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Social Unrest...


It is an exercise in contrasts seeing Mr. Bernanke appear before Congress and reading some of the stories Kevin Depew linked to regarding labor unrest. The trend worldwide has been for greater and greater labor unrest over the past year, a trend we believe will only increase as the next few years unwind. Why a contrast? Because we believe the Fed is the cause of social unrest.

At present, China and India are secular deflationary forces in the world, as is the information revolution, free trade, and the globalization of financial markets. Each are creating lower consumer goods prices; all other things being equal, this would be a very good thing for you and I since we're paying less for more. But the Fed, despite the very clear historical and theoretical benefits of deflation on standards of living, abhors deflation. We won't get into the reasons why they are so fearful (though John has a very good idea), suffice it to say that one of the periods of greatest economic growth and greatest increases in standards of living came during a "deflationary" period.

Between 1870 and 1900 the wholesale price level fell about 1.5% per year; real incomes increased about 5% per year, meaning that actual living standards improved 85% over that period. Eighty five percent. In Money, Prices, and Growth, The American Experience, 1869-1896 George Edward Dickey writes: "Such a supply or cost-induced deflation does not have the same deleterious effects as a demand-induced fall in prices.... Deflation in this case is a direct result of the rapid growth of output and is not an inhibitor to growth...The nineteenth century American experience demonstrated that economic growth is compatible with deflation."

Without the Fed creating massive amounts credit - increasing M3 so rapidly and aggressively and keeping short term interest rates well below the natural rate for so long - the current benign (nee beneficial) secular deflationary trend in the world would benefit workers: though their wages and salaries would likely decrease (as a function of the vast increase in the pool of available labor from China, India, etc.), the cost of living would decrease more rapidly. Thus the standard of living for most folks would be increasing. Such are the dynamics of supply-side deflation. This is almost exactly what took place between 1870-1900, one of the most rapid increases in economic activity in the history of the US.

But the Fed, because of their unnatural fear of these deflationary forces instead pumps excess credit into the system. That credit finds its way primarily into speculative hands (hedge funds, etc.) and pushes up soft and hard commodity prices (and assets) and thus the PPI. This puts consumers (and businesses) in the worst possible situation: cost of living is going up while wages are going down. While the secular deflationary trends from China, India, technology, open financial markets, etc. are decreasing wage and salary rates, the cyclical inflationary forces created by the Fed keep those benign deflationary effects from reaching consumer goods. Thus we have real wages - wages less CPI - being negative since 2004.

Cornered thusly, the middle class - unable to make up the difference between wages growth and CPI growth via stock speculation or home equity extraction - are caught between the Scylla of wage deflation and the Charybdis of consumer goods inflation. Such economic pressures have - throughout history - lead directly to social unrest: to labor strikes, to increased tensions between management and workers, to new laws aimed at curbing 'excessive' CEO pay packages. There are bills before Congress as we write purporting to do just that. Thus the Fed is the cause of social unrest.

Thus seeing Mr. Bernanke trot out the old canard that the Fed's policies are good for middle class standard of living is especially galling. It's an abject lie.

Tough way to start a new job.
No positions in stocks mentioned.

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