The Fed's Game Plan: What Ben Bernanke Is Thinking

Bernanke's game plan is becoming more apparent. Based on a reading of his papers and his public statements, here is a distilled view of what we think is his game plan.

1. Grow the money supply quickly and abundantly

2. Stabilize the Banking System to avoid destructive banking failures

3. Do not withdraw the monetary stimulus prematurely to fight inflation.

4. Manage 'confidence' aggressively to dampen the expectation of inflation later, and a panic liquidation now.

Each of these legs of his policy is a reaction to lessons he believes the Fed learned from the Great Depression.

As you consider the specific things he is doing, it is likely that they will fit very nicely into this framework.

He is obviously fighting the 'last war,' the last great battle that the Fed is known to have waged, and lost. For it did lose, as there was no lasting recovery until the world suffered through the Second World War.

Whether he will be successful or not remains to be seen. It is important to bear in mind that the Fed is absolutely confident that they know how to stop inflation once it gets started, even if it becomes rather serious.

The over-arching theme is that this is an emergency, and so long term niceties like moral hazard and systemic reform will be left for later: the ends justify the means.

William Poole says that this is a dangerous approach, because longer term consequences like inflation appear with a one to two year lag after a significant monetary stimulus such as we have just seen.

The timing of the Fed's dampening of inflation will be critical, and perhaps constrained by the real economy. How can the Fed tighten sufficiently if the real economy remains sluggish?

Bernanke is determined to err on the side of too much stimulus, given the trauma of the Fed's experience in the Great Depression. Coupled with the Fed's confidence in their ability to stop any monetary inflation, this raises a higher level of probability in the most likely outcome of the Fed's latest and greatest monetary experiment.

We cannot help but wonder what he thinks the Fed will be doing this time that will be different than 2003-2007 when they reflated the financial system after a market crash the last time without meaningful reforms, resulting in the stock market and housing bubbles.

Whatever happens, it will certainly provide the raw material for economic papers yet unwritten.

Serious Instances of Inflation Since World War II

Presented here is a summary of the major instances of inflation post World War II.

Although each country had its particular set of conditions and triggers for their painful experience of monetary inflation, the most common thread seems to be unpayable debts due to war or civil and societal dislocation.

Particularly strong labor union movements or protectionist policies against offshoring and imports do not appear to be common factors.

An expanded list with additional countries including the pre WWII era can be found at Wikipedia.

Inflation is the common condition of a fiat monetary system. Less probable outcomes are hyperinflation and deflation, with a serious inflation and disinflation nearer the norm.

Hyperinflation is normally associated with some outlier event in the political sphere and/or a series of policy errors by the monetary authority. Hyperinflation is more common when associated with an external monetary standard, but this is not a prerequisite.

Although not uncommon for a short term (less than one year) after unusual and intense monetary expansion, normally referred to as deleveraging or disinflation, a true deflation is a relatively rare phenomenon, especially in fiat currency regimes, usually attributable to a protracted series of policy errors or intentional actions to contract the money supply by a nation's monetary authority. The most familiar instances of a significant deflation are the Great Depression, particularly in the United States, and Japan during the 1990's.


Angola

Angola went through its worst inflation from 1991 to 1995.

In early 1991, the highest denomination was 50,000 kwanzas. By 1994, it was 500,000 kwanzas. In the 1995 currency reform, 1 kwanza reajustado was exchanged for 1,000 kwanzas. The highest denomination in 1995 was 5,000,000 kwanzas reajustados. In the 1999 currency reform, 1 new kwanza was exchanged for 1,000,000 kwanzas reajustados. The overall impact of hyperinflation: 1 new kwanza = 1,000,000,000 pre 1991 kwanzas.

Argentina

Argentina went through steady inflation from 1975 to 1991.

At the beginning of 1975, the highest denomination was 1,000 pesos. In late 1976, the highest denomination was 5,000 pesos. In early 1979, the highest denomination was 10,000 pesos. By the end of 1981, the highest denomination was 1,000,000 pesos. In the 1983 currency reform, 1 Peso argentino was exchanged for 10,000 pesos. In the 1985 currency reform, 1 austral was exchanged for 1,000 pesos argentinos. In the 1992 currency reform, 1 new peso was exchanged for 10,000 australes. The overall impact of hyperinflation: 1 (1992) peso = 100,000,000,000 pre-1983 pesos.

Belarus

Belarus went through steady inflation from 1994 to 2002.

In 1993, the highest denomination was 5,000 rublei. By 1999, it was 5,000,000 rublei. In the 2000 currency reform, the ruble was replaced by the new ruble at an exchange rate of 1 new ruble = 1,000 old rublei. The highest denomination in 2008 was 100,000 rublei, equal to 100,000,000 pre-2000 rublei.

