian countries, in particular, may allow their currencies to appreciate for exactly that reason.
However, Bernanke leaves out a small but important detail: with its latest bond purchase program, the Fed has dramatically increased the stakes, placing the proverbial gun to China’s head and effectively telling China’s policymakers to allow the Chinese renminbi to appreciate, or else.
Having said that, Bernanke rightfully argues that the Fed’s mandate is to foster price stability and maximum employment, not to look after whatever the ills in the rest of the world may be.
Next: Why Bernanke Is Wrong|pagebreak|
Why Bernanke Is Wrong
The trouble is, the very reason the Fed may be engaging in its super-expansionary policies is because it is trying to cure ills that are not part of its traditional mandate.
When the Fed, for example, bought mortgage-backed securities (MBS), it steered money to a specific sector of the economy. That’s fiscal, not monetary policy, traditionally reserved for elected policymakers in Congress.
Just like the MBS program, many of the Fed’s policies continue to appear to be attempts at addressing the “shortcomings” of Congress.
A shortcoming is naturally in the eye of the beholder—we may like or dislike our politicians, but at least they are periodically up for election. Bernanke has felt—indeed, testified—that one of the strengths of the Fed is that it can react swiftly in times of crisis.
Bernanke has argued that without his determined actions, the country might have fallen into a depression. It appears to be a matter of the ends justifying the means.
Rowing Against the Tide
In our analysis, however, the means employed are the wrong ones. Bernanke’s policies have been rather ineffective because they are fighting market forces. Consumers would like to downsize further—but such “downsizing" means bankruptcies and foreclosures.
Policymakers would rather subsidize consumers with massive fiscal and monetary stimuli—it’s simply politically more palatable. Because market forces are fought, such stimuli are rather ineffective. This causes money to flow not to consumers, but where there is the greatest monetary sensitivity: precious metals, commodities and currencies of countries producing commodities.
And while Congress has stepped up spending on a grand scale in an effort to “stimulate” the economy, it’s small compared to the trillions the Fed can print, creating money out of thin air.
The policies pursued by the Fed foster ever more leverage at the consumer level. Bernanke has pounded the table that he wants higher inflation. We have no doubt he will succeed, even as the markets are reluctant to embrace his determination—not so different, by the way, from how the markets were reluctant in taking former Fed Chairman Paul Volcker seriously when he announced in the early 80s that he would fight inflation.
Indeed, we don’t think the Fed will rest until home prices are firmly moving higher—after all, that appears the only politically acceptable way to bail out millions (and a still growing number) of homeowners under water in their mortgages.
But what happens if and when the Fed wants to mop up all this liquidity?
We are rather concerned that, with all the leverage pumped back into the system, any tightening will have an amplified effect—causing the economy to plunge right back down.|pagebreak|
The Greenback in the Dock
That’s why Bernanke has argued that possibly the greatest mistake during the Great Depression was to raise rates too early—so much for raising rates within 15 minutes, as Bernanke has argued he could.
In the early 80s, consumers complained about high interest rates. However, if rates were raised today to only a fraction of the 20% Fed Funds rate of June 1981, the economy might implode.
And while the Fed may be in charge of short-term rates, should the bond market get spooked because of the agency's policies, it may be impossible for the Fed to stem the tide.
A weaker US dollar may also ensue—we have yet to see a country that depreciated itself into prosperity. It simply makes no sense for an advanced economy like the US to compete on price: the day the US will export sneakers to Vietnam (hopefully) will never come.
Just as Bernanke takes it upon himself to implement aggressive policies because Congress may not act according to his playbook, policymakers around the world are also slow to react. Not necessarily because of choice, but simply because that’s how local dynamics play out.
Countries such as Bahrain or Saudi Arabia, with their centralized control, may be acting more swiftly, increasing food subsidies to pre-empt social unrest. Ultimately, for many countries in Asia, allowing their currencies to appreciate may be the most effective tool to tame inflationary pressures.
In the meantime, countries in the Middle East may at some point come to the realization that changing the government may not lead to lower food prices. Unless the next president of Egypt is a great farmer, social instability may prevail for a long time.
Real Reform Getting Harder
Incidentally, while we are not threatened with revolution in the US, discontent has been growing from the fact that real wages have not risen for a great number of people in over a decade.
If you have assets, you may love Bernanke’s policies, as he pushes up everything from equity prices to (shh, don’t tell Ben) commodities. However, many people who have to work for a living have seen their purchasing power erode.
Bernanke puts the blame on a lack of education. However, his policies—in our assessment—contribute more to the wealth gap than policies of either Democrats or Republicans.
In such an environment, disgruntled citizens may increasingly vote for populist politicians. In today’s world, if you can distill your political message into a tweet, you may have a better chance of being elected.
In our view, the polarization of politics will continue, making it ever more difficult to find common ground on tough political questions such as entitlement reform. In the absence of compromise, the government may nominally pay entitlements as promised; it’s just that the purchasing power of what is paid may have eroded due to inflation and a weaker dollar.
As these dynamics play out, investors may want to position themselves to take the risk of a decade of global political instability into account.
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