Mercantilism is alive and well

Most telling statement when asked about what he wanted for the economy-

moderate domestic consumption, more investment, and more exports to eliminate the trade deficit.
(I’m looking for the transcript now to get the exact quotes.)

This fits with the policy of a lower interest rates, lower $, lower domestic real consumption due to higher import prices, and higher exports to sustain demand (at the ‘expense’ of the country you are exporting to who ‘loses’ demand for its products). This can be done for as long as nominal domestic wages remain ‘well anchored’ thereby reducing real wages, particularly vs our intended markets.

This is the old ‘beggar thy neighbor’ policy last seen in the 1930’s. The purpose was to accumulate the world’s gold supply, and increase ‘national savings.’ The policy was called mercantilism. It’s the logical end that follows from being on a gold standard.
A trade surplus tended to increase gold reserves, while a trade deficit tended to drain gold reserves.

Today we have non convertible currency, so government accumulation of its own currency per se is meaningless. However, we have retained some of the gold standard accounting nomenclature, such as ‘national savings’ which still features govt. accumulation of it’s own currency (as well as foreign exchange, which at least does represent value).

Fed Chairman Bernanke, the student of the great depression of the 30’s, sees the tail risk as that of gold standard deflationary collapses, and is cutting interest rates to bring the $ down and increase exports. He deems trade deficits ‘bad’ and ‘unsustainable,’ trade surpluses ‘good’ and ‘wealth enhancing,’ and increasing ‘national savings’ the mark of success.

(Mainstream economics, with all its shortcomings, does recognize the differences between convertible and non convertible currency regimes that Bernanke seems to be missing.)

Additionally Chairman Bernanke made it clear today that he sees lower futures prices for crude oil, a non perishable commodity, as indicative of market expectations for future prices, and is making decisions on that basis.

Ironically, the backwardated crude market is the result of the Saudis/Russians acting as swing producer setting price and letting quantity adjust (imperfect competition), which is functionally an engineered spot ‘shortage’ that supports price.

This brings us back to the present condition of the US economy-

Weak domestic real demand due to ‘well anchored nominal wages’ and falling real wages,

GDP muddling through with the support of booming export demand and a falling trade deficit,

And cost push inflation accelerating.


Based on today’s testimony, the FOMC seems fine with the lower $ and the associated rising costs of imports, as the weak $ supports export growth.

It will get concerned about inflation when it sees signs unit labor costs are accelerating.

6 Responses

  1. Warren I always love your quick and speedy analysis. I was very impressed with the exchange between Ron Paul and Bernanke. Bernanke was easy to understand and very clear. For many years I watched Ron Paul’s blood pressure going up trying to interpret greenspeak, I think Dr. Paul actually had his blood pressure moderate with the clear talk of Ben. I put a very large part of my portfolio into VGPMX, the vangaurd precious metals and mining fund. It seems a passive low cost way to ride the inflation wave crashing on our shores, can you give any other suggestions? Thanks.

  2. Ron Paul let me down, thought he’d be more substantive regarding the Fed’s weak dollar policy, but seemed to recite a prepared statement and then not respond to Bernanke’s answer. Maybe a question like, ‘well, just how much inflation do you consider a problem?’ or something like that. Not to mention challenging the statement that the $ is under the control of Tsy as if the Fed’s policy had nothing to do with it.

    I’ve been thinking the way to play the inflation risks are to be short eurodollar futures. wrong!!! Instead we get a Fed that cuts rates more as inflation goes higher. I assume they have inflation limits, but can’t say what they are.

  3. Warren – There has been a de-coupling in the historical relationship between gold and bond yields. Since gold is an inflationary indicator, it makes sense for high bond yields and high gold prices tend to go hand in hand and vice versa, or at least they used to. Now gold is at an historic high, while bond yields are very low. What’s wrong with this picture? More important, what makes more sense; to sell gold, or the sell bonds? What do you think about selling gold calls to finance buying bond puts?

  4. Right, this time around the FOMC has decided inflation is taking a back seat to attempting near term support of the economy.

    While this ‘theory’ flies in the face of all mainstream theory, they are nonetheless doing it, presumabley up to the point where ‘inflation expectations elevate’ as per their statements.