Bolivia

Bolivia went through its worst inflation between 1984 and 1986.

Before 1984, the highest denomination was 1,000 pesos bolivianos. By 1985, the highest denomination was 10 Million pesos bolivianos. In 1985, a Bolivian note for 1 million pesos was worth 55 cents in US dollars, one-thousandth of its exchange value of $5,000 less than three years previously. In the 1987 currency reform, the Peso Boliviano was replaced by the Boliviano at a rate of 1,000,000 : 1.

Bosnia-Herzegovina

Bosnia-Hezegovina went through its worst inflation in 1993.

In 1992, the highest denomination was 1,000 dinara. By 1993, the highest denomination was 100,000,000 dinara. In the Republika Srpska, the highest denomination was 10,000 dinara in 1992 and 10,000,000,000 dinara in 1993. 50,000,000,000 dinara notes were also printed in 1993 but never issued.

Brazil

From 1986 to 1994, the base currency unit was shifted three times to adjust for inflation in the final years of the Brazilian military dictatorship era. A 1967 cruzeiro was, in 1994, worth less than one trillionth of a US cent, after adjusting for multiple devaluations and note changes. A new currency called real was adopted in 1994, and hyperinflation was eventually brought under control. The real was also the currency in use until 1942; 1 (current) real is the equivalent of 2,750,000,000,000,000,000 of those old reals

Chile

Beginning in 1971, during the presidency of Salvador Allende, Chilean inflation began to rise and reached peaks of 1,200% in 1973. As a result of the hyperinflation, food became scarce and overpriced. A 1973 coup d'état deposed Allende and installed a military government led by Augusto Pinochet. Pinochet's free-market economic policy ended the inflation and except for an economic depression in 1981 the economy has recovered. Overall impact of the inflation: 1 current Chilean Peso = 1,000 Escudos.

China

The Republic of China went through the worst inflation 1948-49.

In 1947, the highest denomination was 50,000 yuan. By mid-1948, the highest denomination was 180,000,000 yuan. The 1948 currency reform replaced the yuan by the gold yuan at an exchange rate of 1 gold yuan = 3,000,000 yuan. In less than 1 year, the highest denomination was 10,000,000 gold yuan. In the final days of the civil war, the Silver Yuan was briefly introduced at the rate of 500,000,000 Gold Yuan. Meanwhile the highest denomination issued by a regional bank was 6,000,000,000 yuan (issued by XinJiang Provincial Bank in 1949). After the renminbi was instituted by the new communist government, hyperinflation ceased with a revaluation of 1:10,000 old Renminbi in 1955.

Georgia

Georgia went through its worst inflation in 1994.

In 1993, the highest denomination was 100,000 coupons [kuponi]. By 1994, the highest denomination was 1,000,000 coupons. In the 1995 currency reform, a new currency lari was introduced with 1 lari exchanged for 1,000,000 coupons.

Israel

Inflation accelerated in the 1970s, rising steadily from 13% in 1971 to 111% in 1979. From 133% in 1980, it leaped to 191% in 1983 and then to 445% in 1984, threatening to become a four-digit figure within a year or two. In 1985 Israel froze all prices by law. That same year, inflation more than halved, to 185%. Within a few months, the authorities began to lift the price freeze on some items; in other cases it took almost a year. By 1986, inflation was down to 19%.

Madagascar

The Malagasy franc had a turbulent time in 2004, losing nearly half its value and sparking rampant inflation.

On 1 January 2005 the Malagasy ariary replaced the previous currency at a rate of one ariary for five Malagsy francs. In May 2005 there were riots over rising inflation, although falling prices have since calmed the situation.

Nicaragua

Nicaragua went through the worst inflation from 1987 to 1990.

From 1943 to April 1971, one US dollar equalled 7 córdobas. From April 1971 to early 1978, one US dollar was worth 10 córdobas. In early 1986, the highest denomination was 10,000 córdobas. By 1987, it was 1,000,000 córdobas. In the 1988 currency reform, 1 new córdoba was exchanged for 10,000 old córdobas. The highest denomination in 1990 was 100,000,000 new córdobas. In the 1991 currency reform, 1 new córdoba was exchanged for 5,000,000 old córdobas. The overall impact of hyperinflation: 1 (1991) córdoba = 50,000,000,000 pre-1988 córdobas.

Peru

Peru went through its worst inflation from 1988 to 1990.

