Bernanke's Latest Folly Will Cost Us

Investors and consumers will pay for the Federal Reserve's misguided move to create hundreds of billions out of thin air. Expect plenty of inflation.

As I noted last week, one of the big-picture questions on my mind lately has been how much the next round of quantitative easing (aka QE2) by the Federal Reserve had already been written into stock prices.

The debate over quantitative easing

Well, on Nov. 3, the Fed dropped the other shoe, and we got the official announcement about its plans. QE-eww With a wave of his magic wand, Fed Chairman Ben Bernanke committed to creating $75 billion a month out of thin air through June by buying government paper (or roughly $600 billion in all). That, combined with other buying the Fed is engaged in, comes to a total of almost $900 billion over nine months.

But, you may ask, how does the Fed create money? Isn't that the Treasury's job?

In a nutshell, the Fed "prints" money by participating in the bond market. It buys Treasury bonds from other large financial institutions and pays for them by adding credits to the sellers' accounts at the Federal Reserve (as opposed to transferring actual cash). Poof! New money.Msn.Video.createWidget('PlayerAd1Container', 'PlayerAd', 300, 213, {"configCsid": "MSNmoney", "configName": "player-money-articles-16x9", "player.vcq": "videoByUuids.aspx?uuids=41952403-a7df-43e6-b13d-b9dcae930fa1,4ffed0f7-bb57-4046-b176-c10f82387696,2f725555-ce22-412c-a737-151fe26568b7,94d066a9-8a09-40f1-a021-095d5b860f8a,b23553aa-ef38-4b94-97cb-a9845e546cbd,f961caa9-a48b-4b32-9367-97b4c725a635,c5c3b558-25d4-498e-96e4-0644f72af05e,f48e2bda-d88a-d702-4f81-d32a6a690bd9,32eac10a-dacf-4d73-9b9d-cb9977a65615,70a9ea56-60cc-49f5-93a6-ad797d9a30df,3e1af930-d577-4695-bd65-5ee05abba95c", "player.fr": "iv2_en-us_money_article_16x9-ContrarianChronicles-bernankes-latest-folly-will-cost-us"}, 'PlayerAd1');Msn.Video.createWidget('Gallery4Container', 'Gallery', 304, 150, {"configCsid": "MSNmoney", "configName": "gallery-money-articles", "gallery.linkbackLocation": "bottom_left", "gallery.numColsGrid": "3", "gallery.categoryRequests": "videoByUuids.aspx?uuids=41952403-a7df-43e6-b13d-b9dcae930fa1,4ffed0f7-bb57-4046-b176-c10f82387696,2f725555-ce22-412c-a737-151fe26568b7,94d066a9-8a09-40f1-a021-095d5b860f8a,b23553aa-ef38-4b94-97cb-a9845e546cbd,f961caa9-a48b-4b32-9367-97b4c725a635,c5c3b558-25d4-498e-96e4-0644f72af05e,f48e2bda-d88a-d702-4f81-d32a6a690bd9,32eac10a-dacf-4d73-9b9d-cb9977a65615,70a9ea56-60cc-49f5-93a6-ad797d9a30df,3e1af930-d577-4695-bd65-5ee05abba95c;videoByTag.aspx%3Ftag%3Dmoney_dispatch%26ns%3DMSNmoney_Gallery%26mk%3Dus%26vs%3D1;videoByTag.aspx%3Ftag%3Dbest%2520of%2520money%26ns%3DMSNmoney_Gallery%26mk%3Dus%26vs%3D1"}, 'Gallery4');How can the Fed do this? There isn't room here for the long answer, but the short answer is: Because it is the Fed.

In any case, not only was there no major sell-off in any particular market, markets everywhere surged higher, which leads me to believe there is still a good bit more volatility (in both directions) in our future. Bernanke moonlights at the Defense DepartmentIf you didn't think the Fed was irresponsible enough with its money-out-of-thin-air policies, all doubts should have been laid to rest Nov. 4, when Bernanke took the unusual tack of defending his moves in a Washington Post op-ed piece headlined "What the Fed did and why: Supporting the recovery and sustaining price stability."

I am not going to go through his entire worthless apologia for the Fed's actions, but I do want to cover two points: first, his bass-ackward thought process regarding inflation, and second, the Fed's targeting of stock prices to achieve its goals (and possibly for validation of its policies).

Bernanke states in the article, "Today, most measures of underlying inflation are running somewhat below 2 percent, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth in the long run."

That is complete nonsense. Under a sound and sane monetary regime, we could actually have deflation and real economic growth at the same time. As James Grant of Grant's Interest Rate Observer has noted in several articles over the years, that outcome has occurred many times over this country's history. A 2% inflation rate ensures nothing except that if that is your target, you will almost certainly get more. In fact, we already do get more, since anyone with a brain knows the Consumer Price Index is a completely understates inflation, given the hedonics, substitution and other fiddles. A nonproductive argument Bernanke goes on to say: "Although low inflation is generally good, inflation that is too low can pose risks to the economy -- especially when the economy is struggling. In the most extreme case, very low inflation can morph into deflation."

