What Sherman Did to Atlanta

Imagine what trying to fight inflation with high rates would do to America's economy today...

AND NOW for the bad news, says Bill Bonner in his Daily Reckoning.

As far as we could tell, the Obama team only had one good man on it...former Fed chief and Daily Reckoning hero Paul Volcker. But word came last week that Volcker is out as head of the president's economic advisory committee.

Dear Readers are reminded that Volcker saved the day back in 1979. He pledged to cut inflation. He kept his word. It wasn't easy. He put interest rates up over 15%...at a time when Consumer Price inflation was running at 13%. And Ronald Reagan backed him up.

If you're going to get control of inflation you can't trail the CPI. You have to get ahead of it. Which is why Bernanke's pledge is such nonsense. He says that as inflation rates go up, he'll put up the key Fed lending rate to 2%. He's already increased the monetary base to 3 times what it was under Volcker. He's committed to raising it another 33% by the end of June, bringing it to 4 times its 1980s level. When all that latent inflation becomes real inflation we'll see prices rise more than just 2% per year. We'll see them fly.

What we won't see is Ben Bernanke getting ahead of them by putting rates up even more than inflation. It won't happen. Because it goes completely against the grain of Ben Bernanke's theories.

The US is in a Great Correction. Bernanke thinks it needs stimulus, not austerity. When inflation rates finally begin to go up, he'll dither. He won't want to put up interest rates at all. At first, he'll hope that it is just a fluke. He'll delay. He'll hesitate. He'll stall. At first, the rise of inflation will be confused with a growing economy. Prices will move up. Consumers will spend money just to get rid of it. Businessmen will think they have more demand on their hands. They may even hire more workers. Stocks may go up.

Bernanke won't want to nip this "recovery" in the bud. "Growth" – even with inflation – is better than no growth, he will reason.

Then, when CPI is really getting up some real speed...and the inflation rate is headed towards 10%...he'll realize that it is too late. The only way to get ahead of it would be to "pull a Volcker"...and bring the whole economy down around him – like Volcker did.

But Volcker was still dealing, three decades ago, with an essentially healthy economy. It could survive the fall. Today, the economy is much heavier...and more fragile. Debt levels are three times what they were back then. Stocks are high, with a long way to fall too. And unemployment – as we saw above – is already about 12%, with mortgage rates still near 50-year lows.

Imagine what would happen with the prime rate above 10%. Who would hire anyone? How could the US finance its deficits? What would it do to the US economy?

We don't know...but we'll guess that Sherman did less damage to Atlanta. So instead, inflation will run wild.

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