By Robert Folsom
Fed Chairman Bernanke earned himself a lot of attention yesterday (Dec. 1) by saying that our current economic crisis is "no comparison" to the severity of the Great Depression. I could say something like "Yea, but the night is young," or even that if the Fed moves markets then the Dow's 680-point decline yesterday was a Bronx Cheer directed at Chairman Ben.
Yet let us instead discuss another speech by the Fed Chairman, on November 21 to the National Economists Club, wherein he spelled out a certain central bank strategy that actually couldmove the markets -- though it would be neither the "market" nor the "move" that Mr. Bernanke may have had in mind. His speech was titled, "Deflation: Making Sure 'It' Doesn't Happen Here." Please bear with the long quotations; I believe it's worth your time:
"Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero."
Now, when the Chairman of the Federal Reserve says that "with fiat money a government should always be able to generate inflation," I'll bet you have a pretty good idea about how. And here it is:
"The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning...U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."
The only thing more remarkable than this public comment is the fact that it drew virtually no attention -- but if nothing else, it does show what Bernanke has on his mind.
But, Bob Prechter had it on his mind as well -- way back in 2002. Printing money out the wazoo would move a market all right: namely the bond market, and the move would be destruction. Here's what Bob said about this very idea in Conquer the Crash:
"While the Fed could embark on an aggressive plan to liquefy the banking system with cash in response to a developing credit crisis, that action itself ironically could serve to aggravate deflation, not relieve it....Nervous holders of suspect debt that was near expiration could simply decline to exercise their option to repurchase it once the current holding term ran out. Fearful holders of suspect long-term debt far from expiration could dump their notes and bonds on the market, making prices collapse. If this were to happen, the net result of an attempt at inflating would be a system-wide reduction in the purchasing power of dollar-denominated debt, in other words, a drop in the dollar value of total credit extended, which is deflation."
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