If he had been uncertain about the power the Federal Reserve chairman wields over markets, it’s safe to say that after his June 5 and June 15 speeches that Ben Bernanke is now fully aware. The irony, as Bloomberg’s Caroline Baum has noted, is that stocks went into freefall after his comments about inflation on the 5th, yet rallied on the 15th despite the fact that he said much the same about inflationary pressures. Baum noted, however, that on the 15th there were “some additional phrases tossed in,” which might help explain the seeming market schizophrenia.
The media consensus about the June 5 speech was that one utterance — that the FOMC would be “vigilant to ensure that the recent pattern of elevated core inflation readings is not sustained” — was the catalyst for driving stocks down. The real story is arguably more nuanced, and involves how Bernanke often discusses inflation, and what actions he’ll engage to arrest it.
On the 5th, Bernanke reiterated output-gap orthodoxy that says inflation is a growth phenomenon, one that rears its ugly head when the economy expands beyond its productive capacity. Specifically, he noted that while “we cannot ascertain the precise rates of resource utilization that the economy can sustain, we can have little doubt that, after three years of above-trend growth, slack has been substantially reduced.”
Implicit here, to some degree, is the assumption that the U.S. economy is a closed economy, in which economic agents don’t access capacity and labor from around the world. This thinking also requires one to accept the notion that the supply of labor and capacity stateside is somehow static, and unable to respond to market signals indicating the need for more of both.
Bernanke also said on the 5th that “increased world demand for crude oil and other commodities” are a “source of inflationary pressure.” But the falling dollar’s role in the global commodity boom was never mentioned, meaning Bernanke, at least publicly, continues to absolve the Fed of any culpability in the near 5-year commodity rally.
Returning to the investor response to Bernanke’s speech, it’s assumed that stocks reacted negatively to presumed Fed vigilance regarding inflation. What a scary, wrong-headed idea. Stocks underperform during times of inflation, and it’s not much of a reach to say that if Bernanke had discussed inflation in dollar/gold or market-focused terms, that stocks would have rallied. A stable, non-inflationary dollar price would be all to the good, contrary to wrongheaded conventional wisdom suggesting the arrest of inflation must involve pain and austerity.
The talk of inflation pressures and their origins on the 5th might help to explain why markets responded more positively to Bernanke’s remarks on the 15th. Rather than discussing inflation in output-gap terms, his “dovish” talk on the 15th incorporated market signals, specifically that inflation-indexed Treasuries had “fallen back somewhat in the past month.” The latter quote was one of the “additional phrases” that Bloomberg’s Baum cited, but it was important for its signal to investors that market prices factor into the Fed chair’s thinking on maintaining price stability.
Looking ahead, it’s hard to conceive of markets responding negatively to an effective fix to the existing inflation problem. Instead, investors will “vote” on good and bad monetary policy. Along those lines, interest-rate hikes have more often than not stimulated inflationary pressures for making the dollar less useful. Furthermore, interest-rate machinations are themselves economically destabilizing for the desire of economic actors to “game” Fed action. So while investors would clearly welcome a realistic assessment from the Fed of what inflation is in terms of market-based variables, they’ll continue to blanch at Fed efforts to cure what is a monetary phenomenon with economic pain.
– John Tamny is a writer in Washington, D.C. He can be reached at jtamny@yahoo.com.