Treasuries (TLT) Are Rallying Because Ben Bernanke is Throwing the Inflation Game!

Sometimes, people will deliberately lose a contest that they are ostensibly trying to win, the way John McCain did in the 2008 presidential election. This will be because they have an ulterior motive.

Ben Bernanke and the Federal Reserve have been talking a good game for over a year about inflation - which fooled lots of other hedge fund managers - yet our deflationary depression shows no signs of ending. So you have to wonder, is Ben "throwing the inflation game"?

Most people have read the Ben's speech, Deflation: Making Sure "It" Doesn't Happen Here, which he gave in 2002 while he was a Fed Governor. This speech convinced many that Ben was the deflation "doctor," brought in specifically to cure the depression by running the money press:

I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief.

But suppose that, despite all precautions, deflation were to take hold in the U.S. economy and, moreover, that the Fed's policy instrument--the federal funds rate--were to fall to zero.

Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.

These comments made investors really, really confident that Ben could and would stop deflation in its tracks. [Note that the conditions he describes in paragraph two are exactly where we are today.] But, in that speech, Ben went further and actually told us what he would do to prevent deflation:

• commit to holding the overnight rate at zero for some specified period
• begin announcing explicit ceilings for yields on longer-maturity Treasury debt
• attempting to influence directly the yields on privately issued securities
• buy foreign government debt, as well as domestic government debt
• use Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money

Ben hasn't done any of this! Could it be that he actually isn't interested in stopping deflation yet? Could it be that my deflationary theory is correct?

It seems clearer and clearer that the Fed won't use any of these inflationary tools unless and until the Treasury has refinanced its massive short-term obligations into something longer-term.

This speech also confirms one of my favorite principles, never believe anything until it has been officially denied, when Ben says, "I believe that the chance of significant deflation in the United States in the foreseeable future is extremely small."