Bernankeism and hyper-inflation

September 24th, 2008

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Today, we will shed another light for our readers in this highly polarising inflation/deflation debate. Since this debate is highly divisive and polarising, there is little wonder that many of our readers are very confused. This article can be seen as a continuation of:

We will assume that you have read and understood the content of these articles. Also, the source of today’s article comes from here at one of Marc Faber’s Gloom, Boom, Doom reports. That article was “originally given as a talk at the Burton S. Blumert conference on Gold, Freedom, and Peace, a benefit for LewRockwell.com.” Lew Rockwell is the former congressional chief of staff to Ron Paul and founder and president of the Ludwig von Mises Institute (an institute of the Austrian School of economic thought).

First, as we quoted Ben Bernanke in Peering into the soul of Ben Bernanke,

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.

This speech gave Ben Bernake the nickname of “Helicopter Ben.” He is a student of the Great Depression and is convinced that deflation must be prevented at all cost. Particularly, he is obsessed with something known as the “zero bound problem.” Japan is a case in point for this zero bound problem. As we all know, Japan infamously cut its interest rates to zero in the 1990s and yet, still failed to win the war against deflation. As we explained before in What makes monetary policy ?loose? or ?tight??,

… remember that the central bank cannot control the demand for money and credit. It can supply whatever amount of them that it wants, but it cannot force business and people to desire them. Put it simply, you can lead a horse to the water, but you cannot force it to drink.

When deflation forces interest rates to be zero, that is the point when monetary policy becomes totally impotent in inflating. Therefore, Bernanke will want to avoid this zero-bound problem by making darn sure that inflation will happen.

But the question is how? The case of Japan showed that it is impossible. In that sense, the deflation argument is right. In the current credit crisis in the US, it is impossible to win the war against deflation.

Well, it is impossible unless unconventional means are used. The word “conventional measures” appeared prominently in much of the Fed’s discussion. According to Bernankeism, when the

… powers of a central bank are limited to “conventional measures,” the central bank may not be able to prevent deflation, nor to fight it once it has taken hold. In the Fed’s view, Japan tried conventional inflation measures to their utmost.

What are the unconventional measures that Bernanke advocated? If you read the Fed’s papers and speeches, you will find a series of “increasingly exotic plans,” from the “merely unsound to the bizarre and terrifying.” For your information, these are not something we invented from our imaginations- they are available in the public domain at the Fed’s web site. The list of references can be found here. Below are the unconventional measures:

  1. Expand the menu of assets that the Fed could purchase through its open-market operations. This measure is already implemented- see New tricks required to bail out financial system.
  2. Purchase of long-term US Treasury bonds.
  3. Writing interest rate option contracts.
  4. Purchase foreign exchange reserves in order to devalue the US dollar.
  5. Loan money into existence, accepting as collateral almost any private-sector asset whatever.

So far, the above measures depend on the willingness of borrowers to borrow the cheap money that the Fed prints. What if the private sector refuses to borrow? Well, no worries! The Fed will print and distribute the money (note: this quote is straight from the Fed’s mouth):

One tool commonly attributed to the Federal Reserve, at least in theory if not by the Federal Reserve Act, is that of conducting ?money rains?.

Money rains are a clean way to study theoretically the effects of increases in the supply of money. In practice, it seems a bit difficult to envision how the Federal Reserve could literally implement a money rain ? that is, give money away either through directly disbursing currency to the public or by disbursing it through the banking system. The political difficulties that are likely to arise from the Federal Reserve determining the distribution of this new wealth would be daunting.

Now, what if the Fed prints and distributes but the people are unwilling to spend? Well, the “next weapon in their arsenal is to make money pay a negative rate of interest.” While that sounds difficult, the Fed has actually written a paper to explain how they are going to do that:

The strategy for eliminating the zero bound, therefore, is to make money pay a negative nominal interest rate, by imposing some type of ?carry tax? on currency and deposits

The technological difficulty lies mainly in imposing such a tax on currency. In the 1930s, Irving Fisher of Yale University, one of the greatest [sic] American economists, proposed such a system, in which currency had to be periodically ?stamped?, for a fee, in order to retain its status as legal tender. The stamp fee could be calibrated to generate any negative nominal interest rate that the central bank desired.

What if this still fails to inflate? There is another weapon- the direct monetisation of goods and services (note: this quote is straight from the Fed’s mouth):

Why not have the Fed just conduct an open market purchase of real goods and services? Even more so than exchange rate intervention, this strategy would represent a direct stimulus to aggregate demand.

These unconventional measures are “absurd, bizarre, and preposterous monetary crank schemes ever proposed by anyone calling themselves an economist.” Some of them are even downright illegal! But is illegality an obstacle? As we said before in Recipe for hyperinflation,

Therefore, watch what the US government is doing with the monetary ?rules? in its attempt to fight deflation.

