In part 1 we looked at how Federal Reserve Chairman Ben Bernanke’s first ever press conference, following an Federal Open Market Committee (FOMC) rates and policy meeting, sent the price of gold through the roof. Traders dived into gold despite the fact that Bernanke was at pains in the conference to emphasize that the Fed did not intend to continue Quantitative Easing 2 beyond June.
Inflation is natural
One of the journalists at the conference asked Bernanke directly whether QE2 should be regarded as a failure since unemployment was still high and the dollar was getting ever weaker. Bernanke’s answer was that the global attractiveness of the dollar had been proven yet again in 2008 when a lot of global money flowed in to the dollar. “What you have seen is the unwinding of this as [global] uncertainty reduces. The best we can do to keep the dollar strong is to execute our mandate,” he answered.
This is typical Bernanke-speak and it takes a little while to learn to navigate one’s way through it, largely because it is so mind bogglingly to one side of the reality most of us are seeing. In fact the meaning of Bernanke’s phrase is derived almost entirely from the context. It’s all about successfully batting away a typically barbed shaft from a senior journalist and then carrying on with business as usual. But it shows the breathtaking style of the man. Inflation is not really inflation, it’s just a natural outgoing of the tide of money that flowed in to the dollar during the anxious times and is therefore a return to the situation prior to all that global anxiety.
This is pure hogwash, particularly since global anxiety is currently being stoked on several fronts, including war in Libya, unrest in the Persian Gulf and the endless saga of the European sovereign debt crises. Of course it is self-evidently true that the Fed would be able to strengthen the dollar if it were able to execute its mandate. Near full employment and low inflation would mean the US economy was spectacularly back on track. The point, however, of the question was precisely to invite Bernanke to recognize that the Fed was singularly failing to execute its dual mandate and that in reality the US economy is still a very long way from being back on track.
Weak US economic growth due to 'transitory' factors
Elsewhere in the conference Bernanke acknowledges this quite openly. Growth is much weaker than anyone would like, he concedes, and indeed in the main body of his presentation he announced that the Fed was slightly revising downward its growth projections for the US economy. However, he emphasised that weaker than anticipated growth was due to factors that look “transitory”. He cited in particular lower than usual defence spending, which will probably be made up in future quarters (despite frantic budget cutting exercises by both sides of the House). The idea that US hopes for recovery rest on substantial increases in military spending sounds little short of daft, but again, this was just another of Bernanke's throwaway lines.
The meat of the speech had to do with points such as his statement that “substantial ongoing slack in the labour market” suggests an accommodative monetary policy stance until the unemployment numbers look a lot better. This is what got inflation watchers thinking that Bernanke was probably not going to move vigorously against inflation in the foreseeable future. Bernanke cited 2013 in his presentation as the probable date when employment might start to pick up in a less anaemic fashion. That, for traders, is a very long way off, so it is no surprise that so many of them dived for gold while he was speaking.
The FOMC is optimistic...
In fact Bernanke made it pretty clear that he was watching the inflation numbers carefully but remains at least optimistic, if not convinced, that the rise in commodity prices that is currently driving inflation, is a passing thing. “The (FOMC) outlook is predicated on longer term inflation expectations being stable and households and firms expecting inflation not to take hold,” he told his audience.
When you come down to it, there really isn’t any other way for the Fed to look at things. If it becomes clear that Americans are starting to develop entrenched expectations of continuing inflation then the Fed will have no option but to tighten policy, even if that hurts growth in the short term. At present, there is no pressing evidence that wage settlements are baking in inflation. There are just too many people hunting for jobs for that to be possible. Meanwhile, even after QE2 ends in June, the Fed won’t be winding back its balance sheet just yet. It intends to continue to accommodative monetary policy by reinvesting mortgage returns. The Fed has the tools to tighten policy if it needs to, but now is not the time, he concluded.
Further reading on inflation and US monetary policy:
- Investment Lessons from the Crash, by Jeremy Beckwith
- Deleveraging, Deflation, and Rebalancing in the Global Economy, by Paul Brain and Laurie Carroll
- Inverse Stagflation and the Global Economy: When Real Assets and Paper Assets Part Company, by Renée Haugerud
Tags: Ben Bernanke , deflation , dollar weakness , Federal Reserve , inflation , labour market , slow growth , unemployment