By Filipe R. Costa
It is well known that Ben Bernanke’s actions have been driven by his firm-held belief that central banks accentuated the Great Depression by not adopting expansionist monetary policies during the early 1930s. Five years into our financial crisis (and with the end still not truly in sight), there is no telling what impact the Fed’s incredible printing operation will have.
One of the main threats of the unbalanced monetary interventions is, of course, the creation of asset bubbles. And, as we have learned time and again throughout the last 100 years, asset bubbles always result in economic crises. With interest rates at zero and the Fed’s balance sheet the size it now is, it is now near impossible for the central bank to take any further substantial action in the event that another asset bubble (ahem… the stock market… ahem!) pops. At the same time, the US government is hardly in a fit financial state to provide any sort of backstop, as its perpetual deficit keeps grinding away at its overall creditworthiness.
“I think we’re in the middle of a kind of bubble market, where it’s going to take something bubble-like to happen to prick the bubble and this will probably cause a pretty bad reaction to the breaking of the bubble.”
This is the view of Julian Robertson, given in a recent interview. He also expressed concerns regarding future monetary policy, referring to Janet Yellen, the newly announced replacement of Bernanke, as being “way too easy money”.
Yellen’s appointment will almost certainly mean a continuation of Bernanke’s “highly accommodative” policies. The Fed will continue to purchase assets on a large scale. They won’t cut the current program until the end of this year (at the earliest) and will most likely still keep at least some of the operation running until the end of next year.
The following table indicates why US monetary policy might be misguided. It shows average US inflation rates over four different periods:
During the last 12 years, between 2001 and 2012, the inflation rate in the US averaged 2.4%, above the 2% target. Inflation was negative in 2009 (-0.4%) and below 2% in 2010 (+1.6%). It has since edged above the 2% level (3.2% and 2.1% in 2011 and 2012 respectively). Bernanke’s concerns aren’t justified based on these current trends.
In fact, since the end of the gold standard in 1971, deflation has never been a concern. First of all, the average inflation rate for the period between 1972 and today has been 4.3%. Second, inflation has been below 2% just five times in 41 years.
So, why is Bernanke concerned with what happened after the Great Depression?
The reason is because in the period between 1930 and 1933, prices decreased at a rate of 6.6% per year. It was a tough deflationary period, and which Bernanke believes could have been avoided by a more expansionist Fed. That may be true, but still it doesn’t justify current concerns about deflation. At that time, the US was using a gold standard, meaning the Fed had little control over the money supply. In 1931, banks started converting notes into gold, which resulted in a large reduction of the money supply. To keep dollar convertibility, the Fed had to provide gold in exchange for the notes. But current fiat currencies have no gold behind them, which means a repeat of such a situation cannot happen.
Printing money out of thin air is a dangerous game. If you take another look at the table above, concentrating on the 12-year period after the end of the gold standard in 1972, you will understand what I mean. As soon as President Nixon ended the Bretton Woods agreement, the Fed started expanding its balance sheet and inflation picked up severely. Between 1972 and 1983, inflation averaged 7.8%.
With all this in mind, I agree with Julian Robertson’s concerns regarding bubbles and easy money. The easiness of money has a cost and its called inflation. There is no escaping this.