Bernanke Just Makes It Worse

In the 2002 speech that earned him the nickname "Helicopter," Federal Reserve Chairman Ben Bernanke warned about the dangers of deflation. That speech showcased exactly how poor his understanding of the economy is and why his reign as chairman has led to such a catastrophic failure of our financial system.

This key sentence betrays his ignorance: "Deflation is in almost all cases a side effect of a collapse of aggregate demand -- a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers."

Reality paints a different picture
The fatal flaw with Bernanke's worldview is that outside of the protected walls of academia and government where Bernanke has spent too much of his time, it doesn't hold water. The price declines he so fears aren't always caused by a drop in aggregate demand. Instead, aside from bursting bubbles, they're usually caused by factors such as:

  • Competition.
  • Productivity enhancements.
  • End-to-end supply-chain efficiencies.
  • Disruptive technological changes.

In other words, the very things that cause economic growth often lead to lower prices. Just look at the positive impacts from these deflationary products and innovations:

Product / Innovation

Deflationary Result

Ford's (NYSE: F  ) assembly line

Cheaper automobiles, accessible to more people

General Electric's (NYSE: GE  ) reliable light bulb

Safer, cheaper nighttime operations

Bell Labs' (formerly AT&T (NYSE: T  ) , now
Alcatel-Lucent (NYSE: ALU  ) ) transistor

Affordable personal computers, worldwide cheap cellular telephony

Intel's (Nasdaq: INTC  ) regular CPU upgrades

Cheaper, more powerful computing

Google's (Nasdaq: GOOG  ) AdSense

Affordable, targeted advertising

How Bernanke fouled up
By viewing the world through his extremely flawed lens, Bernanke set his reputation as someone who would not let prices fall -- no matter what. He even explained how it could be done if interest-rate cuts alone didn't do the job:

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. 

That sounds suspiciously like a certain $700 billion "bailout" package we're in danger of being saddled with.

Bernanke missed the real danger -- inflation
By overzealously fighting the wrong battle, Bernanke's excessive rate cuts let inflation get out of hand. Unfortunately, that inflation first reared its ugly head in the form of food and energy inflation -- so called "non-core" items that the Fed apparently devalues when setting policy. They may be non-core to the inflation numbers, but they're certainly critical to people who have to:

  • Eat.
  • Get to work.
  • Heat their homes.
  • Keep the lights on.

If any of those "non-core" inflation items are central to your life, you're probably all too familiar with the impact those skyrocketing costs have had on your ability to do almost anything else. As a result of that rampant and ignored inflation, real people did what they do every time they're faced with bills that rise faster than their salaries: They cut back wherever possible.

As a result of people cutting back in the wake of higher prices, the economy really is hurting now. Even Starbucks (Nasdaq: SBUX  ) , which just last year was viewed as resistant to pricing pressures, is feeling the pinch, as same-store sales are hurting. It's not because people have suddenly given up caffeine or don't want to buy Starbucks. It's because with all of their cash spent on necessities, there's nothing left for even simple luxuries.

Don't make things worse
Inflation, not deflation, has spurred our economic troubles. If Bernanke wants to exacerbate an inflation-fueled economic crisis, there's no better way for him to go about it than by throwing cash at it. 

That should give supporters of this bailout monstrosity that still looms reason to pause and consider the real consequences it will have on real people. You don't throw gasoline on a fire you're trying to extinguish.

At the time of publication, Fool contributor Chuck Saletta owned shares of General Electric, Intel, and Alcatel-Lucent. Starbucks and Intel are Motley Fool Inside Value recommendations. Google is a Motley Fool Rule Breakers selection. Starbucks is a Motley Fool Stock Advisor pick. The Fool owns shares of Starbucks and has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 01, 2008, at 3:19 PM, cmolinel wrote:

    Deflation is an overall and sustained reduction in prices, not a reduction in specific industries or companies.

    Those specific reductions are caused by the reasons you mentioned, but they are something different to deflation, which is a macroeconomic trend.

    Inversely, inflation is an overall and sustained increase in all prices, not individual increases.

    Furthermore, he said "in almost all" cases, not in all cases.

    Calling him an ignorant seems to be excessive.

    Everything is relative.

  • Report this Comment On October 01, 2008, at 6:40 PM, RBStephen wrote:

    While the jury is still out on which of the threats is more imminient - inflation or deflation - none of the examples listed in this article represent deflation. Nor do any of the factors listed (competition, productivity, efficiency, and technology) contribute to deflation. These examples contribute to increased growth of the overall economy. Deflation is a mecroeconomic phenomenon resulting in contraction of the economy.

    Simply put, you do not see Intel's revenue reducing as chip prices fall; on the contrary, revenue increases due to growth. When deflation takes hold, on the other hand, revenue will decrease.

    So while the point about recent high inflation (understated by core inflation reports) is valid, deflation is nonetheless a serious threat in the event of dramtic demand reduction - which could indeed be triggered by the current liquidity implosion.

  • Report this Comment On October 01, 2008, at 7:03 PM, bbqrooster wrote:

    The author's explanation of inflation and deflation has exposed his shallow understanding of the subject. Calling Bernanke ignorant adds more to my amazement of the author's mentality.

  • Report this Comment On October 01, 2008, at 8:46 PM, TMFBigFrog wrote:

    Thanks for your feedback. But rest assured, I'm not the only one who has grave concerns with Bernanke's inflationist tendancies.

    .

    There is, of course, this classic parody: http://www.youtube.com/watch?v=3u2qRXb4xCU

    .

    And my Foolish colleague Richard Gibbons: http://www.fool.com/investing/value/2008/05/09/bernankes-rec...

    .

    Then, there's this bloomberg article: http://www.bloomberg.com/apps/news?pid=20601068&sid=a8Ev... that basically said that Bernanke was facing a rebellion in the Fed itself about his inflation policies.

    .

    And Larry Kudlow admitted that Bernanke was late to consider inflation was an issue: http://kudlowsmoneypolitics.blogspot.com/2008/06/inflation-i...

    .

    And Megan McArdle at The Atlantic mentioned concerns about Bernanke's credibility on inflation...: http://meganmcardle.theatlantic.com/archives/2008/07/mr_bern...

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