'I don't think the Fed can get interest rates up very much, because the economy is weak, inflation rates are low. If we were to tighten policy, the economy would tank.' - Ben Bernanke's response to a question from the House Financial Services Committee hearing held on Wednesday 17 July 2013.
After increasing the money supply at a rate of 33% per year for the past five years, the best US Federal Reserve chairman, Dr Ben Bernanke can manage to achieve is 'the economy is weak'.
The sheer volume of newly minted dollars has financial experts and gold bugs searching the horizon for evidence of inflation and even hyperinflation. The theory is, 'Surely with this much money being added to the system, higher inflation must soon appear on the horizon?' Conventional wisdom suggests inflation should be a by-product of the central bankers' efforts with the printing press.
However, the fact is we aren't in conventional times. Therefore the world as we know (or think we know) it may not act in its usual 'Pavlovian' way..
..Inflation is the by-product of money creation plus credit.
In the past five years the Fed has produced around US$2.5 trillion of new money. Over the same time, the private sector has cut debt levels by US$4 trillion.
There are a couple of other tell-tale signs of inflation that are pointing in the wrong direction. Commodities prices have trended down for the past two years, and the Baltic Dry Index (an indicator of global shipping activity) is down to levels last seen during the GFC.
The Great Credit Contraction is producing the equal and opposite effect of The Great Credit Expansion. The inner tube of the global economy has a puncture - more air is escaping then the central bankers can pump in.
When a tyre loses pressure it is DEFLATING.
But the deflationary outlook isn't unique to the US. A recent Societe Generale report stated;
'Perhaps, though, the most decisive macro factor for all markets will be any slide into deflation in China... The recent Q2 GDP data contains the surprising fact that China's implicit GDP deflator had slowed to only 0.5% yoy - noticeably weaker than the CPI data... The fact that China is on the verge of outright deflation may prove more important than even Fed tapering.'
But don't worry. Bernanke has it all under 'control' - after all isn't that what central bankers believe?
How's this for supreme confidence. When asked how the Fed will exit its QE (quick & easy) money experiment he said:
'We know how to exit. We know how to do it without inflation... We have all the tools we need to exit without any concern about inflation.'
The only tools Ben has at his disposal are the other board members sitting around the Fed's boardroom table.
Four years of money printing have done nothing but damage the integrity of markets. By distorting interest rates they have forced investors into high risk investments paying low returns. Let's face it, for the average punter a few percent from anything looks a whole lot better than 0.25% in the bank.
The longer this experiment is allowed to continue (and Fed hubris means it will be for longer than anyone expects), the greater the dislocation in markets. When GFC Mk II hits, consumers will retreat even further into the cave of cautious spending and debt reduction or default.
The irony is the Fed's money printing has increased the odds of a deflationary outcome.
A century of central bank meddling in markets has produced another type of inflation - in the form of central banker egos and belief in their abilities.
The pending market upheaval will hopefully deflate these puffed up theorists.
