What's Wrong With a Little Monetary Inflation?

Colleague Porter Stansberry sent us this note:

The Justice Department is assembling a team to “root out any cases of fraud or manipulation” in oil markets that might be contributing to $4 a gallon-plus gasoline prices. Says OBAMA!: “We are going to make sure that no one is taking advantage of the American people for their own short-term gain.”

My bet is the “task force” won’t question Bernanke…

No, they won’t question Ben. That’s not their job. Their job is to find some poor schmuck and make him do the perp walk before the cameras. Maybe some guy who is speculating on oil futures. Or maybe a fellow who is running an oil company.

But let’s look at how this works.

The feds openly and explicitly try to cause inflation. No kidding. Ben Bernanke made it very clear. He was worried about falling prices…about deflation. He practically made his career as a deflation expert…claiming to be able to prevent it by dropping “money from helicopters,” if necessary.

He’s fought deflation in a number of ways. By buying bonds with made-up money. By lending money at zero interest rates. And by helping the US Treasury spend money it didn’t have and couldn’t raise by honest taxation or bond sales.

A little bit of monetary inflation is thought to be a good thing – especially when people don’t know what is going on. Add more money and it makes people feel wealthier. This leads them to spend more…sell more…produce more…and hire more.

But what happens when they see that it’s only a cheap trick? What happens when they see the helicopter overhead and realize that there is something very funny about money you give away for free?

Well, what would you do if you were a commodity producer? Say, you had oil in the ground or wheat in the field? Would you exchange it for dollars? Or would you wait…holding back a little bit…either because you thought the price was going up…or because you were afraid that the funny money might lose its value?

The trouble with a little inflation is that it has a way of becoming a lot of inflation – all of a sudden. In a sense, inflation is always a monetary phenomenon. But it’s also a psychological phenomenon…and an economic phenomenon too.

In a Great Correction, the authorities can add to the Fed’s balance sheet holdings. But, if the member banks don’t borrow and lend…you don’t get much of an increase in consumer prices. And if you do get an increase – such as we are seeing in the price of gasoline – it tends to work against a general increase in the price level. In fact, it tends to correct the inflationary cycle. That is, consumers pay more for gas and have less left over for other things. That’s why a sharp rise in oil prices doesn’t cause an inflationary boom. Instead, it always causes an economic slowdown. And recession tends to lower prices, not increase them.

Since prices remain stagnant or even go down, the authorities think they can get away with more of their inflationary policies. In fact, they believe they have no choice. They have to fight recession! Inflation is the last of their worries.

They “print” money. And they continue printing it. Because, as the recession continues, tax revenues fall. Then, the government comes to rely on the central bank to finance its deficits. Inflationary policies become not just “counter-cyclical” measures; they are an essential part of the feds’ budget.

And then, the psychological component comes into play. Investors begin to worry. They begin to buy gold – it will be their own financial reserves. They begin to expect higher prices – much higher prices. And producers begin holding back supplies. This produces scarcity…which causes prices to soar, convincing producers to hold back even more. And soon, ordinary households are buying gold too.

The feds look for scapegoats. They collar a speculator or two. They accuse producers of “hoarding.” They insist that there is no problem with central government finances or the central banks policies. The problem is “greedy” capitalists. Or the weather. Or whatever…

Remember, people starved in Germany in the winter of the Great Inflation of the early twenties – even though farmers had a record harvest. Why? Because farmers didn’t want to sell. They kept their produce in barns and silos…waiting until the money problems resolved themselves.

Naturally, the authorities tried to shift the blame. Some blamed speculators. Some blamed France and Britain. Some blamed bankers…especially if they were Jewish.

Bill Bonner
for The Daily Reckoning