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.