    Now inflation expectations are showing signs of elevating, but wages, as measured by the Fed, haven’t moved up yet, so that seems to be the new trigger point. Additionally they point to futures backwardations structures as indications of lower prices in the future. While this is a simple error of logic, ‘it’s their story and they are sticking to it.’

    So yes, all the inflation indicators are breaking out, inflation is breaking out, and the Fed doesn’t seem anywhere near caring.

    Interest rates are set by the fed, and longer term rates are indications of where the market thinks the fed will go with the fed funds rate.

    for example, if all knew for a fact the fed would never go over 3%, regardless of inflation, long rates wouldn’t go over 3%.

  5. Lots of chatter on CNBC about main street prices going up. Hardware, fast food, 1 dollar bagels et-al. Looking like main street clamoring about inflation which would translate into hawkish pressure on the Fed vs wall-street’s wanting more easing due to credit crises, stock market.

    Any opinions on how this plays out politically? Doesn’t joe 6-pack look at gas prices and food prices and blame it on bush and the republicans which opens it up for Obama.

  6. Yes, most Congressmen know the voters hate inflation more than they care about unemployment. There are a lot of Ron Paul types out there when it comes to inflation, and the questions to Bernanke showed a rapidly increasing concern.

    I’ve suggested this will accelerate, with the Fed soon being blamed for higher food and energy prices via the apparent weak dollar/inflate your way out of debt policy. The charts line up well enough to ‘prove’ that Fed policy caused the weak dollar and the inflation, mainstream theory that believes all that stuff is a function of interest rates can’t deny it either.

    The story ‘the record tells’ is that the Fed tried to bail out Wall st with rate cuts knowing that the majority of people working on main street would be impoverished as their purchasing power eroded and wages remained ‘well anchored.’ And if the Fed had thought wages were not well anchored they never would have cut rates. The Fed has made it clear the main channel for inflation expectations is workers demanding higher pay, and they have repeated said they haven’t yet seen signs of this so it’s still safe to cut rates, drive the dollar down and imported prices up, without triggering a wage/inflation response.

    Additionally, in Bernanke’s latest testimony, he further specifically stated and repeated that he didn’t want domestic consumption to go up, but rather exports and investment. The channel for this has been higher prices for consumers keeping real consumption down, and the weaker dollar policy driving exports higher, which leads to investment in the export sector, and domestic consumption remains subdued.

    Note my posts with subtitles ‘this is what an export economy looks like.’

    From last week’s testimony:

    BERNANKE: “It depends on how the inflation — as you
    say, on how — if it becomes entrenched.

    If inflation expectations were to rise and that were to
    lead to a wage/price spiral, for example,…”


    “…we want to make sure the economy is growing in a
    stable and healthy way which will attract foreign

    Foreign investment, I should emphasize, continues to be
    strong. We’re not seeing any shifts — significant shifts
    out of dollars among official holders, for example.

    And I anticipate that it will continue — that we’ll
    continue to have the capital inflows we need.”

    The idea that we ‘need’ foreign investment is also an error that supports his notion of what the US economy ‘should’ look like.

    And soon after from Bernanke:

    “With respect to inflation, I think our principal tool
    would be the interest rate.”

    And does this sound possible?:

    “So, what I’d like to see, essentially, is a reduction
    in the risks — the downside risk which I’ve talked about,
    particularly the risk that a worsening economy will make the
    credit market situation worse.”

    And if inflation was a problem then, what is it now?:

    “When we lowered interest rates on the last day of
    October, that morning we received a GDP report for the third
    quarter, 3.9 percent, which was substantially revised to 4.9
    percent, and inflation was a problem.

    So, in fact, I think as we look back on this episode,
    we will see that the Fed lowered interest rates faster and
    more proactively in this episode probably than any other
    previous episode.

    As you point out, the unemployment rate is still below
    5 percent.”

    Again, this can all be construed as bailing out the financial sector via a weak dollar/high inflation policy at the expense of working people who’s ‘inflation expectations/wage demands are well anchored.

    It also can mean that if wages do start to rise the game is up and policy turns to rate hikes.

    BERNANKE: “Well, if inflation were to — higher
    inflation were to become well embedded in inflation
    expectations and wages and other parts of the economy, it
    would be difficult, and we don’t really have new methods.”

Leave a Reply

Your email address will not be published. Required fields are marked *