Bernankeism and the Destruction of the Dollar

The only thing I don't think will be cheaper a month from now is gold itself.

Therefore I would say that the prevention of the beginning of deflation has failed.
 
Unconventional Measures:
Bernankeism and the Destruction of the Dollar
Robert Blumen, E-mail: robert@RobertBlumen.com.
This article was originally given as a talk at the Burton S. Blumert conference on Gold, Freedom, and Peace, a benefit for
LewRockwell.com.
In 2002, then-Fed Governor
Benjamin Bernanke burst into our
monetary consciousness with his
printing press speech. His fine work
earned him the honorary title
“helicopter commander”. While
largely a background figure since
then, his recent appointment to
succeed Alan Greenspan as Fed chair
makes this an ideal time to review
Dr. Bernanke’s views on monetary
policy, and to speculate about what
his chairmanship will bring.
Since the Fed emerged from its
near-death experience in the 1970s,
it has largely — and misleadingly —
been identified with the label
“inflation fighting”. Against this
backdrop, it is notable that Dr.
Bernanke’s research and speaking
have dealt predominantly with the
subject of deflation.
While his infamous address before
the National Economists Club, titled
“Deflation: Making Sure ‘It’ Doesn’t
Happen Here” (2002), has been
endlessly reported and debated, more
revealing and less well known are Dr.
Bernanke’s many speeches on
deflation between 1999 and 2004,
and a series of research papers on the
same subject produced by the then-
Fed governor and a number of his
colleagues.
I have identified 14 papers and
speeches dealing with deflation (see
the references section), seven by Dr.
Bernanke and seven by other Fed
governors and staff economists. These
materials are all available for public
download on the Fed’s website. To
steal a line from columnist Dave
Barry, “I’m not making this up.”
A review of the most important
points from these sources outlines a
consistent point of view on deflation.
While Governor Bernanke is not the
only member of the anti-deflation
wing at the Fed, the chair-in-waiting
has emerged as the most prominent
advocate of this new agenda. His
leadership merits the name
“Bernankeism” for this policy
program.
Upon reading the source
materials, three main tenets of
Bernankeism emerge. I will describe
them and illustrate with examples in
the Fed’s own words. The three are:
prevention is better than cure, learn
the lessons of history, and the
possibility of “unconventional
measures”.
PREVENTION IS BETTER
THAN A CURE
The first principle of Bernankeism is
that it is better to prevent deflation
than to attempt a cure after the
disease has set in.
The basis of the Bernanke school’s
thinking on deflation is the standard
(mainstream) macroeconomic view
that consumer spending (not saving)
drives economic activity, and that
insufficient consumer spending is the
cause of recessions. According to this
view, when recession strikes,
inflation is called for.
Inflation works in three ways. One,
by lowering real prices when nominal
prices are for some reason “stuck” at
above-market-clearing levels; and two,
by threatening a continued erosion in
the purchasing power of cash,
inflation motivates anti-social cash
hoarders to spend, thus providing the
missing stimulant to economic
activity. A third is through so-called
“wealth effects”: when asset prices
inflate, people misperceive the
inflation as true wealth and then
increase their spending.
Deflation is so dangerous,
according to Dr. Bernanke, because it
is a self-reinforcing process that is
very difficult to reverse once it has
begun. They start from the true
observation that when people spend
less, prices fall. They then reason that
when prices fall, people become
increasingly reluctant to spend (and
businesses to invest) because they
anticipate that prices will continue to
fall. People start to hoard cash,
planning to buy tomorrow when
things are cheaper. The less people
spend, the more prices fall, and the
more that people hoard. In the grip of
cash hoarding, according to
Bernankeism, the entire economy
would spiral down, as all spending
ground to a halt.
For an example of this view, I will
cite the research paper titled
“Monetary Policy and Price Stability”
(1999) (by Fed research staffers):
If economic activity is weak or
contracting and interest rates hit
the zero bound, a dangerous
dynamic can be set in motion.
Falling inflation, or even
escalating deflation, would
increase real rates of interest. As
this depresses aggregate demand
further, downward pressures on
prices would raise real interest
rates further: The economy would
potentially face a downward
deflationary spiral.
Governor Bernanke and his
accomplices are obsessed with
something known as “the zero bound
problem”. Eight of the 14 papers and
speeches that I examined deal with
this problem either as their main
point or in passing.
The zero bound comes about as
follows. The Fed commissars concern
themselves largely with controlling a
single rate of interest, the Fed Funds
rate. This rate can be lowered only to
near zero, but not to zero or below,
because no one would buy a bond
that had a zero or negative yield; they
would hold cash instead. This poses a
problem for the central banker
determined to inflate: if the Fed
 
