Incompetence is the Charitable Explanation of The Federal Reserve Board's Behavior

All who have a growing concern about a breakout of inflation may be happy to know that the Vice Chairwoman of the Federal Reserve, Janet Yellen, has some comforting words for you.  Speaking at the Economic Club of New York, among other things she said U.S. monetary policy "continues to be appropriate."  This means the Fed is going to continue purchasing the $600 billion of U.S. Treasury securities issue by the Treasury Department of the Obama Executive Branch of our government.

The academic name of this is quantitative easing.  For working people, it is called printing money.  This activity in lesser nations always results in inflation.  If you need a definition of inflation, it is the most destructive tax that ever existed.  It destroys the value of your labor and the value of everything you own that is denominated in dollars.  And as income shrinks relative to selling prices, you get poorer and poorer.  Then economic activity starts to decline just as it has in lesser nations.

For instance, Venezuela is the home of 30 million people with some of the largest oil reserves in the world.  It is also, unfortunately for those people, the home of Hugo Chavez, an emergent socialist dictator who is printing a lot of Venezuelan "dollars" to pass out benefits to prospective loyal voters who have just given him dictatorial power for one year.  Here are the rates of inflation for Venezuela for the last 5 years:

And the wreckage Hugo Chavez has created has even seeped into once growing
areas of Venezuela's economy:

...Hugo Chavez put himself in charge of Venezuela's coffee sector.  Last  year, for the first extended period of time in and country's history, Venezuela did not produce enough of the little red berry to satisfy domestic demand.  It has become a coffee importer and is facing serious shortages.

And so descends an economy with vast natural resources where all workers get poorer and poorer while their tyrannical government impoverishes their economy with inflation.

But, we don't have to worry about this, because Ms. Yellen is on the job: "Recent increases in prices of oil, grain and other commodities are 'unlikely to have persistent effects on consumer inflation' ... "

Let's see what the data shows.  Here in America, we are provided with data that shows price increases in the first 4 1⁄2 months of 2011 as follows: Cotton has risen around 40%, Oil has risen around 20%, and Wheat has risen around 10%.  These are reasonable proxies for food, energy, and clothing.  They direct us to relevant parts of real personal consumption expenditures using 2010 data:

So in 2011 to date, we have extraordinary upward price pressure in Food, Clothing, and Fuel, which represent about 21% of personal consumption expenditures.  And, here is what the
CEO of the one of the world's largest companies by revenue had to say about this:

American consumers face 'serious' inflation in the months ahead for clothing, food and other products, Wal-Mart CEO Bill Simon warned. ... 'We're seeing cost increases starting to come through at a pretty rapid rate.'

Our Ms. Yellen would only say that "...the that the households and businesses don't expect inflation to take off in the long run."

And inflation today is a global phenomenon.  Everywhere you go you will find it.  It is rampant in what is now the world's second largest economy:

China's consumer prices rose 4.9% in January from a year earlier,  prompting worries that the world's second-largest economy is falling behind in the fight against inflation. ...

... the headline numbers also underplay the impact on many ordinary Chinese.  The foods component, for instance, jumped 10.3%, and has averaged more than 10% for the past four months.

Here we find an excellent example how inflation causes its own acceleration.  People think the prices are going up so they run to the store.  The store anticipates they are coming so it raises prices some more.  Just the expectation that prices are going to rise causes them to rise.

Chinese shoppers are clearing supermarket shelves of soap, laundry detergent and shampoo after media reports warned of sharp price increases, the latest signal of public alarm over rising inflation despite government attempts to bring it under control.

And the Chinese have their own opinion of exactly what the Federal Reserve's quantitative easing is doing to them:

To Beijing, rising commodity prices owe much to the Federal Reserve's continuing campaign against disinflation through quantitative easing and zero interest rates, undermining confidence in the dollar.

As the Chinese grow frustrated the Fed's policy of quantitative easing, they agree with the rest of the world's belief that inflation is upon us.

So, have you heard people cursing when you were at the local gas station?  Maybe you were the one cursing.  My first experience was an HVAC repairman putting over $100 of gas into his van.

... In early March, prices settled above $100 a barrel for the first time since the record-breaking year of 2008 ....

... oil rose 16.79% in this year's first quarter, compared with a 15.15% gain in all of 2010.

