Fed Chairman Ben Bernanke hastened to assure Congress on Tuesday that, while he thinks the economy still needs stimulus, he remains sensitive to the danger that expansive monetary policy could stoke inflation. But should he worry? Might inflation be not only the most efficacious but also the kindest way out of America’s economic doldrums?
No question, by the tenets of monetary policy that have prevailed in economic thinking in recent decades, the Fed’s recent policies set the stage for an inflationary spiral. With short-term interest rates effectively negative, the Fed has been buying up hundreds of billions of dollars worth of U.S. Treasury securities, mortgage bonds and other securities — the monetary equivalent of printing money by the carload. As they teach you in Econ 101, when the supply of something increases more rapidly than the demand for it, its price will fall. Applied to money, that means the dollar would lose value and the price of things bought with it would rise. Voilà – inflation.
Of course, the textbooks haven’t worked so well in recent years. Even the free-marketing Economist magazine recently took note of that. And Bernanke, a long-time student of the 1930s Depression, is highly sensitive to the fact that a deflationary spiral can build up momentum equal to or greater than that of its inflationary opposite. Moreover, Bernanke is maneuvering along a narrow margin between those, including some of his Fed colleagues as well as Wall Street worriers, who fear that his easy money ways will stoke inflation and those, perhaps a larger number, who worry that the Fed will pull back too quickly and squash a still nascent economic recovery.
But looking beyond the p.r. needs of the moment, it’s worth asking if a carefully monitored dose of inflation, might be the fastest — and maybe only — way to spring America free of its debtor’s shackles. After all, inflation has traditionally been the debtor’s best friend. That of course was why the farmers of the 19th century were the moving force behind the “free silver” movement, while the bankers pressed the case for a gold standard. And while the U.S. savings rate has perked up a bit in recent months, the fact remains that the average American household is mired in debt not just mortgages, but auto loans and other “non-revolving” debt and, of course, loads of revolving (mostly credit card) debt. And that debtors’ burden, of course, dampens consumer spirits, the lifeblood -for better or worse–of the American economy.
Experimental studies have also shown that the average American finds a dose of “money illusion” far more palatable than a forthright cut in pay or purchasing power. How much easier to tell a worker that he/she is going to get only a tiny raise – or even no raise at all — than to tell them their next paycheck will have shrunk? And apparently most people feel good about a tiny pay hike even if prices at the supermarket are creeping up a good deal faster.
Much of America’s debt, especially government debt, is held by foreigners – most notably China’s central bank, which is estimated to hold more than a trillion dollars worth of dollar-denominated securities. Inflation would – or should, anyway — lower the value of the dollar on international exchange markets. (The textbooks also instruct that the gigantic U.S. trade deficit should have driven the dollar down long ago — but, thanks to mercantilist policies that kept the Chinese and some other currencies artificially low, that didn’t happen.) Now, however, even China is signaling a limit to its tolerance for amassing dollars it doesn’t want to spend on U.S. goods and services. In recent months, beginning in March, Chinese authorities, including Prime Minister Wen Jiabao, have expressed concern that the huge fiscal deficits produced by the U.S. government’s stimulus spending could erode the dollar’s value and hence the value of China’s horde of dollars.
True, diminished Chinese interest in buying US securities would drive up U.S. interest rates, but China still has a huge vested interest in selling far more to America than it is willing to buy from us. And how many unspent and univested dollars is it ultimately going to pile up under its central bank’s mattress? Moreover, as the president’s chief economic adviser, Lawrence Summers reminded a questioner at his speech at the Peterson Institute of International Economics last week, if China doesn’t like the stimulus program, far less would it have liked the economic collapse that might well have otherwise occurred without it.
More on Ben Bernanke
