I am of two minds regarding the Fed Chairman. The conventional wisdom of the gold bugs, commodity bulls, financials bears, and others who have made a killing in this market is that Bernanke fundamentally gets almost all his information from private bankers. If you control most of the inputs into a black box (or a human being), you can estimate, with a high degree of confidence, what the output of the black box will be. Beyond his critiques of “the global savings glut,” Bernanke’s academic origins by themselves connote an activist/ inflationary bias in Federal Reserve policy.
As a huge gold bull myself, this has been a very rewarding sort of conventional wisdom ever since I first began buying gold stocks in early June, and again in September. Bernanke’s every further move seems to further vindicate his worst detractors – namely, cutting interest rates by 25 basis points as the economy (supposedly) grew 3.9 percent in the third quarter, as well as a $41 billion repo injection into the banking system, the largest one-day injection since September 19, 2001. To add insult to inflationary injury, the Fed also injected $47.25bn of repos into the banking system on November 15.
The financial media, in somewhat Orwellian fashion, unanimously emphasized that because this operation was to “replace expiring repos,” the net injection was “only” $6 billion. Is it like the government-spending debate now, where cutting the rate of increase is the new baseline of discussion and debate? Is it somehow offensive to suggest that the $41 billion of repos injected at the beginning of the month are supposed to have stayed expired? (Just think, think of the children bankers!)
At any rate, although I don’t have too much confidence in Bernanke (and still less in Mishkin, whose myriad arguments for dovishness are stenographed all too credulously by Bloomberg), there are very legitimate arguments in favor of a weaker dollar. All indications are that the easy-money/ artificially depreciated-yuan interests triumphed at the 17th Plenum of the Communist Party of China, meaning that, unless external pressure (in the form of a cheaper dollar) punishes them enough, an artificially cheap yuan will be de rigueur for as long as the PRC can sustain it.
If China will not allow the yuan to trade freely, then, the Fed may well have consciously chosen to do the PBoC’s work for it. (There are some who have argued that Greenspan essentially outsourced Fed policy to the People’s Bank of China.) The dollar-yuan pair does not trade in an open market, so the Fed must counter-manipulate to compensate for Chinese yuan intransigence. Inflation is certainly rising in the United States, but it is rising still faster in the PRC, and if the Chinese want to keep playing chicken with their currency, they will be forced to blink first, and in any event they have more to lose from a head-on collision.
Whichever rationalization for Bernanke’s behavior you prefer, competitive currency devaluation – higher inflation, more-expensive commodities, drastically more expensive gold – is the name of the game. With the Fed’s drastic devaluation of the dollar, Chinese exports to Europe have more than replaced lower exports to the United States. European political instability is increasing, and European bankers (not to mention politicians) are not going to play that game for nearly as long as the United States did.
However, the USD has already been gutted. The GBP has begun to follow. The Euro is the only hawkish currency left. While the ECB does have a significant hawkish bias (if only to capture more “world reserve currency market share” from the USD), it cannot stray too far from the pack. Germany, Austria, Netherlands, Scandinavia, UK, and Ireland are indifferent to a strong euro–their exports are highly specialized, and so demand for their exports is inelastic relative to the price of the euro–and in the meantime, their citizens have gained enormous international purchasing power from the euro’s appreciation.
However, the ECB must also pay heed to the Mediterranean and Eastern European economies in its currency union, especially Spain, France and Italy. The Eastern European economies are experiencing double-digit inflation and double-digit trade deficits as a percentage of GDP, while France, Italy and Spain–lower-end exporters more dependent on fluctuations in the value of the euro–have seen their competitiveness crippled by the stronger euro. Thus, the eastern and southern Europeans are howling for euro depreciation, and judging from Trichet’s latest rhetoric, the ECB has begun to fear the consonance of the depreciators’ collective demands.
The political equilibrium of the ‘guzzler’ economies thus seems heavily tilted in favor of inflation. US inflation is now at 3.5%, and almost certainly rising. Who will be left to mop up global liquidity if the ECB begins to ease? Or will everyone just wait until Chinese peasants (once again) choose revolution over asphyxiation-by-inflation?
The Chinese economy is a total train wreck in way too many ways to get into in this post. For now, I will just say that Chinese stated inflationary figures severely understate both the extent and the future trajectory of the problem. Price caps have been institutionalized across China for about two months. Three people were killed in a stampede to buy rationed cooking oil in Chongqing, a megalopolis in central China. Another widely-circulated report stated that a truck driver was killed while fighting with a diesel queue jumper in Henan province.
While the short-term inflation problem can be “solved” by lifting some of China’s price controls–and it probably will be, because the Chinese government remembers very well that inflation was the proximate cause of the Tian An Men Square protests, among others–the bottom line is that China’s economy is overcapacitated, overcapitalized, unbalanced, not subject to any market mechanisms (such as a real debt market), and unable to be supplied at this rate forever.
There are many other reasons why China should have slowed down well before now (for its own good as well as everyone else’s), but that’s for another post.
