Fed Fears Inflation

An article in today's Wall Street Journal reports that some investors are growing increasingly worried about the possibility of inflation rearing its ugly head. Even after all the noise that has been made over the past year claiming that inflation is low and that there is no need to worry, investor confidence seems to be shrinking. This is no doubt due to the fact that the Fed itself has just publicly stated that it is worried about inflation. Dallas Fed President Richard Fisher stated that the Fed can't "let the inflation virus infect the blood supply and poison the system."

Don't be deceived by the confusing language employed here. The inflation has already been created and has already infected the blood supply. Saying that the Fed fears inflation is an outright lie that is based in semantics. The job of the Federal Reserve is to create inflation. That is essentially the sole reason for its existence. What the Fed fears (for political reasons) are the effects of inflation; namely the general rise in prices that eventually accompanies it and the distorting effects it has on the production structure and the economy in general. This is why the Fed spends enormous amounts of time and money collecting and analyzing data about unemployment, prices, business investment and consumer spending. They are attempting to subdue, mute and delay the effects of their profligate policies.

Often, they do a decent job making it seem as if inflation is low. Despite creating and spending huge amounts of new money and depressing the interest rate for long periods of time, the rise in prices that usually accompanies this behavior has seemed pretty negligible over the past two decades. This is due to a number of factors. For one, because we have the world's reserve currency, we are able to export a lot of our inflation to other countries (like China) which simply hold dollars in reserve rather than selling them. Another reason may be that when thinking of inflation, we think only about prices of consumer goods, (many of the most important of which are excluded by the Fed's official statistics,) while ignoring extreme run ups in asset prices such as we have recently witnessed in stocks and then real estate. A general rise in Asset prices, if not justified by increasing demand or productivity, is a result of inflation just like rises in consumer prices are.

But regardless of where the new money goes or how much tweaking is done by the Fed to keep it out of sight, eventually we will feel its effects. Especially when we're dealing with money creation on the scale we have seen in recent years. Surely as night follows day, for sowing the wind we will reap the whirlwind. Normally in circumstances where it is believed that prices are set to rise beyond the Fed's target rate, they will raise interest rates and slow down monetary growth to try and stem the tide. It is the equivalent of taking the bottle away from the whino when he has had too much to drink, giving him some black coffee and making him take a cold shower. Despite these precautions, a hangover is imminent and the more the man drank the worse it will be.

At some point there won't be any tools left to use. We have ridden the easy money wave for so long that soon our only choice may be between runaway inflation (hyperinflation) or a serious correction marked by deflation. If the Fed tries to stem the rise in prices by shutting off the spigot and raising rates, the economy could tank. If they insist on keeping the party going in order to avoid a correction, they risk rampant price inflation. In light of America's huge fiscal imbalances, unfunded pension and social security liabilities and the threat of perpetual war in the Middle East, the future of the economic and investment landscapes look increasingly uncertain.

It's near impossible to say with any accuracy when these problems will really start to come to a head. Maybe they already have. Maybe the day of reckoning is still a ways off. Either way, it's safe to say that Keynesian central banking has created a no-win situation. What we have is an alcholic national economy that either must continue the self-destructive drinking or suffer painful withdrawals before it can begin the healing process. Neither of these scenarios are enticing. But oddly enough, the one that is economically the most prefferable, (allowing a correction and putting and end to the fiat plague,) is also politically impractical. So take caution and protect yourself and your assests from the ravages of the Fed. The Fed is not going to protect you from inflation. Rather than looking to the Greenspan & Co. to save us from the self-inflicted effects of their expansionist policies, we should be striking at the very source of the problem: fiat paper money.