Now, as you are reading this, you may find it incredulous to see these crazy ideas mentioned by Ben Bernanke and his accomplices. Are we making them up? No, you can download this article here and check out the list of references at page 11. They are all straight from Ben Bernanke/Fed’s mouth (or pen).

The question is, are they really crazy enough to do it?

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  • Those unconventional measure sure do sound crazy and perhaps hyper inflationary. I wonder who benefits from the destruction of the USD.

    Does anyone have any idea what kind of effects that the destruction of the USD would have on the global financial system (considering in particular that the USD is used as a reserve currency)?

    As a saver, I am very concerned about the inflation/deflation scenario. It’s fine to point out that inflation might be more likely but many people prefer it for some reason… I haven’t currently taken any position in commodities or property in order to counter massive inflation. I would like to buy gold but haven’t done my homework yet – particularly on the taxation side of things (any pointers would be helpful).

    I wonder if there’s any chance that fiat money would be replaced by sound money after this debacle. I have noticed more and more that people are blaming lack of regulation and want to nationalise control these financial institutions. This goes away from the free market and Austrian views and towards socialism. I am only just starting to read the Debtonation blog by a UK-based economist but it seems to have socialist overtones at least.

    Debtonation

  • Those unconventional measure sure do sound crazy and perhaps hyper inflationary. I wonder who benefits from the destruction of the USD.

    Does anyone have any idea what kind of effects that the destruction of the USD would have on the global financial system (considering in particular that the USD is used as a reserve currency)?

    As a saver, I am very concerned about the inflation/deflation scenario. It’s fine to point out that inflation might be more likely but many people prefer it for some reason… I haven’t currently taken any position in commodities or property in order to counter massive inflation. I would like to buy gold but haven’t done my homework yet – particularly on the taxation side of things (any pointers would be helpful).

    I wonder if there’s any chance that fiat money would be replaced by sound money after this debacle. I have noticed more and more that people are blaming lack of regulation and want to nationalise control these financial institutions. This goes away from the free market and Austrian views and towards socialism. I am only just starting to read the Debtonation blog by a UK-based economist but it seems to have socialist overtones at least.

    Debtonation

  • Hi Steven!

    I wonder who benefits from the destruction of the USD.

    Nobody will benefit out of this. Only the Islamist terrorists will gloat over it. Maybe countries like Iran and Venezuela will love it.

    Will gold bugs benefit? Well, what use will gold be if the country that you live in is disintegrating through the ravages of hyper-inflation? Unless migration is an option. People like Jimmy Rogers has already migrated to Singapore and ensured that his daughter is fluent in Mandarin.

    Does anyone have any idea what kind of effects that the destruction of the USD would have on the global financial system (considering in particular that the USD is used as a reserve currency)?

    We recommend What if the US fall into hyperinflation?.

    I wonder if there’s any chance that fiat money would be replaced by sound money after this debacle. I have noticed more and more that people are blaming lack of regulation and want to nationalise control these financial institutions.

    We don’t know for sure whether hyper-inflation or hyper-deflation is the outcome. Therefore, we don’t know whether sound money will prevail in the future. We may hope so, but it will take a terribly severe crisis to force change from the status quo.

    If you notice, Bernankeism’s last crazy idea is monetisation of goods and service. That’s very much like a Soviet-style command economy. It’s a worry that the US is moving towards socialism to solve its financial crisis.

  • Hi Steven!

    I wonder who benefits from the destruction of the USD.

    Nobody will benefit out of this. Only the Islamist terrorists will gloat over it. Maybe countries like Iran and Venezuela will love it.

    Will gold bugs benefit? Well, what use will gold be if the country that you live in is disintegrating through the ravages of hyper-inflation? Unless migration is an option. People like Jimmy Rogers has already migrated to Singapore and ensured that his daughter is fluent in Mandarin.

    Does anyone have any idea what kind of effects that the destruction of the USD would have on the global financial system (considering in particular that the USD is used as a reserve currency)?

    We recommend What if the US fall into hyperinflation?.

    I wonder if there’s any chance that fiat money would be replaced by sound money after this debacle. I have noticed more and more that people are blaming lack of regulation and want to nationalise control these financial institutions.

    We don’t know for sure whether hyper-inflation or hyper-deflation is the outcome. Therefore, we don’t know whether sound money will prevail in the future. We may hope so, but it will take a terribly severe crisis to force change from the status quo.

    If you notice, Bernankeism’s last crazy idea is monetisation of goods and service. That’s very much like a Soviet-style command economy. It’s a worry that the US is moving towards socialism to solve its financial crisis.

  • Sergey Stadnik

    I wonder if the feds will resort to literally throwing money from helicopters…

  • Sergey Stadnik

    I wonder if the feds will resort to literally throwing money from helicopters…

  • Me

    “Will gold bugs benefit? Well, what use will gold be if the country that you live in is disintegrating through the ravages of hyper-inflation?”

