Here are two excellent examples of prevailing conventional wisdom from the world of Folk “facts don’t matter” Finance.
The first is from FT:
Consumers have a beef with Fed over inflation
Last week, a Texas man brandishing an assault rifle was involved in a three-hour shoot-out with police and had to be subdued with tear gas after ordering seven Beefy Crunch Burritos at a Taco Bell drive-through and being informed that their price had risen from 99 cents to $1.49.
. . .
With his petty gripe, the gunman, Ricardo Jones, is no Muhammad al Bouazizi, the self-immolating Tunisian fruit seller who inspired millions across the region to throw off the yoke of tyranny, but 50 per cent is 50 per cent in San’a or San Antonio. Food inflation is a global phenomenon.
. . .
The finger of blame is increasingly pointing toward central banks and the US Federal Reserve in particular. By printing money through quantitative easing, there are supposedly more dollars, yen and pounds chasing the same number of Beefy Crunch Burritos. Fed chairman Ben Bernanke actually was asked during a speaking engagement last month whether the central bank was culpable for the revolution in Egypt.
“I think it’s entirely unfair to attribute excess demand pressures in emerging markets to US monetary policy because emerging markets have all the tools they need to address excess demand in those countries,” said the clearly annoyed banker.
But an increasingly common view is that, with the very best intentions, he is at fault. Critics regularly cite the words of Milton Friedman, who said that “inflation is always and everywhere a monetary phenomenon”.
The great economist’s words and work are being misinterpreted though. The monetary base has indeed mushroomed but, in the quantity theory of money, it is not a simple increase in the base that causes inflation. It is an excess supply of money, which is not the case – not yet anyway. At the moment, the money shows up as excess reserves on bank balance sheets, for which they receive interest.
The second one is a real gem where Glenn Beck asks, Do We Need the Fed?
In Inflation, Deflation and “Money Printing”, Ben Bernanke explained to Rep. Jim Jordan how money supply is not the same as inflation.
Tony Crescenzi explained it again in the January 2011 Global Central Bank Focus:
Only Banks Can Create Money Supply
Debasement of indebted nations’ currencies depends importantly upon the excessive creation of money. Today, the deleveraging process is preventing this from happening. This brings us to a critical point: By themselves, increases in the quantity of bank reserves resulting from central bank activities cannot boost the money supply; only banks can create money supply. To illustrate the point, let’s look at a sample T-account (that is, a basic two-column accounting table; see Figure 1) for a US bank and its customer.
. . .
In normal times, the banking system can turn one dollar of reserves into about eight dollars of new money supply, because a bank can lend 90 cents on the dollar after putting 10 cents aside at the Fed for a reserve requirement. A bank on the receiving end of the 90 cents can lend out 90% of that, or 81 cents, and so on and so forth until presto: One dollar becomes eight dollars. This is why the monetary base, which represents the money, or reserves, injected into the financial system by the Federal Reserve, is called “high-powered money”.
Bank reserves in their enormous quantities therefore are toxic, but in the same way that nuclear waste is of no danger so long as it is tucked away either in Yucca Mountain or concrete casks, bank reserves are of no danger to fuelling inflation so long as they are held at the Fed. When the concrete cracks – when banks utilise their excess reserves and lend again – the Fed must remove the toxins, beginning first with technical operations such as reverse repos, but ultimately ending with rate hikes. This is the expected sequencing.
The key here is this: the current accepted wisdom is shared by the vast majority of individuals, advisers and funds because the idea is appealing and intuitive. That does not automatically make the thesis right. They are also acting on this belief, positioning away from bonds and leaning toward stocks and commodities.
IF most people expect increased inflation in the near future and have positioned for this, THEN there is the potential for a large correlated mistake. See The World According to Brock (preface) and The World According to Brock – Exploiting Mistakes.
The question to ask is this: if it’s not the Fed, where is the inflation really coming from? We answer the question in Part 2.