Sunday, May 1, 2011

Epilogue: Lost in Conversation

Why would you stay up all night to see the sunrise? Every day, sun rises at an exact moment. You only have to get up a minute before the designated time to see it; no need for staying up all night.

Why would you then strain yourself to analyze the utterances of a central banker for clues to his future actions? Those, too, have an almost mechanical predictability. The old joker of the economics officialdom, Milton Friedman, gave away the game when he suggested replacing the Fed with a computer.

Yet, the “Fed watchers” – Fed watchers! What asses they must be! – come running whenever a Fed chairman opens his mouth. Alan Greenspan played them, constantly casting fake pearls before the real swines in market, media and academia and letting them munch on the drivel he had just delivered.

All this is by way of saying that Bernanke’s comments require no analysis. What he would/could say is scripted. All the time. Let me take you to the highlights of his Wednesday news conference to show what I mean. It neatly ties in with what I said in Lost in Conversation.

The New York Times tried to frame the central issue confronting the Fed as the question of balance between unemployment and inflation.
The questions reflected the difficulty of the choices the Fed now faces. Some reporters pressed Mr. Bernanke to explain why he was not more concerned about inflation. Others asked why he was not more concerned about unemployment
But there has never being a question of a choice, as the Chairman made clear:
“While it is very, very important to help the economy create jobs and help to support the recovery, I think every central banker understands that keeping inflation low is absolutely essential to a successful economy, and we will do what we can to make sure that happens,” he [Bernanke] said.
So no matter how many times Ben Bernanke modifies very with very, his job is nipping inflation in the bud.

But why this pre-occupation – obsession, really – with inflation; and obsession is the word:
Mr. Bernanke cautioned that if the economy did falter, it could prove difficult for the central bank to provide fresh support because of growing inflationary pressure ... “Inflation is getting higher. It’s not clear that we can get substantial improvement in payrolls” without creating a considerable risk of a dangerous rise in inflation.
Read the last sentence one more time, that begins with “inflation is getting higher”. Bernanke can substantially improve the payrolls if he so chooses, but he is not sure he can do that without the risk of dangerous rise in the inflation. So he would not do that, because he earlier said that his main mission is fighting inflation.

This inflation thing must be a real scrooge then. How else to explain that its containment trumps fighting joblessness. Right?

If you are like the blue collar residents of Queens, you probably half-agree with that statement and the Fed chairman, seeing the price of gas at about $4.20 and food prices up almost 20%. Yeah, someone has to do something about that. It's crazy.

But as we saw in the previous post, food and energy prices are not of concern to Bernanke. He does not even consider them in calculating the "core inflation". Better yet, his actions are the very cause of food and energy price rises. (Oil is heavily taxed in Europe, and food has its complex politics so a direct comparison is difficult. But the rise in the price of oil in Europe has been less than half of the U.S. A better, “unadulterated” measure is gold, which has risen by almost 35% in the U.S. in the past year but actually fallen by 2.5% when expressed in euro.) So in dealing with that inflation, you are on your own. Here is the proof from the newspaper of the record:
Critics of the Fed’s position on inflation argue that higher commodity prices will push up the price of other goods and services. But Mr. Bernanke and his allies consider it more likely that the higher prices will force Americans to reduce consumption, because wages are not rising and therefore Americans do not have more money to spend. As demand drops, they say, the price of food, oil and other commodities will also fall.
Got that?

The “critics” want the Fed to inflict pain on the populace immediately. The Fed argues that there is no need to rush and the pain will come in due time. That is what the contention is all about, a matter of when and not if.

Then what is Bernanke talking about when he talks about the inflation?

As I said, the “inflation” for him is the measure of the industrial capacity. Go back to the quote above, starting with "inflation is getting higher" and you will see this. He talks about “improvement in payrolls”. By that, he means improvement in employment, i.e., a decrease in unemployment or joblessness. Who calls improvement in employment the improvement in payrolls? Why, those who have payrolls, i.e., hired workers. Bernanke is talking from their viewpoint. That's the only viewpoint he has.

Let me explain.

Suppose traffic in a highway is 50% of its capacity. Under this condition, there is no “traffic”. Should a car develop a mechanical difficulty or brake to avoid a pothole, the traffic will flow unimpeded.

If the traffic flow rises to the 90%, the cars would still move freely. But now, if a car develops a mechanical problem, it would create a traffic jam. With 90% of the capacity full, there is no avoiding backlog when one lane is substantially slowed down.

If the highway is full to 100% capacity, braking by one car for a few seconds will crated miles-long backups, the familiar situation in roads leading to beaches during the summer.

Replace highway capacity with the industrial capacity and traffic jam/slowdown with the increase in labor wages and you have the function of the Fed as an entity which is designated to keep the traffic flowing smoothly.

If you have a plan that can employ 100 workers and you currently employ only 50 – because there is not sufficient demand for all you can produce – your payroll can “improve”. That is, you have room to hire more workers.

If your payroll goes up to 95 workers – “improves”, in Bernanke’s parlance – you are operating at close to capacity. After that, any demand for hiring more workers would translate to demand by workers for higher wages. The Fed’s “core inflation” measures that condition; its main function is to prevent that situation from developing.

The Fed does other things too. We cannot childishly view it as a one-trick pony. But what I just said ultimately trumps all other considerations.

The Fed cannot, in the sense of not being allowed to, slowdown economic activity by raising interest rates. That nonsense is for college textbooks and the “Fed watchers”. If Bernanke did anything that remotely affected the bottom line of corporations, his head would be handed over to him. The Fed would go the way of the American buffalo – or Fannie and Freddie.