Has Federal Reserve chief Ben Bernanke suddenly turned into an inflation fighter? To my knowledge, Bernanke has never before stressed the dollar’s decline, the inflationary dangers it poses and his intention to guard against these as much as he did yesterday.

The immediate reaction was for the dollar to rally and for gold and other commodities to sell off.

But think about it for a second.

Have things really changed? Have we suddenly now turned a corner and are about to get Paulson’s oft-talked-about, but never-delivered ’strong-dollar policy’? Has anything actually been done?

In a word, no.

“We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations,” said Ben Bernanke yesterday. “And will continue to formulate policy to guard against risks to both parts of our dual mandate, including the risk of an erosion in longer-term inflation expectations.”

Let’s have that again in English. “Yes, we have noticed that the dollar is going through the floor, and we are aware that we’re meant to care about inflation, and not just about the level of the Dow Jones.”

Could Bernanke have changed his inflationary philosophy overnight?

Strong words indeed. But the first thing to remember is that these were just words. They were not actions. Almost without exception, every action the Fed has taken in recent years, from lowering rates to injections of liquidity, has been to create inflation, not to fight it.

A man does not change his philosophy overnight. Let’s remind ourselves of Bernanke’s. In 2002 he said, “people know that inflation erodes the real value of the government’s debt and, therefore, that it is in the interest of the government to create some inflation.” It is also worth reminding ourselves of the unprecedented and dangerous levels of debt America holds, both individually and nationally. Inflating away the value of the currency has been and remains America’s easiest short-term solution to its problems.

If the Fed meant what they said about a strong dollar policy and fighting inflation, we would see Paul Volker-style interest rate rises (Volker was the Fed governor in the late 1970s and early 1980s, and had to take interest rates well into double-digit levels to combat inflation). But we are not seeing any such thing. Nor is any such thing possible in today’s debt-ridden environment. They would be crippling. What’s more they would be deflationary and deflation is something Bernanke will not tolerate. At Milton Friedman’s funeral he said regarding the deflationary 1930s, ‘You’re right. We did it. We’re very sorry. But thanks to you, we won’t do it again.’

How the Fed are putting the ‘con’ into confidence

The Fed seems to be trying to create a situation whereby they are seen to be fighting inflation, simply by not lowering rates any further. This is because, while the Fed may have no interest in fighting inflation, they have a big interest in fighting what they call ‘inflationary expectations’. In other words, they are more interested in fighting people’s perception of the problem, rather than the problem itself.

They seem to think if people do not see a problem, then there is no problem. As Ian McAvity puts it, they are putting the ‘con’ into confidence. It is the old politician’s trick of saying one thing and doing another. ‘Look over there,’ shouts the magician, the Wizard of Oz. ‘A strong dollar policy’. And everyone looks over there to see a strong dollar policy. Meanwhile, over here, a bucket load of money is emptied onto the audience.

The problem is that when inflation spread into homes and stocks, everything was just fine – unless you were a saver who rented of course. Now that inflation has moved from asset prices into energy and food, then there is a real problem for those who were unprepared, such as our very own Gordon Brown.

We saw the inflationary reaction of the Fed and the Bank Of England to the subprime crisis and the subsequent credit crunch. The notion that the worst is behind us is tosh. All that is behind us is the first wave of an ongoing financial crisis – perhaps a couple of cavalry charges. We still have the infantry, the artillery and the rest of the cavalry to get through before this is over.

The next wave will be in the form of a derivatives crisis: the oft-mentioned collateral debt obligations and credit default swaps. It is apparent that few people really understand what they are and how deep they go. That is bad news. Because it means when the crisis hits, people are more likely to panic. Panics tend to be disproportionate to the problem, particularly when trust in institutions has disappeared, as is the case with banks today.

Source: The Truth Behind Bernanke’s Fears for the Dollar