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Inflation on the Menu

Written By Brian Hicks

Posted September 24, 2007



"All the perplexities, confusion and distresses in America arise not from defects in the constitution or confederation, nor from want of honor or virtue, as much from downright ignorance of the nature of coin, credit, and circulation."

–John Adams


Well, after a whole two weeks of reading the tea leaves and the chicken entrails, the Bernanke Fed finally showed its true colors. Choosing between a roast pig (the economy) and a cooked goose (the dollar), Chef Ben decided to cook the goose after all.

Now how long Chef Ben plans to cook the goose is a matter of speculation. After all, he is sort of new to the kitchen. Chef Ben, however, has assured us that it will all be delicious.

Besides, he opined, it’s way easier than cooking the pig!

Pigs everywhere were heard to snort sighs of relief, and back to the trough they went. A 50 basis-point cut in both the Fed funds rate and the discount rate was pure music to their ears.

Jim Cramer and company were well fed that day.

But in choosing to ignore the very real threat of inflation in return for the promise of continued growth, the Bernanke Fed has put us on a dangerous course that could deteriorate into stagflation.

Stagflation, of course, is the worst-case scenario, characterized by high inflation, high unemployment and slow growth. In short, the economy nosedives and inflation soars.

The Fed, however, seems to dismiss this scenario since it runs counter to the Keynesian notion that slower growth inevitably leads to lower inflation. According to their playbook, it will all just go away.

Of course, it sounds like a great plan if only it would work out that way. But it won’t, because it ignores reality. Here’s why: A growing economy doesn’t explain every instance of inflation. It never has.

Just look at the 90s. It was a period of enormous growth, yet there was very little inflation. Using the Keynesian model, inflation should have soared but it didn’t.

And look also at the 70s–the last time our economy tangled with stagflation. The period was marked by soaring unemployment, little or no growth and rampant inflation. The conditions were so bad they gave birth to the misery index.

In the Keynesian world it shouldn’t have happened, but it did. So clearly there is a ghost in the Keynesian inflation machine.

That ghost, of course, is an out-of-control money supply, because the truth is it’s the monetarists that have it right. Inflation is not about demand as much as it is about supply. When the supply of money is larger than the demand, inflation is the natural result.

Inflation, in other words, is a monetary phenomenon.

Simply put, the expansion of the money supply itself can cause inflation. And in case you weren’t paying attention, the printing presses have been running at max for years now. In fact, in ten short years the money supply has more than doubled!

Now all of those dollars that were created when the Fed funds rate went to an all time low of 1% and flooded the world with cheap credit are coming back to haunt us in the form of inflation.

And unfortunately, it’s not over. Because nobody will ever confuse Chef Ben with Paul Volcker.

Instead of raising rates as Mr.Volcker did in the late seventies, the current Fed has blinked in its stare-down with inflation. It’s that lack of will that could put us on a collision course with stagflation.

Don’t think so?

Well, consider this scenario, because it’s not that far fetched. In fact it is beginning to happen now. It plays out something like this, and is quite different from the Fed’s own rosy scenario:

Housing crashes despite low rates. Home prices fall and the net worth of most Americans falls with it. (Note to the Fed: Housing cannot be saved.)

Consumer spending–70% of the economy–takes a massive hit since the housing ATM has been closed by falling home values.

Unemployment rises, as the 3 million jobs created during the run-up in housing are no longer needed.

Consumers and businesses both stop spending. (Note to the Fed: Most current business spending has gone to stock buybacks.)

The stock market tanks. The bond market tanks.

Interest rates rise.

Inflation persists despite the drop in demand. (Keynesians, it seems, are wrong.)

A recession ensues.

The Fed begins to cut rates again as it lives up to Bernanke’s promise to throw money from helicopters if necessary to induce spending.

The money supply surges and inflation goes even higher.

In short, the economy is plunged into a nasty case of stagflation. It is not pretty.

But that’s not the worst of it. All along this road the dollar gets cooked . . . cooked. . . . and cooked some more. It drops dramatically as its "storehouse of value" role disintegrates under the many pressures of inflation.

The Fed’s refusal to defend it at this point only seals its fate. And foreign banks will begin to abandon it. In the end, it will lose its long-time place on top of the currency heap.

The ramifications of this, needless to say, are enormous.

But this is the world that we have placed ourselves in when we turn the power of the monetary printing presses over to the smartest guys in the room.

Because in doing so we have given them the power over coin, credit and circulation. In the wrong hands this can be devastating, as we’re about to find out.

Think about it–your money and your freedom are inseparable. To do what you want in this world requires money. Without it your hopes are just dreams, nothing more than figments of your imagination.

So when the very value of the dollar in your wallet erodes, your freedoms erode with it. It’s true, inflation is the hidden tax that we could all well live without.

But it seems the dollar is on its own. Where she stops, nobody knows.

But it’s not all bad news. Holders of gold should prosper as the dollar declines. Naturally, this will send more and more investors into hard currencies.

This should continue well into the future as it becomes more and more apparent that inflation persists despite the slowing of the economy. In turn, gold will likely power to new highs.

So break out the bell bottoms, the blacklights, and the Jiffy Pop. Climb into the Magic Bus and crank up the Doors. Chef Ben is driving. He says we’re just detouring the 30s, but I’m not so sure. The truth is he’s got the wrong map.

This bus is headed back to the 70s. Buckle your seatbelts . . . it could be a wild ride.

And a word to the wise: Don’t sit next to the goose.


Wishing you happiness, health, and wealth,

Steve Christ, Editor