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As the
world confronts one of the most critical periods of economic upheaval that it
has ever seen, it is clear that our most influential economic stewards have
absolutely no idea what they are doing. But, like kids with a new chemistry
set, they are nevertheless unwilling to let that stand in the way of their
experimental fun. As they pour an ever-growing number of volatile ingredients
into their test tubes, we can either hope that they magically stumble on the
secret formula to cure the world's ills, or more pragmatically, we can try to
prepare for the explosion that is likely to result.
Recent
comments from current and former Federal Reserve Chairmen, and from the
leaders of the European Central Bank, have starkly illustrated this stunning
lack of understanding. In an extended interview on CNBC today, former Fed
Chairman Alan Greenspan, once considered the sagest of all economic gurus,
admitted that he had no idea whether the Fed's current quantitative easing
program will help or hurt the economy. The Maestro simply said that we must
wait and see, and if positive economic indicators come, then we may begin
considering the policy to be a success. That's some serious insight.
In
other words, after dedicating his life to the study of macroeconomics,
Greenspan is left with no deep understanding of how the injection of
trillions of dollars of printed money affects an economy. The chicken who
plays tic-tac-toe in Chinatown could likely offer the same level of critical
analysis. To paraphrase Nancy Pelosi: according to Greenspan, we have to
conclude the policy to know if it works. Although I have never been thought
of as an economic expert by anyone with actual access to power, permit me to
offer a thought on the subject: printing money creates inflation, which
weakens an economy. Unfortunately, this kind of common-sense thinking never
seems to penetrate academic circles.
Without
fundamental understanding, all economists are left with is surface analysis
of current data and an inclination to play probability and statistics. This
is like a meteorologist opening the window, checking current conditions, and
making predictions based on analysis of recent days. While this may be
useful, it is no substitute for an understanding of atmospheric dynamics and
climatology. In his interview, Greenspan essentially confirmed this bias for
"open window" economics, saying that Ben Bernanke and Jean-Claude
Trichet both follow the same models, but with different statistical
sensitivities: Bernanke toward growth data and Trichet toward inflation data.
In that sense, both are no better than Las Vegas odds-makers, with one
putting his chips on inflation risk and the other betting on recession risk.
This
gambler's approach helps explain why economists fail to understand the
obvious benefits of a strong currency. According to people like Bernanke, a
weak currency is like an ace up the sleeve, a clever way to undercut the
competition. The problem is either everyone does it and the game ends up
swimming in aces, or Bernanke gets caught and other countries decided they
don't want to play anymore (sell Treasuries).
Conventional
warfare in this arena used to involve central bank buying and selling
currency reserves in the open. But in the aftermath of the financial crisis,
these timid measures were abandoned. In the last few years, the United States
has upped the ante and brought out unconventional weaponry. The trillions of
dollars printed by the Fed are the economic equivalent of carpet bombing.
Initially our enemies responded in kind, and sought to devalue their
currencies in lock step. They fought fire with fire and showered liquidity on
their own economies. However, as the collateral damage mounted in the form of
surging food and energy prices, they have begun sounding the general retreat.
In an
interview on CNBC this week, James Bullard, the President of the Federal Reserve
Bank of St. Louis, claimed that the Fed's easy money policies were not
responsible for inflation overseas, arguing that foreign central banks had a
choice. They could have allowed their currencies to rise, which would have
kept prices from rising in their internal markets. Instead, they chose to
prevent their currencies from rising - thereby importing our inflation. In
other words, they had to choose between exchange rate stability and price
stability. Apparently, they couldn't stand the heat, so they are getting out
of the kitchen.
Bernanke's
recent testimony before Congress, in which he argued that the Fed can't be
blamed for rising commodity prices, will surely increase international
unease. Yet still, as the issuer of the world's reserve currency, the Fed is
blazing a trail that other central banks feel compelled to follow. It is no
coincidence that inflation is highest in those nations that maintain a peg
against the dollar. But making this fundamental connection is beyond the
ability of our statistician-in-chief.
Bernanke
makes another fundamental error by blaming higher commodity prices on faster
global growth. Growing economies produce more stuff, which keeps prices in
check. However, if money supply grows faster than production, prices rise.
So, the increased demand to which Bernanke refers is merely a function of
more money, not faster growth.
In the
end, we will overwhelm our competitors with a show of extreme force. By the
time the Fed rolls out QE IV or QE V, the US will emerge as the undisputed
winner of the currency war. To the victor goes the spoils, which, in this
case, will be higher consumer prices and interest rates and lower standards
of living. On the other hand, the losers will enjoy rising living standards,
as their stronger currencies serve to lower prices and increase consumption.
If that doesn't make perfect sense, maybe we should run it by the chicken.
Peter D. Schiff
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