Bernanke Remains Focused on Banking System Solvency, or Lack of Same

When inflation is driven by strong economic demand, slowing business activity can help ease inflationary pressures. The current inflation problem, however, is not due to strong demand for goods and services, but rather it is due to commodity supply (oil and food) distortions, a weakening U.S. dollar and accelerating growth in the broad money supply. Accordingly, the current downturn in the economy will not bring meaningful relief from rising prices.

Fed Chairman Bernanke testified before Congress yesterday and is doing so again today, that the slowing economy will take care of the inflation problem, hence, the Fed can concentrate on preventing recession by further cutting the fed funds rate. With both the Fed and Wall Street now tacitly recognizing the inflationary recession, the same pitch on "recession will cure inflation" is being circulated widely in the popular financial media. Irrespective of economic and inflation conditions, however, the Fed’s primary focus and concern remain maintaining the solvency and the functioning of the banking system. Performance on Wall Street is closely tied to that, and such factors dominate Fed policy to the exclusion of serious risks to inflation and U.S. dollar stability. Both the currency and gold markets are reacting appropriately, despite heavy intervention aimed at propping the U.S. dollar and at depressing the price of gold.

In fairness, there is little the Fed can do to stimulate the economy, reduce inflation or salvage the dollar, whereas the U.S. central bank should be able to prevent a collapse of the banking system, on which it is concentrating its efforts.

The economic data of the last week or so consistently signaled recession and mounting inflation pressures. The fourth-quarter GDP revision was nil, with annualized real (inflation-adjusted) quarterly growth at 0.6%, and annual growth at 2.5%, both unchanged from prior reporting. January help-wanted advertising and February consumer confidence both plunged month-to-month and year-to-year, moving deeper into recession territory. Annual contractions in January existing and new home sales also remained deep in recession territory, while the ever volatile new orders for durable goods series not only fell month-to-month in January, but also remained in contraction on an annual basis, net of inflation.

On the inflation front, the upside surge in January PPI offered a mild surprise to the markets, as did the prior week’s CPI number, and both series even showed some firming in energy and food-free "core" inflation. Then there is the money supply.

February M3 Growth Accelerates.  The Fed’s propping of the banking system appears to be spiking broad money growth. If the numbers for the first 11 days of February just hold as they are for the balance of the month, the year-to-year change in February’s monthly average for M2 would surge to 6.6% from 5.8% in January, while the annual growth in the February average for the SGS-Ongoing M3 would jump to a near-record 16.5% from 15.5% in January. Such activity suggests explosive monetary inflation in the year ahead.

Full updates on the above economic reporting will follow in the February SGS newsletter.

_______________________________________________

The February SGS is targeted for posting March 5th, and the March SGS is targeted for late in the week of March 24th. An e-mail advice will be made of all Newsletter and Flash Update/Alert postings.