By Peter D. Schiff
Having neither the will nor the means to confront our major economic challenges, Washington is instead hanging its hopes on words alone. A week ago, despite the clearest signs yet that the U.S. greenback is in critical condition, President George W. Bush and U.S. Treasury Secretary Henry M. Paulson Jr. tried to provide reassurance by once again invoking the name of the mythical "strong dollar policy."
Meanwhile, across town, with the latest crop of inflation figures pointing to the greatest price surges in a generation, U.S. Federal Reserve Chairman Ben S. Bernanke tried to do the Bush Administration one better by insisting to Congress that inflation expectations remained "well anchored," and that stagflation was nowhere in sight.
The truth is that Bernanke's view that inflation expectations are "anchored" should be afforded as much respect as his prior pronouncements that the subprime mortgage problems were "contained." With official inflation numbers – the producer price index (PPI), the consumer price index (CPI) and import prices – all showing unacceptably high levels of inflation, the dollar hitting new all-time lows, and such key market indicators as gold, silver, oil and agricultural commodities all heading straight up, the central bank chairman risks losing what's left of his already-tattered credibility.
Bernanke contends that the source of our inflation is rising commodity prices, which he attributes to strong global demand. This is Bernanke's attempt to shift the blame for inflation to external factors that are beyond his control. This, of course, completely misses the point that increased global demand is a direct result of the rapid increase in global money supply – the source of which is Bernanke himself. This Alfred E. Newman routine is obviously wearing thin as the dollar seems to tick down and gold ticks up every time Bernanke completes a sentence.
The biggest factor pumping up demand around the globe is the Fed's excessive money creation and irresponsible monetary easing, which requires foreign central banks to follow suit to keep their own currencies in relative alignment with the greenback. Of course, some of this growing global demand is genuine, but that demand is being met by increased supply. It is only the artificial demand created by inflation that is pushing up prices.
Amazingly, Bernanke feels that rising food and energy prices themselves do not present a problem as long as the increases are contained in those areas. In other words, as long as these costs can be excluded from the officially messaged PCE deflator, Bernanke doesn't care if American families have to pay more to feed their families, heat their homes, and drive to work.
What the Fed chief doesn't seem to understand is this very key point: If these basic costs continue to rise, it doesn't matter what happens to prices of other goods, as few people will have any money left to buy them.
Bernanke also seems to think that if the economy does somehow slip into recession, that inflation will subside as a consequence. This is pure nonsense, as diminished demand here at home will be offset by enhanced demand abroad. As a weak dollar forces Americans to cut back on their consumption, strengthening foreign currencies will give foreigners added purchasing power to consume more. Therefore, fewer foreign-made products will be imported, while more U.S.-made – or, in most cases, U.S.-grown – products will be exported.
The result: Reduced domestic supply will put additional upward pressure on prices.
Equally naïve is the concept that the Fed can stabilize the economy now by slashing interest rates, while holding out the hope that future inflation could be reined in through aggressive rate hikes in the future. Even if a recession could be avoided by easing, our economy is so dependent on cheap debt that as soon as Bernanke reaches for his hawk mask, the economy would immediately destabilize, necessitating a fresh round of rate cuts and still more inflation.
If Bernanke really were serious about fighting inflation, he would do it right now. By postponing the cure he simply allows the disease to get that much worse.
Of course, Bernanke is not the only one in denial. Wall Street's brain trust has recently devised many explanations that rationalize the inflation problem. For example, some argue that falling housing prices are deflationary, and negate the impact of other prices that happen to be rising. While it may be true that home prices are falling, the costs associated with home ownership itself are rising. Most homeowners are not only facing rising mortgage payments, but also higher insurance premiums, growing maintenance costs, bigger utility bills and stiffer taxes.
In addition to those costs, potential homebuyers also face higher down payments and tighter lending standards. Also, when home prices were rising, few considered it an inflation problem, so why should those very people consider the reverse deflation?
Others talk about "food inflation" or "energy inflation" as if there were different kinds. There is only one type of inflation, which is an expansion of the supply of money and credit. Prices do not inflate; they merely rise and fall. When people refer to rising food prices as being "food inflation," they are shifting the blame for inflation to rising food prices, rather than attributing the rise in food prices to inflation itself.
I have heard others maintain that rising commodity prices are merely a supply problem. However, tight supply is a function of the artificial demand created by inflation. If the government handed out million-dollar bills there would be a shortage of, as everyone would want to buy one.
Of course, one of the most problematic turns of events is the way some of the Fed's biggest cheerleaders have turned into critics. For example, CNBC's Larry Kudlow, who just months ago was calling for "Shock and Awe" rate cuts to boost the dollar and revive our "Goldilocks economy," now blames those very rate cuts for pummeling the dollar and the U.S. economy.
If the Fed can't even inspire confidence in its biggest boosters, this show can't be playing well to the more-skeptical audience overseas. And there's no improvement in sight.
[Editor's Note: Money Morning Guest Columnist Peter D. Schiff is the president of Euro Pacific Capital Inc., a Darien, Conn.-based broker/dealer known for its foreign-markets expertise. A well-known financial author and commentator, Schiff is a regular Money Morningcontributor, and has most recently written about the futility of "juicing" the economy, speculative bubbles and soaring gold prices. In mid-August, when analysts were touting beaten-down financial shares, Schiff said the stocks were "toxic," were destined "to get hit hard," and advised investors to "stay away." Investors who heeded that advice, and avoided such shares as Merrill Lynch, also avoided some stressful, subprime-induced losses. Schiff's first book, " ," was published by Wiley & Sons in February 2007. To order the book, please click here].
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