Ben Bernanke is confident America has inflation under control. Speaking in Tokyo last Wednesday the Federal Reserve chairman said: "Despite increases in inflation a few years ago and now declines of inflation to very low levels, inflation expectations in the United States are very stable.”
The remarks helped pour oil on troubled markets, which are fretting about financial instability and possible sovereign defaults in Europe. There have also been understandable fears that the recent rounds of money printing (“quantitative easing”) by the US authorities might allow the inflationary genie out of the bottle.
Keeping American inflation low is one of the Fed’s principal remit. It also suits Bernanke extremely well at this juncture. For the only way he can keep US interest rates at the "emergency" level of 0%-0.25% (where they've been since December 2008) is if there's little sign of inflationary pressure. And luckily for Ben, he doesn't detect any.
However it may be that he is not looking hard enough or is perhaps even deluding himself because of the way America calculates inflation. David Einhorn, president of hedge fund group Greenlight Capital, last week claimed that US inflation could be four times higher than suggested by official figures.
In a controversial speech at the Ira W. Sohn Investment Research Conference last Wednesday Einhorn—who won kudos for predicting the collapse of Lehman Brothers—cited figures from Shadow Government Statistics, that using the pre-1980 method of calculation, US consumer price inflation is actually 9%, not the official rate of 2%.
Einhorn accused the US authorities of concocting a system that deliberately distorts inflation downwards. If the price of chocolate bars goes up, they're simply removed from the inflationary "basket." It's assumed consumers will stop buying chocolate and switch instead to peanut bars—which are promptly added to the inflationary "basket" in chocolate's place. There are also plenty of items in the basket that noone ever buys.
Einhorn portrayed the system as being 100% designed to mislead. All the Fed and US government wants, he argues, is to keep perceived American inflation low. So it ensures it does with this skewed approach to CPI. “It enables the Fed to rationalize easy money.”
The Fed wants to keep interest rates ultra low believing this helps reduce unemployment. The Fed's logic is that easy money equates to feeble returns on savings accounts, which incentivizes people to speculate on the stock market, which in turn inflates share prices, which in turn creates a trickle-down effect, which in turn leads to new jobs.
Einhorn said the Fed is basically banking on "speculators who get lucky” spending their winnings on goods and services. “These purchases increase aggregate demand and lead to job creation,” he said.
Easy money suits banks because it helps them to "earn" back their unacknowledged losses. The downside, however, is it discourages them from making new loans to individuals or businesses.
Einhorn added that the policy encourages banks to lend to the government, with no capital charge and no perceived risk and earn an adequate spread walking down the yield curve, which gives them even less incentive to lend to small businesses or consumers. Easy money also helps the government’s fiscal position, said Einhorn.
“Lower borrowing costs mean lower deficits. In effect, negative real interest rates are indirect debt monetization."
If he is to be able to get away with maintaining his easy money policies, Bernanke of course has a strong incentive to ensure inflation seems low. But Bernanke's conjuring trick is not risk free, especially given the scale of the US deficits. Einhorn said:
“Allowing borrowers including the government to get addicted to unsustainably low rates creates enormous solvency risks when rates eventually rise.
"Why is the Fed proceeding with an “emergency” zero-rate money policy when the emergency is over? A zero-rate policy can create bubbles that collapse, with terrible consequences."
So will the massaging of the American inflation figures reap dividends for the US economy? Einhorn doesn't think so: “I don’t believe a US debt default is inevitable but unless serious steps are taken, we might find ourselves negotiating austerity measures with foreign creditors some day.”
Not everyone agrees the Fed is pulling wool over its own eyes about inflation. Financial blogger The Pragmatic Capitalist believes Einhorn's talk is dangerous poppycock, arguing that deflation is more likely than inflation and that it's impossible for the US to be instructed by "the markets" (i.e. overseas holders of Treasuries) to introduce austerity measures since "the US is a monopoly supplier of currency in a floating exchange rate system."
Further reading on American inflation and Federal Reserve chairman Ben Bernanke
- The Globalization of Inflation, by Diana Choyleva
- Viewpoint: Todd Buchholz, Trust Fear and Dead Economist
- Bernanke's land grab falls flat, by Ian Fraser [blog post]
Tags: banking , central banks , fiscal stimulus , inflation , quantitative easing , real economy , stocks and shares , US