I'll See It When I Believe It

The Fed's approach to U.S. monetary policy

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In the Q&A session following a February 3, 2011, speech by Federal Reserve Chairman Ben Bernanke entitled Economy and Macroeconomic Policy to The National Press Club, the question was conveyed, “Do you believe that any of the growing political unrest around the world, especially Tunisia and Egypt, is linked to higher food prices which, the questioner says, results from the Fed’s large-scale asset purchases?”

The Chairman’s bottom-line reply: “I think it is entirely unfair to attribute excess-demand pressures in emerging markets to U.S. monetary policy because emerging markets have all the tools they need to address excess demand in those countries.”

Notice how the Chairman stealthily redirected the essence of the question as to the source of growing political unrest from “the Fed’s large-scale asset purchases” to “excess-demand pressures in emerging markets”.

One thing on which the Chairman and the questioner would agree is that soft commodity prices have risen spectacularly over the past year. According to data compiled by Chris Martenson PhD, corn is up 85%; wheat is up 76%; oats up 73%; soybeans up 57%; and sugar up 16% – all of which Tunisia and Egypt import heavily. I will focus on wheat.

Egypt is the world’s largest importer of wheat at about 6.3 million metric tonnes per year; and Tunisia, with the highest per capita consumption of wheat in the North African region at 258 kg per year, imports 1.7 million metric tonnes annually. But even together, 1) they account for only 1.2% of 678 million metric tonnes in yearly global production; and 2) these countries have a combined GDP of $564 billion, which is roughly the same as that of the state of Pennsylvania, and the Fed Chairman expects us to believe it is “excess demand” in these countries that has driven global wheat prices up 76%? I hope not.

Now, to be fair, Mr. Bernanke did say “emerging markets” as a whole, so let’s consider them collectively. Emerging-market nations make up about 40% of global GDP, which is quite significant. However, according to the United States Department of Agriculture (USDA), global 2010/11 wheat supplies are higher, and consumption is projected to be 1.2 million metric tonnes lower. So if supplies are up and consumption down – and in a competitive market, the law of supply-and-demand implies prices fall when supply exceeds demand – why are wheat prices rising? Here’s why: The problem is not excess emerging-market demand, but an excess supply of U.S. dollars, which are bidding up asset/commodity prices. Does the Chairman not see this? Consider the following:

To the question, “Do you attribute the stock market’s rise to QE2?”, the Chairman replied, “The way monetary policy always works is through interest rates and asset prices. That’s how it always works, by changing those prices in financial markets. So, yes, I do think that by taking these securities out of the market and pushing investors into alternative assets, we have led to higher stock prices and lower stock-market volatility.” It is therefore evident that the “alternative assets” of choice include wheat, corn, oats, soybeans, sugar, and the like. For the excess dollars the Fed and Treasury put into circulation have made their way into these soft commodities, and hard commodities such as gold, silver and copper. Why does the Chairman not accept the connection?

To what level have dollars been put into circulation so far via Treasury purchases? Well, my friends, America is now #1 in a new category: The Fed is now the largest holder of Treasury securities at $1.14 trillion, followed by China at $895.6 billion (as of the latest November 2010 data), and then Japan at $877.2 billion. The Fed’s goal in buying Treasuries is to keep interest rates low for as long as possible in order to give the U.S. economy an accommodative environment in which to grow. But rising commodity prices spurred by a ballooning money supply are undermining Fed efforts. Higher commodity prices are feeding their way throughout the economy, forcing wholesalers and retailers to raise prices on higher commodity costs. Just on February 4, 2011, cereal giant Kellogg’s said it would raise prices 3 % in 2011 due to the rising cost of commodities.

On a broader scale, the USDA reported the following price increases in food costs from December 2009 to December 2010: Beef up 6.1%; pork up 11.2%; chicken 1.3%; eggs 6.1%; cheese 4.3%; butter 21.9%; bread 1.2%; fresh fruit 3.1%; and fresh veggies 1.2%. And the agency’s 2011 forecast is for dairy prices to rise 4.5 ~ 5.5%; pork to rise 3 ~ 4%; beef 2.5 ~ 3.5%; produce 2.5 ~ 3.5%; and beverages 1 ~ 2%.

What’s more, a one-year food-basket survey by The Tennessean newspaper from November 2009 found a 12.5% spike in prices for a typical grocery basket filled with staples. Do such news and data not reach the Chairman’s desk?

Interestingly, the latest Consumer Price Index (CPI) reading indicates prices have risen only 1.5% over the last 12 months, before seasonal adjustment. CPI tracks prices in the following sectors (I distinguished food and energy, and included a weighted breakdown): Food (14.8%); Energy (8.6%); Housing (37.9%); Transportation (12.2%); Medical Care (6.5%); Recreation (6.4%); Education & Communications (6.4%); Apparel (3.7%); and Personals (3.5%). I don’t know the details on the 100,000 or so individual items the CPI considers in calculating its results, but a reading of up just 1.5% doesn’t seem to reflect what is happening on the ground.

Moreover, the Fed prefers to use Core CPI, which excludes food and energy prices because it considers them volatile. However, can you imagine a typical family “excluding” the cost of food, gasoline, heating and electricity when considering its level of spending? One would think such “in-your-face” expenses – which account for a whopping 23% of total outlays – would be “core” to the Fed and to an index that wishes to be taken seriously for gauging how much Americans are paying for goods & services.

I am reminded of the Hans Christian Andersen story, The Emperor’s New Clothes. Everyone saw that the emperor was exposed, and even after the king accepted the fact that he had on no clothes through the honest statement of the young boy, he continued to parade proudly before the crowd. In the same way, if Chairman Bernanke wants to pretend inflation, induced by excessive printing, is not a problem, that is his prerogative. I just hope he accepts reality before it’s the American people who become the financially dismayed laughing stock of the international community, as the world looks on and says, “Those 'rich' Americans can’t even afford their own goods. They can’t see that they are broke!”

In conclusion, rising commodity prices, through Fed large-scale asset purchases, are indeed contributing to political unrest; eating into U.S. discretionary spending; and limiting U.S. economic growth. Why doesn’t the Chairman get it? You may be familiar with the saying, “I’ll believe it when I see it.” In the Fed’s case, it seems they will see it once they come to believe it.

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