Bernake's Debacle: The Law of Unintended Consequences

One of my favorite economic and political laws is The Law of Unintended Consequences. It's what happens when a policy or statute is enacted, and something else happens that the folks who originated these actions didn't anticipate.

Case-in-point: Ben Bernanke's "Quantitative Easing II" (aka money-printing on steroids) was designed to boost economic activity and spending here in the U.S., and get America's economy back to "normal" (i.e., borrowing and spending like the good old days of the stock market and real estate booms - or as close to it as possible).

There's one little problem that "Helicopter Commander" Bernanke overlooked - the unintended consequences of excessive money-printing around the world, and how it would affect America's foreign policy.

One of the few practical things I learned in college was from an Ag Policy professor named Dr. Barry Flinchbaugh. He was a quick-witted, heavy-set guy who liked to smoke cigars, and told great stories. As a result, I never fell asleep in his class - even though it was right after lunch.

The quote Dr. Flinchbaugh said that stuck in my mind was (to the best of my recollection):

"The only way that policies get enacted or laws get passed, is when they're both politically and economically feasible."

The corollary of that quote is that policies get reversed (or laws get repealed, which is very rare) when they're not politically and economically feasible. It looks Ben Bernanke is close to proving that corollary with the Fed's monetary policy.

QE2 skyrocketed food prices here in the US and around the world, and it's why you're seeing political unrest in the Middle East. People are angry because food has gotten outrageously expensive, and people in Egypt, Tunisia and other neighboring countries pay a much higher percentage of their income on food.

When people's bellies start growling, they get mad and take to the streets. Or as Gerald Celente says, “When people have nothing left to lose, they lose it.” And recent events in the Middle East have thrown a major monkey-wrench in the United States' foreign policy in this part of the world; and I believe it's on the verge of spreading to America. What was supposed to be economically feasible and positive in the US, has turned out to be politically unfeasible and volatile in the Middle East/North Africa.

Egypt had the misfortune of pegging their currency to the US Dollar in 2005. The Unintended Consequence they didn't anticipate, was that our Federal Reserve Chairman would be a monetary madman, doing his crazy money-printing experiment in the real world – where real inflation would lead to really bad consequences.

Although Bernanke claims to be a student of the causes and effects of the Great Depression, he's terribly wrong about his conclusion that the reduction in money supply and the fiscal restraint of the gold standard were the causes. Since the inception of the Fed in 1913, it did just the opposite – from February to July 1932, it purchased $1.1 billion of government securities (sound familiar?) to a total holding of $1.8 billion, while total bank reserves were only $212 million.

The gold standard provides a fiscal check and balance on governments, and takes away the temptation of excessive borrowing and spending. And history is littered with examples of failed fiat currencies (backed only by government decree) that allowed profligate government spending, and destroyed the wealth of its citizens. Take post-World War I Weimar Germany, for example.

Burdened with crushing war debts, the government cranked up the printing presses to pay them back with less-valuable German marks. In 1919, one US Dollar was worth 12 German marks. After just a few years of consistent money-printing, the exchange rate went parabolic with one US dollar equal to:

November 1921: 263 marks

January 1923: 17,000 marks

August 1923: 4.621 million marks

October 1923: 25.26 billion marks

December 1923: 4.2 trillion marks

Eventually, Germans were using stacks of their currency to heat their furnaces. As the Daily Reckoning reports, currency devaluations and hyperinflations aren't isolated or historical events. More recent examples of currency crises are: Mexico's "Tequila Hangover" in 1994... Thailand 1997... Russia 1998... Argentina in 2001... Zimbabwe in the 2000s.

Mark Twain said, “History doesn't always repeat itself, but it often rhymes.” And I'm hearing a very familiar tune in the US.

Bernanke and the Fed are walking a fine monetary line. If they don't keep pumping money into the system to keep "zombie banks" alive, credit will contract further and many banks will fail... and America will have to take some harsh economic medicine. If they stay the course, they risk even higher food prices everywhere around the world, more civil and political unrest in the Middle East, and a Treasury bond and currency crisis here at home. And America will take some harsh economic medicine.

Almost all Republicans and Democrats don't seem to have the stomach to make the tough spending cuts at the state or federal level. They want to continue to "kick the can" down the road, get re-elected and have someone else make the tough calls. And the Fed seems hell-bent on increasing the money supply in an attempt to keep what's left of the economic party going. But the unintended consequences of putting these decisions off, are more economic pain for the federal and state governments and American citizens in the future.

Like the mechanic said in the Fram filter TV commercial: "You can pay me now, or you can pay me later." I'll add my twist to that: Politicians will have to make tough decisions now, to avoid making tougher decisions later... or they may have to make both.

My hope - for the sake of our country - is that our leaders make these tough decisions sooner, instead of later.