The general conclusion from Bernanke's long-winded paper is that central bankers should not tighten monetary policy in response to oil prices shocks. Of course! What else would you expect from Zimbabwe Ben? In the Zimbabwe School of Economics, interest rates should remain at zero forever to "encourage economic growth." Inflation, you may say? Inflation is a myth, according to the Zimbabwe school, created by evil people who want responsible monetary policy. The Zimbabwe school believes prudent monetary policy is responsible for recessions, unemployment, and world wide suffering. Unlimited amounts of liquidity will solve all of these problems with no negative consequences. Insanity personified!
This ludicrous paper from Bernanke completely ignores oil's impact on businesses and consumers. This is what leads to the eventual economic downturn. Rising oil prices hurt companies by substantially increasing raw materials costs across the board. Companies have two choices: They can either try to pass through the higher costs to consumers and sustain margins or eat the cost themselves and watch margins contract. The US consumer has been destroyed over the last three years with the implosion of the housing market. Unemployment, and, more importantly, underemployment remains in the high double digits. Under these economic conditions, companies will find it very hard fully to raise prices (especially brand names). If they are unable to pass the costs to consumers, businesses quickly see margins (and therefore profits) shrink. When margins are contracting, businesses are less likely to increase capital spending, which reduces business investment. In fact, most companies will start to downsize and lay-off workers to counter the effect of falling margins. This is where we see how oil could lead to a serious recession. Rising oil prices reduce corporate profitability, severely hampering consumer spending. This is what causes recessions.
Bernanke's thoughts regarding oil and the economy makes QE 3 much more likely. If the market falls 10-20% over the next few months and other central banks raise rates (as the ECB recently threatened), Bernanke's natural reaction would be to print more money to stimulate the economy. He would be justified as he wrote a 65 page paper about this exact possibility and has a fancy computer model which shows he is correct. Bernanke will not doubt leak his policy shift through Jon Hilsenrath at the WSJ. You will start to read articles in the press about how oil is deflationary and that the Fed has to print money to counter this effect. This is the exact same way the Fed communicated QE 2 to the market back in Aug 2010. In fact, we have already seen Fed President Lockhart mention that the Fed may have to ease in response to high oil prices. Let's see if other Fed presidents start to say similar things and refuse to rule out further money printing after QE 2 concludes. We may see QE 3 by the third quarter of 2011. The Fed is succeeding in its mission to destroy the dollar. The scary part is how quickly they are accomplishing their task. Between 1913-2008 the dollar lost approx. 95% of its value. Does anyone want to see whether the Fed is going to break that record much sooner? I bet they could easily devalue the dollar by 95% over the next 10 years at the current rate of money printing. The Fed is becoming more efficient! Got Gold?
Black Swan Insights
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To much QE
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