Doug Marshall

Market Assessment
Published August 4, 2009

Yes, hindsight is 20/20. Yes, wearing the mantle of officialdom often means having to censure oneself and not say what you know, for the greater good.

Shown below is a very illuminating speech by Ben Bernanke, current Chairman of the Federal Reserve, back in 2002 before he attained his lofty position and had reason to hold his tongue.

After months of telling you that I believe inflation is on the horizon, it depresses me to realize that Bernanke knows it, too, and has for some time. He opines:

“The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning.

A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject’s oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost.

Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days.

What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet.

Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply.

But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.

By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services.

We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

This from the one man in the nation, perhaps in the entire world, that has the most weapons at his disposal to bring inflation under control.

Over the past several months the Bush administration followed by the Obama administration have poured trillions of dollars of money we don’t have to prevent a banking collapse, to bail out the American auto industry and then to stimulate the economy out of our current recession.

This excessive money creation by the Federal Reserve has to adversely impact the value of the dollar.

The verdict is still out whether they will succeed on any of these fronts but this we know for sure: the once mighty dollar is going down for the count.

Erste Group Research reprint of Ben Bernanke, “Deflation: Making Sure ‘IT’ Doesn’t Happen Here.” November 21, 2002.