Over the last few months, I have had this recurring thought. It sort of takes the form of a girl having a conversation with Ben Bernanke. I know, very odd, but bear with me.
Girl: Mr. Ben, why are you so sad? You’re the most powerful person on earth.
Bernanke: This deflation is unstoppable. I keep trying, but I just cannot figure out how to create inflation.
Girl: Mommy says that the price of everything keeps going up—that’s why we can’t go out for dinner anymore and why I can’t get any new clothes.
Bernanke: Your mother should be hedonically adjusting her basket of goods towards more affordable items. If you peasants don’t conform to the model, it’s not my fault that you have no money.
Girl (sobbing): But aren’t rising prices the definition of inflation?
Bernanke: We have a model based upon interest rates. If there was inflation, interest rates would be rising.
Girl: How can interest rates rise if you continue to print money and suppress interest rates?
Bernanke (frustrated): You just wouldn’t understand. You don’t have a Ph.D. in economics from Princeton like I do. Interest rates are the key indicator of inflation.
Girl: But YOU don’t understand—there is inflation. Everything is going up in price.
Bernanke (annoyed): I’ve had enough of this conversation. I need to go print more money and buy some more bonds; otherwise we will never see interest rates rise.
Girl: You know, if you print enough money to corner the bond market and buy every bond in existence, you will drive interest rates to zero. What would your model say then?
Bernanke (not really paying attention): You’re right. I’m off to go corner the bond market…
Of course, this conversation has just a touch of hyperbole, but there is no other way to describe the thinking of a man armed with a hammer who sees every problem as a nail. On last Wednesday, for a brief moment, Bernanke stepped out of character to say that quantitative easing would eventually taper off. Investors panicked and the 30-year bond dropped nearly 3 points, culminating a 10% decline in bonds since the highs in late April.
I don’t pretend to have a crystal ball, but I see a time in a few years where inflation is raging, interest rates are struck at artificially low levels, and men like Bernanke are complaining that they cannot seem to cause any inflation, no matter how many bonds they buy.
Is this an opportunity for investors? I sure as hell don’t want to own bonds for the long term, especially if the central bankers start to lose control of the bond market–but for a trade, caveat emptor, Bernanke still has your back–at least for now.