Did Ben Bernanke really just say that?

dget — Sat, 10 Nov 2007 02:34:00 GMT

While addressing the House Financial Services Committee recently Federal Reserve Board Chairman Ben Bernanke said something quite astonishing. Responding to an absolute drilling from Representative Ron Paul, Bernanke claimed that the devaluation of the dollar will not affect the purchasing power of the dollar assuming the dollar is being spent in domestic markets. To quote the Chairman:

“If somebody has their wealth in dollars, and they’re going to buy their consumer goods in dollars, and it’s a typical American, than the decline in the dollar, the only effect it has on their buying power is it makes imported goods more expensive.”

Let’s analyze this comment for a moment. First, this seems to dismiss the fact that a substantial percentage of consumer goods are indeed imports. The devaluation of the dollar will necessarily increase the cost of those items to end-user consumers, which will assuredly have an impact on all rungs of society.

But what of the domestically produced items that Mr. Bernanke claims will not become more expensive in real terms? Indeed, assuming these products compete with foreign produced goods, they absolutely will increase in price. And to come to this conclusion, one needs only access a few very basic economic assumptions.

Consider first, as an example, the case of China and the repetitive devaluation of the Chinese yuan as a means of increasing export sales. The policy artificially reduces the value of the Chinese currency as a method of ensuring reduced prices for Chinese goods abroad. China uses this policy to prop up their labor market and reduce unemployment in their massive work force. Unfortunately, the policy creates an inverse effect for foreign imports, as the yuan has a reduced value on the global market.

The next and very easy step in logic, then, is that domestic suppliers are afforded an advantage in competition, as they are not subjected to the detrimental exchange rates imposed on the foreign producers. Let us now return to the present situation in the United States.

As has been noted, the devaluation of the dollar, much like with the yuan, will produce a situation wherein domestic suppliers now have an economic advantage against foreign suppliers. Is it likely, then, that those domestic suppliers will simply maintain their prices and reap a nominal increase in sales? Clearly, as even a very limited understanding of supply curves suggests, this will not be the outcome. Instead, on an aggregate level, the supply curve will shift to the left, resulting in an overall increase in prices on the market.

Ultimately, then, we can see a subsidization effect taking place. But where do the subsidization dollars come from? The answer is from the holder of the American Dollar through the indirect tax that is inflation. Let me restate this in other terms. Every inflationary move utilized by the Federal Reserve equates in to an indirect tax on American citizens through a devaluing of the legally stipulated domestic currency.

How, then, can Ben Bernanke, the Chairman of the Federal Reserve Board, possibly claim that the expansionary policies utilized by the Fed to prop up the economy will not have a meaningful effect on the average American? Well, he’s either lying through his teeth, or he fails to grasp some quite basic economic assumptions. Frankly, I’m not sure which would be worse.

You can watch a video of the exchange between Congressman Paul and Chairman Bernanke here.

dget : Inflationary Policy, Ron Paul

Did Ben Bernanke really just say that?