Charles Evans Speaks. Complete Lack of Common Sense Ensues

I can’t help but scratch my head over the sheer ignorance, lack of common sense, and continued commitment to espousing increasingly questionable economic theories even in face of the obvious.  

Charles Evans, president of the Chicago Fed, cites that rising commodity prices are mostly due to supply/demand imbalances and that monetary policy has had a minimal effect (fast forward to 3:05).  

First issue with Mr. Evans comments.  You call (see pic below)…small movements in monetary policy?

I agree that while it may be impossible to prove just how much commodity price appreciation can be attributed to either emerging market growth or monetary policy, the latter is sure to have been an integral ingredient. 

How am I so sure?  Pure common sense.  If the Fed prints money, there are more dollars in the marketplace.  The more dollars you have in the marketplace, the lower the value of each individual dollar.  A higher supply of a good without a corresponding increase in demand, the lower the price/value of said good (Economics 101 here).  The dollar’s real purchasing power decreases (ie. a gallon of gas is $4.00 vs. $3.50).  Investors have been acting rationally.  They’ve taken steps to protect their capital’s purchasing power by migrating to hard/tangible assets.  

I understand that in the bigger picture, the Fed is simply conducting an asset swap.  They are replacing Mortgage Backed and Treasury securities with cash (dollars).  However, they are also replacing an asset, which is very illiquid and can’t be used to buy a commodity, with an extremely liquid alternative — CASH.  The short/medium term effect of this asset swap is a total average asset mix that is far more liquid than what it used to be and supports an easy-money mentality that has dominated Fed policy since the mid-2000s.  An increase in liquidity leads to extreme movements in hard assets.  All one needs to do is look at a long term chart of most commodities (vertical lines = QE operations announced).

Is it coincidence that extreme swings in the prices for most commodities occur during the Greenspan and now Bernanke eras?  Is it a coincidence that the price of gold is almost perfectly negatively correlated with the value of the dollar over the longer-term?  Is it coincidence that now all I hear on the news waves is how stocks and commodities rise due to “hope that Bernanke will unleash QE3”?  Is it coincidence that commodities ripped higher once Jackson Hole (version ‘10) was announced?  So much for price stability.

Isn’t the definition of “insanity” the act of repeating the same process expecting a different result?  We’ve gone through two QE operations; neither leading to a sustainable improvement in the economy.  In fact, the second operation clearly caused a deterioration in economic activity vs. expectations for improvement (see pic below).  When gas prices were approaching $4.00 a gallon, anyone with half a brain who follows the US economy should have known that consumption would suffer.  It was a mirror image of what occurred in late 2008.  Yet still, Mr. Evans believes that they should do more of the same.  It’s astounding that highly educated people still put so much stock in the Fed.  They’ve had a huge part in this whole mess! 

I’ve said it a thousand times it seems: continued implementation of QE isn’t a prudent long-term strategy for our economy.  True, growth in Asian (emerging market) economies has had a significant part in commodity price appreciation, however, printing money is will only exacerbate a potentially menacing longer-term problem.  

In the near-term, all you need to keep track of is the price of gasoline.  Should the Fed be seriously considering QE3 in the near-term, it would be taking a sizable risk.  It would be a bet that monetary policy has a minimal effect on commodity prices, which is exactly what Mr. Evans believes.  I think it’s too big a risk for our country and the Obama administration to take.  It seems like common sense that they wouldn’t embark on such a risky strategy with gas prices at such high levels.  

 

If the Fed initiates QE and the economy falls into a recession due to increasing commodity prices (stagflation), then a serious push for the abolishment of the Fed could be in the cards in the coming years.