Wednesday, October 26, 2005


Jim Grant On Bernanke And The Fed

The New York Times has this editorial by Jim Grant. "President Bush's choice to succeed Alan Greenspan as chairman of the Federal Reserve Board has raised a roar of approval. But there is one rub. The man..professes to believe the impossible. He insists that the Fed can keep the economy chugging and prices stable just by pushing a single interest rate (the so-called federal funds rate) up and down."

"If Mr. Bernanke then ventured a long-term oil-price forecast, would anyone even bother to write it down? Would anyone expect him, once confirmed, to actually fix the price? Those who did would have to call the idea by its discredited name, price controls, and would have to explain why the secretary-designate knew better than the market at which price the supply of oil would meet the demand for oil. They would also have to explain why this episode in price controls would turn out better than the long series of flops that preceded it. The world would laugh."

"Yet we seem to accept, and even desire, exactly such ludicrous claims of foresight from a Fed chairman. It follows that anyone who is willing to take the job as Fed chief is, by that reason, unqualified to hold it."

"Now Mr. Bernanke stands to inherit what Mr. Greenspan and he, among others at the Fed, wrought. Certainly they have whipped deflation. But by pressing down interest rates to the floor, they have pushed housing prices to the sky. And they are the uneasy witnesses to an unscripted climb in the Consumer Price Index, which, in September, registered a 4.7 percent increase over last year."

"Don't worry, many counsel. The seemingly alarming inflation data are the statistical tracks of a boom in energy prices caused by the Iraq war and the Gulf Coast hurricanes. It will pass."

"But what if it doesn't? What if a new cycle of rising prices has already begun - as I happen to believe it has? Mr. Bernanke, as sure of himself as he is of the future, won't soon be changing the way the Fed operates. Rather, it will be the world's dollar holders who will change the way they operate."

"If America's creditors sense that inflation is robbing them of their wealth and that the Bernanke Fed is too slow to raise its interest rate, they will sell their dollars and dollar-denominated securities. Such an exodus would, among other things, tend to increase the costs of imported goods and drive up dollar-denominated interest rates. In other words, events would control the Fed."

"Since each of the world's major currencies is a scrap of paper of no intrinsic value, some of these disaffected dollar investors may buy gold. Mr. Bernanke doesn't talk much about that barbarous relic. What would he make of a flight from a rationally managed currency into an inert precious metal? I will guess that it would astonish him."

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