Ben Bernanke at Year Two

This week marks Ben Bernanke’s second anniversary as Chairman of the Federal Reserve. Since his nomination in 2005, the dollar has plummeted against major currencies worldwide, while the price of gold has nearly doubled on its way to an all-time high. And with both domestic and world markets presently gyrating due to monetary and economic uncertainty, his stewardship of the world’s most important central bank is increasingly being called into question.

Unhappiness with Bernanke might surprise some considering the mostly glowing praise he received upon his nomination over two years ago. Though he possessed a conventional academic background, he was thought to be open to classical views suggesting economic growth is inflation’s worst enemy, that marginal tax cuts are useful for facilitating long-term growth, and that the price of gold is an important signal to follow when it comes to understanding the existence (or lack thereof) of real inflationary pressures. Bernanke was seen as a worthy successor to Alan Greenspan, and one who would soothe investors understandably fearful of change at the top of the Fed.

Two years later stock markets and the economy are as mentioned uncertain, and contrary to assumptions from the past suggesting he was open to classical ideas, his public utterances since then have shown him to be every bit the conventional academic so many investors hoped he was not. Perhaps owing to the latter, investors are disappointed, but they should not be surprised. Bernanke is merely acting on long-held beliefs about monetary policy and the economy; beliefs that he made apparent right up to his nomination.

For anyone who’s read the various post-meeting FOMC press releases since Bernanke took over, there’s been a consistent theme in nearly every one. Rather than defining inflation as something monetary in nature, the Bernanke Fed has reverted to Phillips Curve logic suggesting it results from too much economic growth and too many people working. In Bernanke-speak, “high levels of resource utilization have the potential to sustain inflationary pressures.”

Owing to Bernanke’s view that growth is the cause, not the cure for inflation, he’s persisted in his adherence to Keynesian rate targeting rather than floating the Fed funds rate in favor of a dollar-price target. But it would be unfair to say Bernanke duped anyone when it came to his views on the causes of inflation. Indeed, in an August 2005 Wall Street Journal op-ed, he asserted that there is a “highest level of employment that can be sustained without creating inflationary pressure.” Despite a gold price that had risen well above its 10-year average during the time in question, the inflationary evidence revealed by the dollar’s fall was never mentioned.

Moving to taxes, supply-siders were understandably unhappy with the way in which Bernanke endorsed President Bush’s economic stimulus package. They were because in the grand Keynesian tradition of demand-side “stimulus,” Bernanke called for fiscal measures so long as they were “explicitly temporary.” Hardly the musings of a supply-sider, but then Bernanke had already made plain his Keynesian orientation when it came to taxes in the aforementioned Journal op-ed. According to him, the “fiscal stimulus” that resulted from the 2003 Bush tax cuts had diminished “in the past few quarters.”

During his November 2005 confirmation hearings, Bernanke certainly mentioned gold as an inflation indicator he would look at among others, but his belief that adherence to the gold standard caused the Great Depression is also well known. In a 2002 speech Bernanke told the late Milton Friedman, “Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

If uncertainty remains as to Bernanke’s true views when it comes to gold’s inflation-signaling power, he answered those questions last week with the release of the FOMC statement announcing the latest round of interest rate cuts. With the yellow metal at all-time highs, the statement said, “The Committee expects inflation to moderate in coming quarters.” A stronger non-endorsement of the gold signal would be hard to find. Mainstream accounts in the aftermath of the cuts suggested further dollar weakness resulted from those same cuts, but it says here the bigger factor at play was a statement suggesting there’s no link between currency weakness and inflation.

With the Fed Chairman seemingly oblivious to how the dollar’s weakness and instability retard economic activity worldwide, traders continue to sell it lower with full knowledge that irrespective of the nominal level of interest rates, Bernanke has taken his eye off the ball. Simply put, the dollar’s value is being ignored by the Fed and Treasury, so its value continues to plummet.

Some might say we should be surprised by the state of things, but that’s unfair. Bernanke gave fair warning of who he was long before his nomination. Instead, blame lies with a Bush Administration that failed to do its homework on Alan Greenspan’s replacement. And with that same administration lacking any dollar policy other than one of “benign neglect,” it has essentially outsourced its policy to Ben Bernanke, a Fed Chairman whose seeming countenance of dollar weakness weighs on the Administration’s approval ratings like no other policy today.