Funds rate hit zero (or near-zero, as it
did with Japan), inflation cannot be
accelerated by cutting the Fed Funds
rate. In these circumstances, the Fed’s
inflation program would be frustrated.
For this reason, Bernankeism
advises the central bank to avoid the
zero bound problem by creating a
constant state of pleasant and benign
inflation of around 2–3%. This will
keep the economy a safe distance
away from the dangerous precipice
beyond which lies deflation, and
gives the Fed room to cut rates.
For an example of their thinking,
I cite a speech titled “An Unwelcome
Fall in Inflation” (2003). Dr.
Bernanke states:
I hope we can agree that a
substantial fall in inflation at this
stage has the potential to interfere
with the ongoing U.S. recovery,
and that in conceivable —
though remote — circumstances,
a serious deflation could do
significant economic harm. Thus,
avoiding a further substantial fall
in inflation should be a priority of
monetary policy. To my mind, the
central import of the May 6
statement is that the Fed stands
ready and able to resist further
declines in inflation; and — if
inflation does fall further — to
ensure that the decline does not
impede the recovery in output
and employment.
LESSONS LEARNED FROM
HISTORY
The second principle of Bernankeism
is that central bankers must heed the
lessons of history. According to the
papers and speeches, the Fed’s fear of
deflation is based on the two great
20th-century failures of central banks
to inflate: America’s Great
Depression and the Case of Japan in
the 1990s.
Dr. Bernanke accepts Milton
Friedman’s theory of the Great
Depression. In the Freidman view, a
contraction of the money supply
brought about by loan defaults and
then bank failures turned what would
have been an ordinary recession into
the Great Depression. This
catastrophe could have been avoided
had the Fed inflated sufficiently. The
Friedmanites depict a Federal Reserve
System ideologically paralysed by the
so-called liquidationists.
A recent front-page story in The
Wall Street Journal delved further into
the pending chairman’s views on the
Depression.
For decades, many economists and
policy makers thought the
Depression was the inevitable
consequence of excess
investment, flawed corporate
governance and speculation in the
1920s, culminating in the 1929
stock-market crash. That view
was reinforced by John Kenneth
Galbraith’s 1955 book The Great
Crash, 1929.
Milton Friedman and Anna
Jacobson Schwartz upended that
view in 1963. In A Monetary
History of the United States, 1867–
1960, they argued that the
Depression was far from inevitable,
but brought about by an “inept”
Federal Reserve. First, they said,
the Fed foolishly raised interest
rates in 1928 to end speculation on
Wall Street, causing a recession
the next year that precipitated the
crash. Then, it let thousands of
banks fail and the money supply
shrink. In part, it thought weak
banks should be allowed to fail. It
also feared that lower interest rates
might lead foreigners to dump
dollars, straining the currency’s
link to gold.
Our next Fed chair, in a speech
given in honour of Milton Friedman
(2002), expressed contrition on
behalf of central bankers everywhere
in saying, “I would like to say to
Milton and Rose: Regarding the
Great Depression. You’re right, we
[the Fed] did it [caused the
Depression]. We’re very sorry. But
thanks to you [Friedman], we won’t
do it again.” The Fed has learned its
lesson.
The Depression has also shown
that central banks should adopt an
“asymmetrical” attitude toward asset
bubbles. Smile on the way up, and
then, try to reinflate them on the way
down. From the same WSJ article.
… addressing the Fed’s Jackson
Hole, Wyo., conference in 1999,
Mr. Bernanke and Mr. Gertler
said the Fed should raise rates if
rising asset prices fuel inflation,
but not to prick a bubble. “A
bubble, once pricked, can easily
degenerate into a panic,” they
said. When the bubble eventually
collapses on its own, the Fed
should cut interest rates to limit
the damage to the financial
system and the broad economy.
and:
The Depression, he contends, has
taught the importance of avoiding
both deflation — that is, generally
falling prices — and inflation. It
has also shown the threat that
falling asset prices — such as,
potentially, in housing — and
weakened banks can pose. Most
important, it shows the damage
the Fed can do when it follows
wrong-headed ideas.
The failure of Japan’s central bank
to inflate its economy out of the mess
following the bursting of the 1980s’
stock and real estate bubbles comes
in a close second to the Depression in
the Bernanke manual for deflation
fighters. Four of the 14 Fed speeches
deal mostly or entirely with Japan’s
attempt to inflate its way out of a
series of recessions that followed their
bust. Despite successive Keynesianstimulus
public-works programs (that
have nearly paved the entire island of
Japan into a parking lot), several
years of a near-zero short-term
interest rate, and a massive program
of foreign exchange intervention that
has left the BOJ holding hundreds of
billions of dollars worth of US
Treasuries, the BOJ has been unable
to generate much inflation at all.
To cite one of many examples, in
a speech titled “Preventing Deflation:
Lessons from Japan’s Experience in
the 1990s” (2002) (a paper by four
Fed staff economists) we read:
We conclude that Japan’s
sustained deflationary slump was
very much unanticipated by
Japanese policymakers and
 
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