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Revised December 7, 2005

Propensity to Print - Thoughts of a Professional Investor - Macroeconomic Articles on

If anyone has doubt about Ben Bernanke's propensity to print dollars, a front-page article from the December 7 Wall Street Journal will remove it. The article offers insight to one of Mr. Bernanke's passions: study of the Great Depression. In his first major research paper on the Depression, published in 1983, Mr. Bernanke squarely places culpability for the Depression's depth and length on deflation. By allowing deflation to run its course, he states, the value of collateral held by debtors shrinks while loan value does not. This imbalance makes lending seem riskier to bankers, and so they do less of it, thereby preventing economic activity.

While much of what he says may be true once a nation is in such a predicament, Mr. Bernanke fails to step back and explain why the Depression occurred in the first place. It is no coincidence that this great calamity arose less than two decades after the Federal Reserve was created. The Federal Reserve itself caused the Depression via excessive money printing during the 1920s. The economic distortions brought about by easy money compels misallocations of resources which eventually lead to the need for rebalancing.

Even without government tinkering, misallocations will occur. Economics is nothing more than the study of actions taken by human beings attempting to maximize their lot in life, and humans make mistakes. The quality of their decisions is based upon the information they have available to them and their ability to process that information. Economies will suffer downturns when misallocations build up to a certain point. These downturns wash out the misallocations and free capital for more productive use.

When a central bank pumps money into the banking system to artificially stimulate the economy, it only exacerbates the misallocations. Money is not wealth. Money simply gives the bearer the means to control resources, and when poor decision-making is reaching a critical point… i.e. when an economy is in need of a cleansing recession… pushing cash into the system only enables decision-makers to extend their poor choices and amplify imbalances. The greater the imbalances the more painful the adjustment process.

Mr. Bernanke adheres to a paper published by Milton Friedman and Anna Jacobson Schwartz in 1963 in which the two popular economists claim that the Depression was brought about by the Federal Reserve. While this statement is true, they place blame on the wrong action, saying that the Fed "foolishly raised interest rates in 1928 to end speculation on Wall Street." In fact, it was the Fed's foolish money printing the years before that concocted the speculative environment. If the asset bubble of the 1920s had not been blown so big, the ensuing deflation would not have been so terrifying.

Mr. Bernanke is also a strong believer in government tinkering to spur economic activity. The WSJ article describes Bernanke's admiration of Franklin Roosevelt as a creative thinker with the "willingness to be aggressive and to experiment." Indeed. It is Roosevelt's experimentation that has stuck us with the two largest financial fiascos this country has ever faced. Social Security threatens to divide and bankrupt this nation more than any President has ever done by waging unnecessary war. As with most feel-good programs, social security has little economic tenability. If not for habitual devaluation of the US Dollar via money printing, the program would have collapsed years ago, caused a bit of uproar, and then drifted into the world of case studies, leaving us with a healthier system. Instead, we have only managed to expand it into a bigger problem.

Then there is the Federal National Mortgage Corporation, which after decades of competing unfairly within a free enterprise banking system, has become so large that its very liquidity is vital to our financial stability. Now known as Fannie Mae, the company, along with its counterpart, Freddie Mac, has helped exacerbate a housing bubble caused by Fed money printing. How ironic that a cornerstone of Roosevelt's New Deal may play a key role in pushing us into our next great depression.

Bernanke continues his praise of Roosevelt saying he appropriately reacted to the Depression's deflationary effects by driving down the exchange rate (read: print money). He also criticized Japan's central bank for not doing the same during the 1990s. Our nation now faces multiple bubbles, each of which dwarf the misallocations of the 1920s. Massive imbalances have been built in housing, personal and government debt, and international trade.

Mr Bernanke seems to believe that asset bubbles occur all by themselves, an inevitable result of mass psychology. Our Harvard and MIT-educated incoming Federal Reserve Chairman is oblivious to the fact that impetuous deflation-fighting by our central bank is at the root of these bubbles. In some areas of practice, too much education is detrimental to the prognosticator's abilities, and the first two fields that come to mind are psychology and economics.

In his tenacious resolve to prevent deflation, which in an unburdened financial system is a natural and healthy occurrence, Mr. Bernanke will no doubt fire up the presses like never before. Our incoming Fed Chairman has spent his career preparing to fight deflation, and that's exactly what we can expect from him.

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