Bernanke's Speech Brings Inflation to the Forefront...Sort Of

“Our interpretation of the increase in gas prices is the economist’s basic mantra of supply and demand,” mused chairman Ben Bernanke yesterday during his first-ever regularly scheduled press conference.

At that moment, the price of oil reached a new post-2008 high.

This morning, it’s pulled back a bit, but not much. A barrel of West Texas Intermediate goes for about $113.15 right now.

“The Federal Reserve believes that a strong and stable dollar is both in the American interests and in the interest of the global economy,” he also said.

At that moment, the dollar index reached a new post-2008 low.

This morning, it recovered…barely…and clings to 73 by some very closely clipped fingernails.

Back when Bernanke signaled the advent of a new round of easy money – QE2 – during his annual speech at Jackson Hole, Wyo. last August, oil was $75 and the dollar index was at 83…

Performance of Oil and the Dollar Index Since Jackson Hole Speech

We agree it’s, as Bernanke points out, due to supply and demand, but perhaps not in the sense he meant.

“He never admits it’s the inflation of the money supply that’s the problem,” Rep. Ron Paul told MarketWatch yesterday, after putting himself through the mild torture of watching the news conference.

“The [Federal Open Market] Committee expects the effects on inflation of higher commodity prices to be transitory,” spake the chairman.

The Fed can no longer assert “inflation” is a nonissue. So the line now is that it’s a “temporary” one.

But even the Fed now admits that consumer prices will likely rise this year higher than the Fed would like. After wrapping up its two-day meeting yesterday, the Fed’s Open Market Committee forecast a headline CPI between 2.1% and 2.8% during 2011.

That’s higher than their original target zone of 2%.

(Yes, it’s the Fed’s goal for your money to be worth 18% less over a 10-year span. And true, that doesn’t seem to fit in with the Fed’s mandate of “stable prices” or their stated belief in a “strong dollar”… but that’s a story for another day. And not to worry, the Fed informs us, CPI will magically return to a 1.4-2% range in 2012.)

“I do believe that the second round of securities purchases [QE2] was effective,” Bernanke said. “We saw that first in the financial markets. The way monetary policy always works is by easing financial conditions. We saw increases in stock prices.”

And there it is… the wealth effect, writ large. The Fed favors the stock market. Savings and investment in a traditional sense be damned.

“Hear, hear!” cheered stock traders, who brought the Dow and S&P to new post 2008 highs. This morning, both indexes have added to those gains and the Dow is now a hair above 12,700.

In sum, the higher inflation target was the news nugget that made its way out of the back end of Bernanke’s dog and pony show yesterday.

Everything else was status quo: Zero-interest rate policy remains in effect… and the $600 billion in new Treasury purchases at the center of QE2 will proceed as scheduled through the end of June… after which the Fed will continue rolling over existing debt to make this chart go flat, at least for a while…

The Fed's Balance Sheet Since the Start of the Credit Crisis

As an aside: The word “gold” did not slip from the chairman’s tongue once while he held court. But the spot price powered to its own new all-time high… and sits still there now at $1,534.

Silver busted through $48 as the chairman spoke. This morning the blaise metal has powered its way to $49.08. Meaning today could be the day the 1980 record of $50 finally goes down.

Where to from here? If the past is prologue, we’re due for something along the lines of when QE1 ended in early spring last year: The S&P fell 13%… and the VIX, the market’s “fear gauge,” zoomed up 48%. Then in August, Ben gave his Jackson Hole speech, and the rest is history.

We figure the Fed will lather, rinse… and repeat: Wait for the stock market to correct, and then launch QE3.

For reference, the S&P is up 28% since, and the VIX is below 15 as we write – as low as it’s been since mid-2007.

Addison Wiggin
for The Daily Reckoning