    Eds,

    You have previously express the view that owning gold would be an effective hedge against collapse of fiat currency. Are you repudiating that view, or do you still consider gold to be an effective medium for storing wealth, just that it can’t be used at a time when the economy and society are being torn apart?

    Cheers,

    Me

  • Me

    “Will gold bugs benefit? Well, what use will gold be if the country that you live in is disintegrating through the ravages of hyper-inflation?”

    Eds,

    You have previously express the view that owning gold would be an effective hedge against collapse of fiat currency. Are you repudiating that view, or do you still consider gold to be an effective medium for storing wealth, just that it can’t be used at a time when the economy and society are being torn apart?

    Cheers,

    Me

  • Hi Me!

    You have previously express the view that owning gold would be an effective hedge against collapse of fiat currency. Are you repudiating that view, or do you still consider gold to be an effective medium for storing wealth, just that it can?t be used at a time when the economy and society are being torn apart?

    Yes, we still hold the view that gold is a hedge (i.e. insurance against) against loss of confidence in fiat money. But you are sort of close to being correct in interpreting us when you said,

    … just that it can?t be used at a time when the economy and society are being torn apart?

    For example, what’s the use of having lots of gold and living in Zimbabwe today. Sure, one may be relatively better off than other Zimbabweans, but what’s the use? Do we really want to live in Zimbabwe regardless of how much gold we have? It’s not so much that gold cannot be used in Zimbabwe (we’re sure you can, through the black market), but rather, how much can gold buy in a disintegrating economy which can hardly feed its own people?

    Let’s suppose that Bernanke and company are going to destroy the US dollar with their misguided economic ideology. In that case, the US will fall into hyper-inflation i.e. into the same situation as Zimbabwe today. For Americans stuck in the US, owning gold will make the world of a difference (relative to fellow Americans). But if Americans can migrate, wouldn’t this be a better option?

    The question that we’ve been thinking about it this: would the rest of the world follow the US into hyper-inflation? If the answer is no, the world has to choose an alternative reserve currency. If gold is chosen as the alternative reserve currency, it will be really handy to own some AND migrate. Perhaps owning some will make it easier for one to migrate?

    If gold is not chosen as the alternative reserve currency, then the currency of powerful foreign nations that have the best prospect of supplanting the US is the next best choice. That’s the best way to explain why Jimmy Rogers did what he did- he hold gold and Chinese Yuan, migrated to Singapore and make sure that his daughter speaks Mandarin since she’s born.

    Please note that we are speculating about the future. There’s no telling how this Black Swan scenario will turn out.

  • Hi Me!

    You have previously express the view that owning gold would be an effective hedge against collapse of fiat currency. Are you repudiating that view, or do you still consider gold to be an effective medium for storing wealth, just that it can?t be used at a time when the economy and society are being torn apart?

    Yes, we still hold the view that gold is a hedge (i.e. insurance against) against loss of confidence in fiat money. But you are sort of close to being correct in interpreting us when you said,

    … just that it can?t be used at a time when the economy and society are being torn apart?

    For example, what’s the use of having lots of gold and living in Zimbabwe today. Sure, one may be relatively better off than other Zimbabweans, but what’s the use? Do we really want to live in Zimbabwe regardless of how much gold we have? It’s not so much that gold cannot be used in Zimbabwe (we’re sure you can, through the black market), but rather, how much can gold buy in a disintegrating economy which can hardly feed its own people?

    Let’s suppose that Bernanke and company are going to destroy the US dollar with their misguided economic ideology. In that case, the US will fall into hyper-inflation i.e. into the same situation as Zimbabwe today. For Americans stuck in the US, owning gold will make the world of a difference (relative to fellow Americans). But if Americans can migrate, wouldn’t this be a better option?

    The question that we’ve been thinking about it this: would the rest of the world follow the US into hyper-inflation? If the answer is no, the world has to choose an alternative reserve currency. If gold is chosen as the alternative reserve currency, it will be really handy to own some AND migrate. Perhaps owning some will make it easier for one to migrate?

    If gold is not chosen as the alternative reserve currency, then the currency of powerful foreign nations that have the best prospect of supplanting the US is the next best choice. That’s the best way to explain why Jimmy Rogers did what he did- he hold gold and Chinese Yuan, migrated to Singapore and make sure that his daughter speaks Mandarin since she’s born.

    Please note that we are speculating about the future. There’s no telling how this Black Swan scenario will turn out.

  • Me

    No, indeed. The uncertainty has elevated my blood pressure a few notches for the last couple of weeks, I’m sure.

    But then, life would be boring without the unexpected…..

  • Me

    No, indeed. The uncertainty has elevated my blood pressure a few notches for the last couple of weeks, I’m sure.

    But then, life would be boring without the unexpected…..