In the 1985 currency reform, 1 inti was exchanged for 1,000 soles. In 1986, the highest denomination was 1,000 intis. But in September 1988, monthly inflation went to 132%. In August 1990, monthly inflation was 397%. The highest denomination was 10,000,000 intis by 1991. In the 1991 currency reform, 1 nuevo sol was exchanged for 1,000,000 intis. The overall impact of hyperinflation: 1 nuevo sol = 1,000,000,000 (old) soles.

Poland

Poland went through its worst inflation between 1990 and 1993.

The highest denomination in 1989 was 200,000 zlotych. It was 1,000,000 zlotych in 1991 and 2,000,000 zlotych in 1992. In the 1994 currency reform, 1 new zloty was exchanged for 10,000 old zlotych.

Romania

Romania is still working through steady inflation.

The highest denomination in 1998 was 100,000 lei. By 2000 it was 500,000 lei. In early 2005 it was 1,000,000 lei. In July 2005 the leu was replaced by the new leu at 10,000 old lei = 1 new leu. Inflation in 2005 was 9%. In 2006 the highest denomination is 500 lei (= 5,000,000 old lei).

Russia

In 1992, the first year of post-Soviet economic reform, inflation was 2,520%, the major cause being the decontrol of most prices in January. In 1993 the annual rate was 840%, and in 1994, 224%. The ruble devalued from about 40 r/$ in 1991 to about 30,000 r/$ in 1999.

Turkey

Throughout the 1990s Turkey dealt with severe inflation rates that finally crippled the economy into a recession in 2001. The highest denomination in 1995 was 1,000,000 lira. By 2005 it was 50,000,000 lira. Recently Turkey has achieved single digit inflation for the first time in decades, and in the 2005 currency reform, introduced the New Turkish Lira; 1 was exchanged for 1,000,000 old lira.

Ukraine

Ukraine went through its worst inflation between 1993 and 1995.

In 1992, the Ukrainian karbovanets was introduced, which was exchanged with the defunct Soviet ruble at a rate of 1 UAK = 1 SUR. Before 1993, the highest denomination was 1,000 karbovantsiv. By 1995, it was 1,000,000 karbovantsiv. In 1996, during the transition to the Hryvnya and the subsequent phase out of the karbovanets, the exchange rate was 100,000 UAK = 1 UAH. This translates to a hyperinflation rate of approximately 1,400% per month. And to this day Ukraine holds the world record for most inflation in one calendar year, which was set in 1993.

Yugoslavia

Yugoslavia went through a period of hyperinflation and subsequent currency reforms from 1989 to 1994.

The highest denomination in 1988 was 50,000 dinars. By 1989 it was 2,000,000 dinars. In the 1990 currency reform, 1 new dinar was exchanged for 10,000 old dinars. In the 1992 currency reform, 1 new dinar was exchanged for 10 old dinars. The highest denomination in 1992 was 50,000 dinars. By 1993, it was 10,000,000,000 dinars. In the 1993 currency reform, 1 new dinar was exchanged for 1,000,000 old dinars. But before the year was over, the highest denomination was 500,000,000,000 dinars. In the 1994 currency reform, 1 new dinar was exchanged for 1,000,000,000 old dinars. In another currency reform a month later, 1 novi dinar was exchanged for 13 million dinars (1 novi dinar = 1 German mark at the time of exchange). The overall impact of hyperinflation: 1 novi dinar = 1027 pre 1990 dinars. Yugoslavia's rate of inflation hit 5 × 1015 percent cumalative inflation over the time period 1 October 1993 and 24 January 1994.

Zaire (now the Democratic Republic of the Congo)

Zaire went through a period of inflation between 1989 and 1996.

In 1988, the highest denomination was 5,000 zaires. By 1992, it was 5,000,000 zaires. In the 1993 currency reform, 1 nouveau zaire was exchanged for 3,000,000 old zaires. The highest denomination in 1996 was 1,000,000 nouveaux zaires. In 1997, Zaire was renamed the Congo Democratic Republic and changed its currency to francs. 1 franc was exchanged for 100,000 nouveaux zaires. The overall impact of hyperinflation: 1 franc = 3 × 1011 pre 1989 zaires.

Zimbabwe

At Independence in 1980, the Zimbabwe dollar was worth about USD 1.25. Since then, rampant inflation and the collapse of the economy have severely devalued the currency, causing many organisations to favour using the US dollar or South African rand instead.

In Defense of Economics

Yves Smith at Naked Capitalism has an interesting essay on her site Why So Little Self-recrimination Among Economists? which we would urge you to read if you are interested at all in this topic, as it is sincerely well thought and written, for which we her readers are always grateful.

It is difficult to assess the quality of an unfamiliar game if one does not know the rules, and even more if one does not understand the objectives. What is the 'goal' of the economics game which we all have been observing with greater than usual interest these past few years?

