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Bernanke’s Biggest Fear

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The Fed created an uproar on Wall Street this week by changing the language in its post-meeting Federal Open Market Committee (FOMC) statement. The FOMC is, of course, the committee that sets monetary policy at the Federal Reserve. The new language that excited investors was the following:

Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.

This is language investors have not seen from the Fed before. Bernanke & Co., apart from consistent FOMC dissenter Thomas Hoeing (apparently the only sane member of the FOMC), have redefined the term “stability.” The last time I checked, “stability” was the quality of being unchanging or not liable to change. By that definition, the Fed is as close to achieving its goal of price stability as it has been in decades. Inflation is running at only 1.1% today compared to a long-term average of 3%–4%. The closer the rate of inflation is to zero, the more stable prices are. Yet the Fed wants inflation to increase, which would make prices less stable. How does that make sense? It doesn’t. The Fed is not concerned with price stability; it is concerned with the low inflation rate. The doves on the FOMC want to inflate away the nation’s problems.

Bernanke’s biggest concern is undoubtedly home prices. Many homeowners are already upside down in their mortgages. Others have a thin margin of equity. An increase in the number of upside-down-mortgage holders could lead to a surge in strategic defaults. That would wreak havoc on the financial system. This is Bernanke’s biggest fear, and this is why he is and will continue to be quick on the easy-money policy trigger. In his mind, a destructive debt deflation is the only alternative.

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Jeremy Jones, CFA

Jeremy Jones, CFA is the Director of Research at Young Research & Publishing Inc., and the Chief Investment Officer at Richard C. Young & Co., Ltd. Jeremy is a contributing editor of youngresearch.com.