Oh, yeah? Says who? I have not seen any instance where a "too low" inflation rate led to deflation. When deflation is caused by new inventions or increased productivity (or in the old days, bumper crops), which we might term "good" deflation, it was not a consequence of too little inflation; it was due to progress. Similarly, the "bad" deflation isn't created via inflation that is too low; it tends to come from burst bubbles. In other words, misguided policies, not low inflation, are the cause of deflation.

Continued: Put your money where his mouth isMore from MSN Money

Hiking inflation won't help, Ben

The Fed's clear goal: Inflation

Warning: Retirement disasters ahead

Not your grandfather's deflation

Why you (probably) need more gold

 1 | 2 | next >

Rate this Article Click on one of the stars below to rate this article from 1 (lowest) to 5 (highest). LowThank you for rating.UGR('ratCntrl')High var avgRating=0;avgRating=9.4; if(avgRating!=0){avgRating=avgRating/2;avgRating=Math.round(avgRating*100)/100;var sDisplayText="Average rating: " + avgRating + " from ";var usersCount=40;sDisplayText = sDisplayText + usersCount;if (usersCount==1)sDisplayText=sDisplayText + " user";else sDisplayText=sDisplayText + " users";avgRatingElem=document.getElementById("averageRating");avgRatingElem.innerText=sDisplayText;} View all top-rated articlesE-mail us your comments on this article Discuss in a message board MSN Money InsightNew Investor CenterMarket DispatchesJubak's JournalTop Stocks blogCompany FocusContrarian ChroniclesSmart Spending blogFast AnswersDecision CentersStart InvestingMutual FundsFind Hot StocksSimple StrategiesPower ToolsInvesting for IncomeReal Estate InvestingRecent Contrarian Chronicles ArticlesThe Fed's clear goal: Inflation 10/29/2010Not your grandfather's deflation 10/15/2010Why you (probably) need more gold 10/08/2010More . . .Contrarian ChroniclesAbout Contrarian ChroniclesLearn the Contrarian Chronicles lingoSubscribe to Market Rap on Fleckenstein CapitalFund data provided by Morningstar, Inc. © 2009. All rights reserved.StockScouter data provided by Gradient Analytics, Inc.Quotes supplied by Interactive Data.MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.Msn.Video.createWidget('Gallery8Container', 'Gallery', 500, 230, {"configCsid": "MSNmoney", "configName": "gallery-money-article-site-wide"}, 'Gallery8'); 1CommentNewestOldestBestWorstControversialLynn X11 hours agoIn a nutshell, the Fed "prints" money by participating in the bond market. It buys Treasury bonds from other large financial institutions and pays for them by adding credits to the sellers' accounts at the Federal Reserve (as opposed to transferring actual cash). Poof! New money.

Bill Fleckenstein - I wish I could do that!

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In any case, not only was there no major sell-off in any particular market, markets everywhere surged higher, which leads me to believe there is still a good bit more volatility (in both directions) in our future. Bernanke moonlights at the Defense DepartmentIf you didn't think the Fed was irresponsible enough with its money-out-of-thin-air policies, all doubts should have been laid to rest Nov. 4, when Bernanke took the unusual tack of defending his moves in a Washington Post op-ed piece headlined "What the Fed did and why: Supporting the recovery and sustaining price stability."

I am not going to go through his entire worthless apologia for the Fed's actions, but I do want to cover two points: first, his bass-ackward thought process regarding inflation, and second, the Fed's targeting of stock prices to achieve its goals (and possibly for validation of its policies).

Bernanke states in the article, "Today, most measures of underlying inflation are running somewhat below 2 percent, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth in the long run."

That is complete nonsense. Under a sound and sane monetary regime, we could actually have deflation and real economic growth at the same time. As James Grant of Grant's Interest Rate Observer has noted in several articles over the years, that outcome has occurred many times over this country's history. A 2% inflation rate ensures nothing except that if that is your target, you will almost certainly get more. In fact, we already do get more, since anyone with a brain knows the Consumer Price Index is a completely understates inflation, given the hedonics, substitution and other fiddles. A nonproductive argument Bernanke goes on to say: "Although low inflation is generally good, inflation that is too low can pose risks to the economy -- especially when the economy is struggling. In the most extreme case, very low inflation can morph into deflation."

Oh, yeah? Says who? I have not seen any instance where a "too low" inflation rate led to deflation. When deflation is caused by new inventions or increased productivity (or in the old days, bumper crops), which we might term "good" deflation, it was not a consequence of too little inflation; it was due to progress. Similarly, the "bad" deflation isn't created via inflation that is too low; it tends to come from burst bubbles. In other words, misguided policies, not low inflation, are the cause of deflation.

Continued: Put your money where his mouth isMore from MSN Money

 1 | 2 | next >

Bill Fleckenstein - I wish I could do that!

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