The inflation hawks have been waiting for this for a while. For the first time, Federal Reserve Bank chairman, Ben Bernanke, addressed in a speech today [June 3] in Barcelona, Spain, a question that‚Äôs in everybody’s mind and bundled in one: Inflation and the Dollar.
Bernanke has no choice. After rescuing the banking sector and fighting the peril of a recession, the main concern now is the pain at the pump, which is almost $4 a gallon today versus $1.45 five years ago.
The Fed dramatic rate cuts have caused the dollar to fall (or to fall more than it would have fallen without the cuts). Now, some say that we are paying the monetary easing with higher gas prices. So the main question is:
Is the weaker dollar causing commodity prices to jump up?
The media reports say so, just because many commodities are priced in dollars. But some economists are not convinced. ‚ÄúIt’s more than just the dollar going down because even if you measure it in Euros, which has been one of the strongest currencies, they have had a huge increase recently,‚ÄĚ says Wharton finance professor, Jeremy Siegel in Knowledge@Wharton.
Regardless. The inflation and high oil prices scare everyone now. It‚Äôs in the headlines. It‚Äôs hard not to think about it when you drive. Three months ago, everyone was predicting the imminent comeback of the Great Depression. Now the buzz word has switched to inflation. And since many credit the Fed for the price increases, Bernanke had to address this issue.
Bernanke acknowledged the problem. ‚ÄúInflation has remained high, largely reflecting continued sharp increases in the prices of globally traded commodities.‚ÄĚ
That‚Äôs fine. We know that. But then he added: ‚ÄúThus far, the pass-through of high raw materials costs to domestic labor costs and the prices of most other products has been limited, in part because of softening domestic demand.‚ÄĚ
That means that the slow economy itself is our best safeguard against the risk of higher prices.
This theme reminds us of Paul Krugman‚Äôs article called A Return to That ‚Äė70s Show, in the New York Times yesterday.
In his piece, Krugman acknowledges the anguish caused by soaring oil prices. But he sees no reason to compare our situation today to that of the stagflation of the 1970‚Äôs and 1980‚Äôs. Why? Because we now have deflationist pressures evidenced by the fact that unions are not asking for wage increases. ‚ÄúThis time around there is no wage-price spiral in sight,‚ÄĚ he writes.
Easing fears does not mean denying the threat. And the Fed loves to say something while adding a little bit of the contrary. In other words, Bernanke also said, and that‚Äôs news, that honestly, he too was a bit concerned about inflation. Or to be precise: he said that he was aware of the risks. Those risks are, he said:
1- The possibility that commodity prices will continue to rise
2- High headline inflation, if sustained, might lead the public to expect higher long-term inflation rates, an expectation that could ultimately become self-confirming.
Point taken. What about the dollar? Bernanke said the following:
‚ÄúWe are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations and will continue to formulate policy to guard against risks to both parts of our dual mandate, including the risk of an erosion in longer-term inflation expectations.‚ÄĚ
Since it‚Äôs always the U.S. Treasury Secretary who speaks about the dollar and not the Fed, Bernanke‚Äôs speech is important for foreign exchange market participants. Does it mean that the government is going to do something to stop the dollar from falling? We doubt it. The Treasury has paid lip service to the dollar before. This administration has embraced the dollar devaluation faith for some time now and has been practicing, although not preaching, this religion also for some time now. The Fed may have more reasons to be concerned about such policy given its anti-inflation mandate. But will it have the power to support the dollar?
We don‚Äôt know. But Tony Cresenzi of Miller Tabak said the speech amounted to a ‚Äústrong defense of the U.S. dollar.‚ÄĚ
Because we haven‚Äôt been used to see Bernanke touching on inflation and the dollar with such focus, some bulls in the market liked it. Sure the equity market continued to worry about financial stocks. But FX and bond traders liked the speech. Both the dollar and the bond market rallied today.
Let‚Äôs see if there is more than lip service here; let‚Äôs see if the Fed is really in a position to fulfill its dual mandate of keeping the economy up while keeping prices from rising. No doubt, it’s a challenge.