Memphis Blues Again

Under the rubric of QE2, the Federal Reserve Bank is engaged in the venture of increasing the money supply with the goal of moderately increasing inflation. I fear that this venture is misguided and destructive. I believe it will result in inflation exceeding the Fed’s goal, if it has not done so already, and that the Fed will apply the brakes well after the damage has been done, as is its style.
David Malpass recently observed:

The Fed’s rationale for buying a stunning $75 billion per month of Treasury notes and bonds (almost the entire issuance) has been its fear that the economy was slowing and its hope that Fed bond purchases would lower Treasury and corporate bond yields in a stimulative manner. Neither part of this logic is working.

This past November Reuters raised a concern about QE2 leading to a commodity bubble. The article observes that the Reuters-Jefferies CRB index, a global commodities benchmark, had hit a two-year high as part of an 18 percent gain since the start of September when markets began to anticipate the Fed’s action.
The powers-that-be at the Fed discount the commodity inflation that appears to be rampant. Diane Chu cites the comments of St. Louis Federal Reserve President James Bullard. “What struck me as totally self-contradictory,” Chu wrote, “were Bullard’s statements regarding the QE2, treasury yield, inflation expectations, and inflation[.]” Chu takes a look at commodity prices:

[B]asically Bullard touts QE2 as building up inflation expectations, driving up treasury yields (thus averting a potential deflationary cycle), which was the goal of the Fed QE2 initiative. Furthermore, Bullard contends that global demand and supply factors are behind the record high prices across almost all commodities, which he believes is unrelated to QE2. . . .
Since the Fed hinted at QE2, commodity price inflation has surged at a record pace during the past six months (Fig. 4) The manifestation of inflation is a combination of many factors including but not limited to expectations, which drives behavior, as well as supply and demand factors.
So, for Bullard to “take credit” for driving up inflation expectations, but ignore its inflationary effect on commodity prices is illogical as well as self-contradictory.

Taming the inflation of the late 1970’s and early 1980’s was a painful process. It seems incredible that the Fed is seeking to spur inflation secure in the confidence it can contain it. By the time it becomes undeniable, it seems to me, the time will have passed when the Fed can shift the gears to reverse without the infliction of substantial pain.
Smarter people than I have the same view. At Zero Hedge, guest poster Bo Peng sarcastically comments on the Fed’s sense of humor, amazing foresight and inflation risk. Peng reviews the latest release of 2005 Fed meeting minutes and concludes: “No matter how confident Bernanke is about his ability to fight inflation in time, I’m exactly as confident that he’ll be too late.”
Malpasss puts it this way (if I understand him correctly): “Since inflation is a deeply lagging data series – the Fed was able to claim throughout the 2003-2007 monetary bubble fiasco that inflation was ‘moderating’ even as the core PCE deflator, upon revision, was rising and always exceeded the Fed’s 2% ceiling — it’s unlikely that inflation will ride to the rescue in time, nor does anyone other than commodity buyers really want that outcome.”
Can this really be the end? Bob Dylan’s lyrics run through my mind: “An’ here I sit so patiently/Waiting to find out what price/You have to pay to get out of/Going through all these things twice.”
UPDATE: Reader Carl Pham takes my concerns a step further:

if you’ve lived long enough, you’ll notice the *order* in which inflation picks up is always the same, or at least it has been for the past 50 years or so: first gas and heating oil prices go up steeply (oil is priced in dollars, after all), then food (lots of transportation in its price), then durable goods and rents, and only last wages and real estate. . . .
I think the mistake many commenters make is assuming that these facts are not already well known to the policymakers, e.g., the Fed or the administration, or even older media talking heads, and that they need to have these facts pointed out to them.
I think that unlikely. I think they know exactly what they are doing, and they rely on muddling the connection between, say, rising gas and food prices on the one hand and what they are doing on the other.
In this particular case, I think both the administration and the Fed feel the inevitable pain is worth it for their goals, which are dominated by the urgent wish to get investors — potential homebuyers, or potential employers — to stop cautiously hoarding their cash and start forking it out, buying houses or employing people.
They have (probably correctly) deduced that Democratic re-election prospects in 2012-14 are tied to the unemployment rate and the price of houses, and they will do anything to move those numbers, regardless of future damage. (Besides, a roaring inflation later is just another crisis that cannot be allowed to go to waste! Wage and price controls are lovely avenues for centralized power.)
It’s little different than FDR in 1934-35 observing that businesses were sitting on cash instead of hiring people (because of the insane regulatory environment, among other things), and determining to pry that cash out of them. In those days he took the blatant approach — the undistributed profits tax of 1936. Nowadays a more subtle approach is called for: in this case, inflation, which is essentially a massive tax on savings and retained profits.
It probably doesn’t hurt that in addition the one party that does well in a strongly inflationary environment is he who owes loads of money (the debt is rapidly eroded by inflation) and who has an income that is fully indexed to inflation, meaning it automatically rises in lockstep with nominal prices and wages. That of course describes state and federal governments today.

These comments aren’t helping with my anger management therapy, but they add an important component to the discussion.

Responses

-->