A couple of weeks ago Federal Reserve Chairman Ben Bernanke hinted to Congress that the Federal Reserve may engage in a second round of quantitative easing (money printing to buy debt) if the U.S. economy experiences a significant downturn.
- I am unsurprised that Bernanke is opened to engaging in a second round of quantitative easing because he has a reputation of being someone who will do anything to prevent a long-term deflation.
I believe a speech Bernanke gave back in 2002 is something that everyone should be aware of because it gives us insight into how Bernanke will deal with a new round of major economic and financial weakness in the U.S. I’ll share some of the salient excerpts of that speech with you in this blog post.
I believe the Federal Reserve will not permit a long-term deflation because they are afraid of its consequences. Americans have suffered a great amount of economic pain in the past couple of years. The Federal Reserve does not want to see the U.S.’s economic and financial situation to evolve into a repeat of the Great Depression where unemployment was sky high, poverty was great, and debt became harder to repay. Bernanke made it clear that he and the Fed would do whatever it takes to prevent a prolonged deflation in a speech that was fittingly entitled “Deflation: Making Sure ‘It’ Doesn't Happen Here”:
“I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief”.[1]
Bernanke also discussed various ways the Fed could prevent prices from falling in the speech. The primary method Bernanke focused on was the creation of money:
“Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. 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”.[2]
A fully-determined and massive money printing campaign is capable of preventing any long-term price declines. However, while stopping prices from falling further, the Fed may provoke a major hyperinflation as citizens and foreigners witness the U.S. purposely and fully-determined to debase its currency. Although Bernanke has expressed some concern with the negative side effects of injecting a large dose of money into the U.S. economy; he made it known that these side effects will not deter him from turning on the printing press:
“One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation”.[3]
Given Bernanke’s power and determination to fight any long-term deflation, it is unlikely that there will be a sustained, long-term deflation in the U.S. while Bernanke remains Chairman of the Federal Reserve. This does not mean that the U.S. cannot experience deflationary periods that are quite painful. In fact, I believe it is likely that there is going to be some deflation ahead. However, I do not expect a deflationary period to last for a long-time because Bernanke and the Federal Reserve are willing and determined to print unlimited amounts of money to counteract deflation.
References
[1] Bernanke, Ben. “Deflation: Making Sure "It" Doesn't Happen Here”. Presented to the National Economics Club. Washington DC, 21 Nov. 2002. http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021121/default.htm
[2] Ibid.
[3] Ibid.
