From time to time, Morningstar publishes articles from third party contributors under our "Perspectives" banner. Here, Axel Merk of Merk Mutual Funds, shares his view on how the politics of the Federal Reserve impact inflation in the US and globally. Bernanke deserves part of the blame for commodity prices surging and purchasing power in emerging markets eroding, Merk says. If you are interested in Morningstar featuring your content, please provide your details and/or submit your article here.
In arguing food inflation is not the Federal Reserve’s (Fed’s) fault, Fed Chairman Bernanke points the finger at everyone but him. Just as with a lot of Bernanke’s policies, his argument may hold in an academic setting, but the real world is a bit more complicated.
Summarising the greatest money printing experiment in monetary history, Bernanke proudly stipulates that the programme has been “effective”, because:
-- “equity prices have risen significantly”; and
-- “inflation compensation as measured in the market for inflation-indexed securities has risen”
Yet, when quizzed about whether his policies contribute to commodity and food inflation, Bernanke argues that the Fed’s policies have only influenced equity prices to the upside, not commodity prices. While that logic is unlikely to convince a preschooler, the Fed chief goes on the defensive to defuse the argument that his policies may actually be destabilising the Middle East and Asia, where a high portion of disposable income is spent on food. With regimes toppling left and right, Bernanke must feel he is carrying the weight of the world on his shoulders.
Why Bernanke is Right
Bernanke argues countries concerned about inflationary pressures stemming from food and commodities have plenty of tools to address these. Amongst those tools available to them are the ability to raise interest rates or allow their currencies to appreciate. Indeed, we have long argued that Asian countries in particular may allow their currencies to appreciate for exactly that reason.
However, Bernanke leaves out a small, but important detail: with QE2, the Fed has dramatically increased the stakes, placing the proverbial gun to China’s head, effectively telling China’s policy makers to allow the Chinese renminbi to appreciate, or else. Having said that, Bernanke rightfully argues that the Fed’s mandate is to foster price stability and maximum employment, not to look after whatever the ills in the rest of the world may be.
Why Bernanke is Wrong
Trouble is, the very reason the Fed may be engaging in its super-expansionary policies is because it is trying to cure ills that are not part of its traditional mandate. Many of the Fed’s policies since the onset of the financial crisis have not been traditional monetary policies: a central bank usually applies a very broad brush in managing economic growth by controlling levers such as interest rates or money supply. However, when the Fed, for example, bought mortgage-backed securities (MBS), it steered money to a specific sector of the economy. That’s fiscal, not monetary policy, traditionally reserved for elected policy makers in Congress. Just like the MBS programme, many of the Fed’s policies continue to appear to be attempts at addressing the “shortcomings” of Congress.
A shortcoming is naturally in the eye of the beholder – we may like or dislike our politicians, but at least they are periodically up for election. Bernanke has felt, indeed testified, that one of the strengths of the Fed is that it can react swiftly in times of crisis. Bernanke has argued that without his determined actions, the country might have fallen into a depression. It appears to be a matter of the ends justifying the means.
In our analysis, however, the means employed are the wrong ones. A key reason why Bernanke’s policies have been rather ineffective is because his policies are fighting market forces. Consumers would like to downsize further; such “downsizing”, however, means bankruptcies and foreclosures. Policy makers would rather subsidise consumers with massive fiscal and monetary stimuli – it’s simply politically more palatable. Because market forces are fought, such stimuli are rather ineffective, causing money to flow not to consumers, but where there is the greatest monetary sensitivity: precious metals, commodities and currencies of countries producing commodities may be the prime beneficiaries.
And while Congress has stepped up spending on a grand scale in an effort to “stimulate” the economy, it’s little compared to the trillions the Fed can print, creating money out of thin air.
It doesn’t have to be that way: traditionally, central banks do not play cheerleader, but party pooper. By keeping the leash tight on politicians, real reform has to be enacted: look at how the European Central Bank mostly allows the bond market to impose reform on policy makers in the Eurozone; it’s an ugly process, but a higher cost of borrowing imposed by the bond market may be the only language politicians understand. In contrast, in the US, we appear to have decided that the Fed’s magic wand will cure all our problems, allowing Congress to go on with business as usual, with the Fed seemingly financing everything, including government debt.
The policies pursued by the Fed foster ever more leverage at the consumer level. Bernanke has pounded the table that he wants higher inflation. We have no doubt he will succeed, even as the markets are reluctant to embrace his determination – not so different, by the way, as the markets were reluctant in taking former Fed Chair Paul Volcker seriously when he announced in the early 80’s he would fight inflation. Indeed, we don’t think the Fed will rest until home prices are firmly moving higher – after all, that appears the only politically acceptable way to bail out millions (and a still growing number) of homeowners under water in their mortgage. But what happens if and when the Fed will want to mop up all this liquidity?
