The Federal Reserve is not Causing Inflation – No

Not to put too fine a point on it, but the Federal Reserve cannot explicitly cause a bubble; it is investor’s speculation. If the government prints money and the price of gold futures go up because of inflationary fears, commentators will pass around airy explanations and blame as if they are marijuana joints at a Grateful Dead concert. Most of the commentary is speculative nonsense.

Last week the Federal Reserve agreed to assist purchase $1.2 trillion worth of U.S. government debt and securities issued by Fannie Mae and Freddie Mac. This is the equivalent of the Fed printing money and dropping it from Bernanke’s proverbial “Helicopter over Tokyo.” It is natural to assume this will cause inflation, and the price of everything from December light sweet crude to pork bellies will drift higher. But it would be wrong to do that.

The argument goes: There is more money in the system, therefore mine is worth less, so prices will go up, right? Many economists don’t think so and their argument seems a good deal more than plausible. What they’re saying is: because of America’s high unemployment and excess manufacturing capacity, there will be negative price pressures and this will kill any inflationary pressure created from the additional money in the system.

More simply put, it’s cheaper to make stuff because there is cheap labor and unused factories. There is a lot of truth to this. Think about all of the idle hands in Detroit right now. Would they be willing to work for $10 an hour? $8.50?

Getting back to the question posed by this debate Are the Federal Reserve’s monetary policies causing an inflationary bubble? My answer is no if one is generated it will be the investors doing it. Now, the price of producing a box of Corn Flakes will cost more in the fall if October corn futures rise today. But what if labor costs less and Kellogg’s produces 20% more than demand? Well then, I guess they’ll sell it for little or no profit. We don’t need to worry, though, because the cost of wheat futures went down last week. Investors are indicating the pricing is correct or slightly high.

Gold jumped 8% last week before resting 2% higher than it began. Gold is typically the harbinger of inflation. The original price fluctuations indicated investors incorrectly thought a period of inflation was imminent, but the later pricing indicates cooler heads prevailed.

The Obama administration has made it clear inflation is far preferable to the damage deflation will do. Ask yourself the following speculative question: Will that foreclosed house down the street go for its 2004 price? $1.2 Trillion is about 8% of our GDP. The Federal Reserve will have to print a hell of a lot more money before it makes a dent in the financial chasm we’re descending into.