What do Ben S. Bernanke and his fellow
Federal Reserve monetary policymakers not see? In its April 28 statement, the Federal Open Market Committee played down fears of inflation. “Commodity prices have risen significantly since last summer, and concerns about global supplies of crude oil have contributed to a further increase in oil prices since the committee met in March,” it said. “Inflation has picked up in recent months, but longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued.”
Likewise, at the press conference following the committee's meeting, Mr. Bernanke acknowledged fears that inflation could be a threat, but said interest rates are unlikely to change in the next few months.
He appears confident that the current signs of inflation are transitory, and that if signs of more-lasting inflation do appear, he and his colleagues will see it and react in time to prevent it from gaining momentum.
But the cost of food and energy is way up and higher prices are leaching through to clothing and transportation. The rise shows no signs of abating anytime soon. Companies report higher prices for many kinds of raw materials.
A significant part of the increase in the price of food can be attributed to the rise in the price of oil, as it increases the cost of oil-based fertilizers, and to packaging and transportation costs.
While uncertainty about supply because of the troubles in the Middle East no doubt is having an impact on oil prices, a far more significant factor appears to be the decline in the dollar. That is related to the easy-money policies of the Fed.
The correlation between the decline in the value of the dollar relative to many currencies and the rise in the price of oil is too close to ignore.
As the dollar has declined, the price of a barrel of oil has increased. Since oil is priced in dollars, this is only logical because those selling the oil have to use the dollars they receive for it to buy the food and other items they need from other countries. The prices of those other items aren't declining with the dollar, so they must get more dollars for each barrel of oil.
At root, inflation is always a monetary phenomenon, as the late Milton Friedman noted, which occurs when the money supply grows faster than the underlying economy. In the past 12 months, M-1 (which measures money in exchange) has increased at a 10.4% annual rate, and in the past three months at a 12.9% rate. M-2 (which measures money in storage) increased at a rate of more than 4% in both periods, significantly faster than the gross-domestic-product growth rate, which was 3.1% in the fourth quarter and a mere 1.8% in the most recent quarter.
Mr. Bernanke and his Fed colleagues have indicated that they will tolerate inflation of 2% to 3% as a lubricant for economic activity. Counting food and energy, it has reached that point, with the Consumer Price Index growing by 2.7% for the 12-month period ended March 31. Still, the core inflation rate, i.e., minus food and energy, was only 1.2%. The concern is that Mr. Bernanke and company will not recognize when inflation is getting out of control.
Mr. Bernanke is a recognized expert on the causes of the Great Depression, a deflationary event, yet he still missed the clues that the Great Recession of 2008-09 was approaching. In fact, in a 2004 speech as a member of the Board of Governors of the
Federal Reserve system, he suggested that such crises were a thing of the past. He argued that modern macroeconomic policy had decreased the volatility of the business cycle to the point that it should no longer be a central issue in economics.
If he could be so wrong about deflation and the business cycle, he could certainly be wrong about the likelihood that inflation will get out of control. If he is wrong, he could cost all citizens, not just investors, as much in asset values and purchasing power as the financial market crash.
The best advice for investors is to establish a hedge against inflation. Judging by the price of gold and silver, many already are doing so. Common stocks will provide some protection as long as inflation does not get significantly above 6%. But above that, watch out.
