Ben Bernacke, Another Bill Miller

October 31, 2005 – We all have heard of Ben Bernacke, who president Bush just recently appointed to be chairman of the Federal Reserve to succeed ‘Bubbles’ Greenspan when he steps down in January. But who is Bill Miller?

Probably not one person in a hundred can answer that question, so don’t feel bad if you don’t know who he is. I’ll give you a hint. His appointment was one of the best things that ever happened to the gold price. Does that help?

Bill Miller was appointed chairman of the Federal Reserve on March 8, 1978 by president Carter. The price of gold that day closed at $189.70. When Miller left the Federal Reserve just seventeen months later on August 6, 1979, gold had already climbed 48% to $281.40, and was just beginning its historic climb that would take it to $850 five months later.

Not all of gold’s meteoric rise can of course be attributed to Fed chairman Miller, but his actions – or more precisely, his inaction – were very gold bullish and the major impetus that set gold on its upward spiral. He essentially refused to raise US dollar interest rates to sufficiently high enough levels to keep people from fleeing the dollar in the worsening inflationary environment that prevailed in the late 1970’s.

Fed funds from the day of his appointment to his resignation only increased from 6.72% to 7.65%, which was not enough to save the dollar. This increase was well below the jump in gold and also kept interest rates below the rate of inflation, which was rising ominously and rapidly approaching double-digit levels.

Miller was a political hack. He did not want to worsen Carter’s already weak popularity with higher interest rates, as Miller knew that higher rates would deepen the widespread despair about what was then already apparent – growing economic distress and depressed economic activity caused by, among other things, raging inflation.

By propitious coincidence, I discussed the post-Miller environment in the last letter. Without mentioning Miller by name, I explained how Paul Volcker was appointed as Fed chairman. The point is that he succeeded Miller and did what Miller was too political – or perhaps too timid – to do. Volcker kept raising interest rates. I said:

“He [Volcker] used the only tool available to him to re-establish confidence in the dollar. He started raising interest rates as soon as he assumed office and kept on raising them. He needed to get people to move out from their gold and back into dollars, and he knew the only way to do this (without imposing capital controls, which I continue to expect are coming soon to the US) was to raise dollar interest rates high enough in order to entice – i.e., essentially bribe – consumers back into the dollar.

Volcker kept raising interest rates until they were much higher than the rate of inflation. In other words, real dollar interest rates (i.e., dollar interest rates less the rate of inflation) soared to record highs – levels that had been unimaginable only a few years before.

The record high interest rates did the job intended for them. They enticed a lot of people out of gold and other tangible assets, and moved them back into dollars so they could earn the high interest rates Volcker created. But Alan Greenspan is not doing this.” [Emphasis in original]

The point is that Bernacke will not do it either! He will not raise interest rates to save the dollar.

Though Bernacke is not a political hack and is thus not concerned about protecting Bush’s poll ratings as Miller was concerned in protecting Carter’s, Bernacke is an academic hack. He is a true statist who mistakenly but sincerely believes in government power and not free-markets.

Thus, Fed chairman Bernacke will follow Greenspan’s lead, jawboning everyone into believing that he is saving the dollar by raising interest rates. But in reality, he will keep real interest rates negative, just like Greenspan has done and for the same reasons. Bernacke will attempt to lessen the burden arising from the growing mountain of debt in this country as well as to maintain the illusion that the economy is on solid footing. This action will build the growing pool of liquidity, which in reality is excess dollars.

The excess dollars created by ‘Bubbles’ Greenspan funded the stock market and housing bubbles. The excess dollars now being created – and soon to be created by Bernacke – will fund the tangible assets bubble, just like the one created in the 1970’s. It promises to be a good time for gold.

In short, I can’t believe that Bush has appointed Bernacke; it is very good news for gold. But it is very bad news for free-markets, and more to the point, it increases the likelihood that capital controls will be introduced.

As explained in the last letter, the US economy is overleveraged. The federal government, most state governments, businesses and consumers are carrying a huge debt burden. So dollar interest rates cannot be raised today the way Volcker raised them, which puts the Federal Reserve in a box with limited alternative courses of action.

It can jawbone the market into thinking that it is acting to preserve the dollar’s purchasing power, but in reality neither Greenspan nor Bernacke is going to do what Volcker did to save the dollar – raise interest rates to the unbelievably high levels necessary to increase the demand for the dollar and entice people out of gold and other tangibles. So the statists like Bernacke will pursue their preferred option to preserve government management of a monetary system that will continue to be based on fiat currencies – Bernacke and his comrades will impose capital controls to maintain their power over this country’s command economy.

It is impossible to predict the exact controls to be imposed. It is easy to determine though what the purpose of these controls will be. They will try to keep people from fleeing the dollar. So my advice has been to flee the dollar now while you still can. The appointment of Bernacke just hastens the need to act.

There is one last point I would like to make. There is one major difference between Greenspan and Bernacke. It is clear that Greenspan understands gold, and the factors that cause the gold price to rise. Bernacke in my view doesn’t have a clue. He’s an academic who believes in the garbage that he taught, that government management of the monetary system is better than letting the free-market take care of it. In the best of circumstances this attitude is a recipe for trouble. In a Fed chairman it is a recipe for disaster.

So while I have never understood how Greenspan stooped to willingly manage a fiat monetary system that he knows to be inferior to that of the classical gold standard, with Bernacke it is clear. He has no understanding of the limitations of today’s monetary system and no self-doubt. He ‘knows’ that fiat currencies and government power are ‘better’ than gold. He ‘knows’ that he can manage this system.

That’s a tall order for an academic who never managed a business or needed to meet a payroll. It’s an impossible order for an arrogant statist who believes in government infallibility.

In summary, gold started climbing after the Bernacke announcement. It’s no secret why. His appointment is the best one that we friends of gold could ask for.