PrintJuly 31, 2009
Bernanke's Harmful monetary policy
The stock market's recent run-up of over 11% has been the best sustained rally of Obama's young Presidency. What to do now, if you are an investor? Unfortunately, the market seems very fully priced now based on historical Price/Earnings benchmarks, especially after its recent run-up - which in fact may well have been primarily due to investors cheering the marginal decline in prospects for ObamaCare.
Indeed, the St. Louis Fed's graph below on growth of the monetary base is all you need to see, in order to understand why you want to buy gold. In congressional testimony last week, Fed Chairman Ben Bernanke talked cleverly about taking reserves out of the system rapidly as things stabilize, but to do that would guarantee another credit crunch, interest rate spike, and bust; there is in fact no political will for this. As F.A. Hayek once said, now that they have unleashed the monetary expansion which drives inflation, they have a tiger by the tail. The gray bars indicate the definition of recession - i.e., at least 6 consecutive months of negative growth.
The best investment plays are now overseas: all dollar-denominated assets are going to be punished as this stimulus spending kicks in. Obama's ignorance of this eventuality is why the huge spending plans will not only go awry, but could trigger a dollar and bond market collapse. Obama's economists arrogantly think that cannot happen due to the dollar's reserve currency status. But a better way to think about it is that the music will stop at some point, and there are not enough chairs for everyone to sit down (viz., a day will come when investors dump the dollar).
What is sad are the number of "brilliant" economists warning against deflation; this chart below does not bother them at all, and like Bernanke, they are thankful for the spike-up. It will bring us no comfort to one day tell them, "we told you so." The great Ludwig von Mises could have said the same thing of Germany in 1923, because he was alone in calling the disaster, well ahead of time.
Here's an irony: if the Chinese wanted to cripple the U.S., they would link the yuan to gold, and relax foreign direct investment rules along with ironclad guarantees of profit repatriation and patent protection, two longstanding complaints of their trading partners. On the foreign policy side, they could unilaterally renounce ever attacking Taiwan, and say their aim is unification according to Taipei's timetable. That would blow the world away, and a flood of capital would flow into China. With the right safeguards, Taiwan would reunify, as trade and growth would expand 2-ways.
This would throw the U.S. into a Depression, because US dollar-denominated holdings would get dumped overnight. Interests rates and prices would soar here domestically, etc. This is of course a near-impossible scenario to imagine, but smart guys like Nobel Prize winner Robert Mundell and John Rutledge are over there telling them to do just this sort of thing. In any case, Obama is playing with fire on many fronts, and Bernanke is one of them.
The Chinese do not think in Cold War terms these days with respect to "burying" the U.S., and in fact it is in their interest to have a healthy US economy that can pay them back. They know this. But something like the above could happen because at some point they will figure out it makes no sense to underwrite American consumption when Obama's fiscal insanity is guaranteed to extend recession, and a long period of no growth. There are endless growth opportunities in a country of 1.3 billion people if it becomes a magnet for capital. And one "benefit" of an American depression when you have $2 trillion in foreign reserves is that assets will come cheaply -- bankrupt companies don't cost much.
Again, adding it all up, what you are seeing in this country the last several months is pure insanity, and the results of a broken political system. "Driving over a cliff" is the right analogy, and the driver is a guy who thinks corporate profits are "excessive", in a time of 10% unemployment. However, has there ever yet been a company earning losses who can hire people? (Of course, to be fair, Bush was no good on economic policy in many ways, and McCain was, likewise, more alike Obama than different -- though McCain would have by now stemmed all spending and "stimulus", and cut spending and tax rates, picked more pro-economic growth judges, etc.).
Mr. Chapman is an Adjunct Scholar in Economics at the American Enterprise Institute. Comments welcome to: john.chapman@aei.org.
