Reappoint Ben Bernanke

The Senate is likely to reappoint Ben Bernanke as Fed chairman. But there is a cabal of senators on both the left and right that want him ousted. And some want the Fed’s powers restricted, a course of action that would only end up politicizing policy, which would be a disastrous turn.

His opponents are making noise and made him mighty uncomfortable in his confirmation hearings today. They feel he and his predecessor have been the source of many of our problems with monetary policy that has been far too loose for far too long, encouraging risk and baiting inflation. The price of gold has them apoplectic as a sign that inflation is just around the corner.

Bernanke is taking the heat for his policies of quantitative easing, in which he has purchased debt instruments to effectively take real interest rates below zero. As we learned in the 1930’s and Japan learned in the 1990’s, bursting financial bubbles are deflationary events. And once deflation takes hold it is difficult to arrest. The value of assets collapse and the economy essentially folds.

The process of turning on the liquidity spigots has had the effect of fighting off deflation and its pernicious economic effects. Unemployment might be 10% and growth without stimulus barely positive, but these numbers would be a lot worse without these policies. In case you’re in doubt consult your history books.

Yes, the dollar is weak and likely to weaken further. And gold is on fire. But we view this as more a vote of no confidence in the dollar than in nascent inflation. The following comparison chart uses ETFs to show gold (GLD), the dollar (UUP), oil (USO), the euro (FXE), the Commodity Research Bureau Index (DBC) and the Australian dollar, with all charts starting at 100 on March 9th of this year, the day the NASDAQ bottomed and started its impressive advance. We selected this date because the dollar was at a three year high at that point and has steadily declined as stocks and other assets have rallied.

(If you click on this particular chart to enlarge it, in order to best view it you might have to adjust your screen size by pressing CTRL and the [-] sign.)

The results are clear. All assets are higher – much higher – against the dollar, but not so much against one another. In fact the commodities are bracketed by two currencies with gold smack in the middle. This isn’t inflation. It’s a sign of severe illness in the United States.

Would higher interest rates repair the damage? To an extent, yes. But they would choke off whatever signs of life are percolating in our economy and only fuel the deflation impulse.

If members of Congress want to place blame for our malaise on someone they need only point their fingers at themselves. The dollar isn’t sick because of interest rate policy. It is sick because of nearly nine years of profligate spending under two administrations and a welfare state that is coming unhinged and, incredibly, set to expand by an unfathomable order of magnitude.

Whoever the Fed chairman will be in the years to come there is a difficult task ahead. A healing economy will need to have quantitative easing artfully withdrawn. And we believe Ben Bernanke is the proper artist for this job. He should be reconfirmed forthwith.