Saturday, August 12, 2006

Central Banking is Based on Deception

As usual, Peter Schiff of Euro Pacific Capital is right on the mark in his latest weekly analysis of the Fed's decision to pause:

"This week, as the Fed came through with its highly anticipated pause, it conspicuously left the door open to future rate hikes. Apparently the rhetorical vigilance took most currency traders by surprise, sending many scrambling to buy dollars. However, given that any weaker statement would have caused a stampede out of the dollar, how surprising should the tough talk have been? Any indication that this was not a "wait and see" pause would have sent both long-term interest rates and consumer prices up, undermining the “benefits” of the pause. So in an apparent attempt to have its cake and eat it too, the Fed “paused” while pretending that it really had not done so.

The Fed’s claim that it is concerned about inflation, and that it will act decisively to contain it, is just a bluff. Any real commitment would have prompted the Fed to have already raised rates much higher. For the Fed to suggest that it stands ready to raise rates in the future, if the data warrants it, completely misses the point that the data warrants it right now!

The flawed CPI is nonetheless a lagging indicator of inflation. There is so much inflation already in the pipeline that its effect on consumer prices will be seen for years to come. For now, the Fed’s private concern is to keep the markets from understanding just how bad inflation already is, and how little resolve it actually has to do anything to contain it....

...My guess is that the Fed will continue to ignore evidence of worsening inflation, using growing signs of a weakening economy as cover for its complacency. All the while it will continue to brag about its “vigilance” and commitment to hiking rates further should inflation become a threat."

In other words, the Fed is certainly not serious about "fighting inflation", but it wishes to fool everyone that it is, as the benefits for the central bank is the highest when inflationary expectations are low.

In The Economist's analysis of the Fed decision in its latest issue (not available online for non-subscribers) a similar point was made. Namely that all leading indicators for consumer price inflation in the short and medium term points to continued high or even higher inflation than today, with the exception of one indicator, namely inflationary expectations which remains strangely low considering the Fed's dismal track record in "fighting inflation". This indicates that the Fed have been successful in its deception. How long will the Fed be able to fool the public with its fake "inflation fighting"? Maybe not forever, but the fact that the ECB is widely considered to be hawkish despite consistently letting consumer price inflation stay above 2% they may just get away with fooling the public for some time longer.


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