The high inflation of the 1970’s gave birth to two phenomena: The “whip inflation now” mantra, and the Bond Market “vigilantes”. The term whip inflation now, was coined by the Ford administration in order to enact a change in the national psyche regarding the explosion in the overall price level. The term bond market vigilante referred to those in the U.S. Treasury Bond Market who would hold government accountable, via price, for bringing inflation back down to acceptable levels. Fast forward almost four decades , and the situation could not be more 180 degrees removed from the situation that existed in the late 1970’s. Today, we have a government, under the guise of the Fed, that is doing all it can to fan the flames of inflation while assuring us that this conflagration will remain under control. If we had Paul Volcker in the 80’s trying to stamp out inflation, even at the cost of GDP growth, we now have his evil twin Ben Bernanke trying to stir it up. As far as the bond vigilantes are concerned, the only thing bond market participants are vigilant about is the degree to which the government will remain the marginal bidder.
In fact, the Fed is so desperate to counter the affects of deflation on the economy that it recently came out with a paper extolling the virtues of a rising oil price. This paper stated that ” The burst of inflation from an oil price increase lowers real interest rates at the ZLB (zero lower bound) and stimulates the interest-sensitive component of GDP, offsetting the usual contractionary effects. In fact, if the increase in oil prices is gradual, the persistent rise in inflation can cause a GDP expansion”. And if you thought commodity prices were the only target of Fed policy, examine the chairman’s speech regarding the pre-announcement affect of QE2 ” stock prices rose and long-term interest rates fell. Easier financial conditions will promote economic growth… higher stock prices will boost consumer wealth and help increase confidence which can also spur spending”. Expectations targeting is now official Fed policy and if you were suspect of this before, the previous statement should put your reservations to rest. Once again, the Fed is trying to shove us all back in the risk pool. The unintended (wink, wink) collateral damage from such actions will be a decline in the dollar. However the Fed white paper justifies the overall decline in the dollar/rise in commodity prices for its stimulative effect on growth.