In a recent American Thinker article discussing the effects of "quantitative easing," I remarked that the "Federal Reserve has laid the charges, connected the leads, and now stands ready at the detonator." From the AT piece:

In QE, a nation's central bank buys financial instruments, such as Treasury bonds, with money decreed into existence through electronic transactions. The objective is to "stimulate" economic activity by injecting additional currency into circulation and bank reserves. Plusher reserves would theoretically encourage lenders to lend, which would kick-start business activity and home purchases. QE derives from the Keynesian economic hypothesis that government spending helps end recessions.

I noted that reality never complies with Keynesian theory.

Economist David Ranson expands, pointing out that the Fed is encouraging "the widespread impression that money creation is inflationary only when that money actually goes into circulation. Indeed, this assumption is the basis of the Fed's 'exit strategy.'" As I've pointed out, Bernanke trusts certain "inflation expectations" to tell him when Fed action is required. But Mr. Bernanke's indicators predict inflation's direction of movement, not the magnitude of increase or decrease.

Ranson explains that by sticking solely with the "expectations" barometer, Bernanke is systematically ignoring inflation by mistakenly assuming that QE will not boost prices until the magically-created dollars go into circulation.

...the Fed's reliance on government statistics such as the "core" CPI to gauge whether inflation is present or absent gives the impression that inflation is under control when the most transparent prices (those of food and energy) are increasing rapidly.

And yet Bernanke is in deep denial. The man has declared that any "increase in inflation will be transitory" and that food prices are merely reacting to supply and demand conditions. But food and energy prices have repeatedly served as signals for economy-wide inflation.

Damage will be done as a result of Bernanke's laid-back approach. The damage will be compounded by the Fed Chief's belief that draining bank reserves will stop prices from rising. He is wrong. Bernanke furthermore thinks that he can convince banks to send the magically-created money back to the Fed. From Ranson:

Even pre-crisis evidence contradicts this hopeful scenario. There is an amazing lack of evidence that the growth of money in circulation is inflationary at all. The statistical relationship between money in circulation and the gold price is not consistent with expectations, and in any case it is fleeting. Over a period of two or three years, the cumulative implications of money-supply growth for the gold price are nil.

So there is no evidence that the magic money must actually circulate in order to boost inflation. Ranson explains:

It is the existence of newly created money that hastens the dollar's decline, and not the use, if any, to which that money is put. Nor is inflation forestalled or curbed by inducing banks to re-deposit reserves at interest at the Fed. Money creation is inflationary whether or not new bank reserves push money into circulation. And the inflation impact of creating those reserves will be the same whether or not they are placed back in the Fed's hands.

In the real world, dollars which are electronically-decreed into existence depress the dollar's overall value. The excess money gets "priced into" the economy the moment that the Fed uses the money to purchase debt, thereby inflating bank reserves. Equity and currency traders, having observed the Fed's actions, don't just hang out in wild optimism and with bated breath waiting for higher bank reserves to one day, possibly, maybe, perhaps inspire loan officers to lend more money--thus getting the magically-created dollars "into circulation." Traders react immediately and continuously.

The bottom line is that Bernanke's story and reality are two fundamentally different animals.

Our economy needs a two-step fix. Congress needs to dramatically cut spending and disassemble Obama's oppressive regulatory regime. And the Fed Chief needs to enact measures to start draining QE1's and QE2's 2.35 trillion excess dollars right now, immediately, pronto. The kinds of measures needed were ugly and painful when Ronald Reagan's Fed Chief, Paul Volcker, took action in 1981. But after the surge in interest rates (Prime at 21.5 percent, a level not required today), inflation subsided, the Reagan tax cuts kicked in, and the results were beautiful--and quite pleasant.

A writer, physicist, former high tech executive, and Cajun, Chuck Rogér invites you to sign up to receive his "Clear Thinking" blog posts by email at http://www.chuckroger.com/. Contact Chuck at swampcactus@chuckroger.com.