No Solid Gold Performance from Bernanke

Fed head Ben Bernanke got hammered today during his reconfirmation hearing in front of the Senate Banking Committee. Jim Bunning was Bernanke’s toughest critic, followed by Richard Shelby, Jim DeMint, and yes, Chris Dodd, the beleaguered committee chair who in all likelihood will be defeated in Connecticut next year.

But unfortunately no one directly asked Bernanke why the current gold price has surged to over $1,200, and what that might mean for future inflation and the U.S. economy.

The Wall Street Journal editorialized this morning that “the country needs a new Fed chief.” The editors went on to say that while the Fed chair knows how to ease money, there’s no evidence during his tenure as Fed chief (or formerly as Alan Greenspan’s copilot) that he knows how to make money sufficiently scarce in order to protect the dollar and prevent inflation.

Surely the steadily depreciating dollar and the surging gold price are bad omens for the future economy. In fact, inflation rates have been edging higher in recent months and will likely continue upward in the months ahead. Import prices channeled through the weak dollar have been rising. So while many of us hoped the Fed chair would be forced to address the gold question, he never did.

Bernanke did respond to questions on the declining dollar exchange rate, but as he always does, he insisted that it doesn’t matter as long as inflation is low. Huh? If you print more dollars than the rest of the world requires, surely this means too much money chasing too few goods. And as Art Laffer has pointed out, the exchange-rate mechanism is itself a transmitter of higher domestic prices.

Time and again Bernanke argued that the Fed was not to blame for the ultra-easy money that created the housing and commodity bubble which got us into this soup in the first place. He insisted that bankers were to blame for their “risky” lending policies, and he acknowledged that the Fed should have been tougher as a bank regulator.

But the point that escapes Bernanke is that negative real interest rates and excess money-creation trigger a chain of consequences throughout the financial system. Mistakes were made left and right that might never have been made had the dollar been sound and the inflationary bubble never appeared.

In effect, you get what you pay for. The Fed paid for easy money, and we all got the recessionary credit-crunching consequences of the Fed’s mistake.

By failing to heed the message of financial and commodity prices, future Fed decisions are likely to be just as flawed as past ones. It isn’t that Bernanke lacks the brains. It’s that he’s employing the wrong monetary model. Targeting the unemployment rate means always erring on the side of ease. On the other hand, targeting market-price signals would get us back to the financial and economic stability of most of the 1980s and 1990s.

The economy is improving, however slowly. And market-price indicators are telling the Fed to curb its balance sheet and let its target rate float upward. Regrettably, until the dollar and gold vigilantes punish the central bank even more, Bernanke will continue to stubbornly resist this message.

Heck, even Tiger Woods fessed up and came clean. Now it’s time for the Fed chief to do likewise.