For the past twenty five years at least modern economics has not been seeking objective truth and the advancement of learning as much as the rationalization of policy positions in pursuit of power, awards, grants, and influence. This is not to say that there was a utopia before this, but rather that the less admirable aspects of the profession were in the minority, and not so widely accepted and tolerated and respected.

Our society on the whole does not value the truth as it had done before, but worships money and power and cleverness. That is both the long and short of it. We obtain the politicians and economists and news commentators that we encourage according to the character of the age.

Economics is a social science, with somewhat murky experimental methods, more like redacted statistical vignettes, and difficult to measure theories with grading periods too widely interspersed to be meaningful. This introduces a strong element of peer pressure and factionalism, of quack theories and nostrums hiding in the safe harbors of ambiguity and plausible error.

Granted, the academics are protected by tenure, but tenure is a weak consolation to the ambitious. It can be at worst a kind of exile, a quiet humiliation. And professors are weak in their resources as compared to the think tanks who have no qualms about pursuing their desired objectives. There is a power to the lie that can overwhelm those who stumble about in pursuit of the truth, or at least a better approximation of it.

Economics is not a purely objective science, because its theories are not readily verifiable through controlled experimentation, even allowing for the work of some of the behaviourists.

In this economics is not alone among the sciences, not at all, especially to those in the leading edge of some disciplines like theoretical physics, where experimentation is difficult, and grading periods are also interspersed widely. We often hear of courageous minds who hold out through years of isolated persistence to be eventually vindicated by new discoveries from experimentation and observation.

But is economics so much the problem? We would suggest that its condition, its character, merely makes it vulnerable, a thing to be encouraged and protected, but not to be relied upon as a bulwark against adverse societal influences.

If anything, economics is guilty of pretension, of having more influence and authority than its knowledge would allow. Was there anything so artfully disingenuous as the Congressional testimony of Alan Greenspan regarding critical policy decisions? Or more craven than the way in which many of the Congressmen sought to gain cover for their action under his prevarication?

How can there be self-recrimination where there is no outrage in general? Where is the objective analysis of what went wrong, and proposals to change things to correct this?

Most academics are notorious followers, trodding the well worn and well marked paths, no matter where they might lead. It is only the exceptional, both in mind and spirit, that dare to blaze new trails. Tenure is no armor for the ego, and there are no politics more vicious and petty than those of academia, excepting perhaps the fashion industry.

We ought not to blame economics, beyond its pretensions to administer advice from some position of authority because of superior knowledge. That has been shown to be hollow, false, a totemism. The pseudo-religious aspects of the extreme elements of some economic schools of thought is apparent, almost hysterically funny, when viewed from a distance.

We ought not to single out economists for not being virtuous because there were too few virtuous people on the whole both then and now, if one defines 'virtuous' as one who tells the truth, come what may, as the facts and their analysis leads them even in their lack of certainty.

This is not to say there is no blame to be attached, no criminality to be assessed, that 'society is to blame.' The problem is that there is so much of it that we can spend years striking at the branches, the scapegoats, without approaching the root.

The remedy is the law, and to affect this we must take back the rule of law from those who have corrupted it.

The Federal Reserve raised an enormous debt bubble to lift the economy out of the slump of 2002, and for this trouble we were rewarded with a housing and stock market bubble, and remarkable imbalances that are just now being unwound. This is what happens when one liberally applies monetary and Keynesian stimulus without reform. And we are doing it again.

Things will change for the study of economics, and probably for the better. There are more extreme examples of professions which were co-opted by the political world, like psychology in the Soviet Union and medicine in the Third Reich, sciences subjected to what some might call deep capture.

How can a society which defines its first principle, the ultimate good, as greed be anything but what it is? Cruel, self-absorbed, shallow, unjust, delusional and imbalanced. Nothing made this more apparent than the spectacle of the outgoing President's press conference today. And, we might add, the actions of his predecessor in that office.

Fear is the tool of a tyranny, and greed is a horse to be harnessed, not the measure of policy or an administrator of justice to run maximized, or even unchecked.

Why the lack of self-recrimination among the economists? Because they are no different than anyone else who failed to exercise their stewardship and basic human obligation to protect the innocent and to stand for justice, and uphold the standards of their profession. In this they are no different than politicians and lawyers and accountants and the mainstream media, although we foolishly expected more.

Economics will recover eventually from this lapse, as the majority of economists look back in quiet horror at the carnage that was inflicted on the world, accommodated by their silence. There were many who spoke out. There were even some who took the time and trouble to go to places where economists frequently discuss things, and caution that their silence would discredit the profession.

What is the next step? Forward, off the beaten path.

US Dollar Weekly Chart with Commitments of Traders