Will Bernanke Become 'Hurricane Ben'?

If the American economy begins to recover to the degree that businessmen are willing to borrow and bankers are willing to lend to them, the monetary base that the FED holds will at long last push up consumer spending by the employees of businesses. The M1 money multiplier statistic will increase as people spend this money on customer goods.

At that point, the FED will have to decide how to offset this in order to head off major price inflation. If it does not sell assets, mainly Treasury bonds and Fannie Mae and Freddie Mac mortgage bonds, it will face mass inflation (15% to 25%). If commercial banks still lend, the near tripling of the monetary base in 2008-10 will produce a near tripling of consumer prices. That will be the hurricane.

At some point, all central bankers will face this decision. They can continue to buy assets, thereby increasing the monetary base. But this increase will produce hyperinflation. This has happened after major wars among the losers. The German and Austrian inflations after World War I are legendary. Even worse was the hyperinflation of Hungary after World War II. In our day, Zimbabwe's hyperinflation early in this century became the worst since Hungary's.

No major West European government has experienced this. The German economy from 1945 until June of 1948 was a ration-based economy. It had repressed inflation. The Allies printed paper money. Then they imposed price and wage controls to hold down inflation. Production then shifted to the black markets. This ended the day after Ludwig Erhard unilaterally abolished the price controls and shrank bank money by 90%. General Clay, who was in charge, backed him. The German economy revived. That was the basis of the "economic miracle" – a miracle only in the eyes of the price controllers.

If Bernanke decides to stop buying U.S. government debt and all other forms of debt, and the FED ceases to create new reserves, there will be a recession. If the FED sticks to its guns, the fractionally reserved banks – very large banks – will fail. That will shrink the money supply. That is what happened in the United States from 1930 to March 1933. About 9,000 banks failed. The FED bailed out the biggest ones.