And consumers all over the world are getting clobbered by inflation:

As prices for food and energy climb, a growing number of governments -- most recently in Asia -- are trying to protect consumers by expanding subsidies, imposing price controls or embracing other short-term fixes that many economists fear will prove counterproductive and lead to higher inflation.

Some well-placed institutional authorities here in the U. S. are also speaking out:

"We got a stronger economy and we got higher inflation and higher inflation expectations than we expected," St. Louis Fed President James Bullard said in an interview last week.  "The logical thing to do is to pull back."

But unfortunately, Mr. Bullard does not have a vote on the Federal Reserve Board of Governors.

The head of the European Central Bank opines there is overwhelming evidence in every relevant corner of the world about inflation rising to unacceptable levels:

Inflation fears -- fueled by spiraling food, oil and raw material prices -- are mounting around the globe, prompting the heard of the European Central Bank to signal that it could raise interest rates in the future even though some countries have been weakened by the Continent's debt crisis.

... Mr. Trichet's warning comes at a time when inflation concerns are mounting among investors around the world.

You don't have to be a genius or even a very practical person to process all this information and reasonably conclude that current and emergent inflation are a real problem.  In fact, we can look at our own economic history during the period of 1970 to 1985 and see what painful economic events result from excessive inflation.  This is the best road map for the Federal Reserve Governors to use in predicting what might be the impact of quantitative easing.

And the similarities between the current situation and the period from 1970 to 1985 have raised alarms with some influential investors.  One of them operates the largest bond fund in the country.  And what he has
done is ominous:

Bill Gross, founder and co-chief investment officer of Pacific Investment Management Co., has turned more bearish on the U.S. government-related bonds including Treasurys, reflecting his growing worries over the country's fiscal deficit and debt burden.

After February's dumping all such holdings in the $235.98 billion Pimco Total Return Fund, the world's biggest bond fund, Mr. Gross in March placed bets wagering on further price declines in these types of securities, known as shorts in financial markets.

But, the Fed doesn't seem overly concerned about other governments and private investors' reaction to the Fed's policies.

Ms. Yellen made the Fed's most extensive arguments to date that its policies aren't pushing up commodities prices and that the rise, so far, isn't a threat to maintaining price stability.

So, in the face of this torrent of information about inflation that the world media is reporting, the Federal Reserve Governors got it exactly wrong.

Instead of making a small hedge against actual and incipient inflation, the Fed will continue to make a huge bet against deflation, which no one sees as a threat.  A rational and prudent person would recognize the risk of inflation, pursue a policy hedging against it by not printing money, and raise interest rates.

If they are wrong about there being no damaging consequences from the quantitative easing, they could ignite a 1970's-type inflation, or worse.

On the other hand, what damage could result from a small increase in interest rates and the termination of quantitative easing now?

Incredibly, as of the week ending April 6, 2011, U.S. Treasury Securities held outright by the Federal Reserve on the Fed balance sheet amounted to $1.345 trillion.

The Debt Held by the Public at the end of the last fiscal year of the Bush Administration (9/30/08) was
$5.808 trillion.  By 4/12/11, the Debt Held by the Public had increased to $9.652 trillion, a $3.844 trillion increase.  Therefore, the Federal Reserve basically holds 35% of Obama's deficits on its balance sheet.  This 66%, or $3.844 trillion, increase, in the amount of Publicly Held Debt in just 3 years is astounding in light of the fact that it took over 232 years of our nation's history to reach the $5.808 trillion level.

Who is doing this to us?  Here are the current members (with two vacancies) of the Board of Governors of the Federal Reserve System:

  • Ben S. Bernanke-appointed by President Bush
  • Janet L. Yellen-appointed by President Obama
  • Elizabeth A. Duke-appointed by President Bush
  • Daniel K. Tarullo-appointed by President Obama
  • Sara Bloom Raskin-appointed by President Obama

These people have outstanding academic credentials and extensive institutional and governmental service.  But in the aggregate, they are insulated from the real world that most people know.  It is incomprehensible that such an extraordinary group of bright people can digest all the available empirical information, reach the wrong conclusion, and just press on with the huge bet against deflation and no small hedge against inflation.  And to think, these five people have no superior oversight.

This is bizarre!  But, perhaps they are just too beholden to some socialist ideology about our economy.  For as Lenin said, "[t]he way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation."

Fred N. Sauer is an American patriot, St. Louis resident, and businessman whose blog can be found at