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Bernanke an Inflation Pollyanna? Bill Gross Thinks So

Federal Reserve Bank Chairman Ben Bernanke
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Federal Reserve Bank Chairman Ben Bernanke

For monetary policy hawks, Fed Chairman Ben Bernanke’s latest strategy could be seen as a small victory. The central bank head at least has gotten around to mentioning inflation, even if he isn’t quite ready to do anything about it.

Bernanke delivered a policy speech Monday in which he declared recent inflation pressures to be “transitory” and of no major threat to the economic recovery. Ultimately, he did acknowledge that his assumptions could be wrong and promised to monitor the situation closely, but gave little indication of major care about the inflation problem.

On cue, the commodity markets continued their nearly unabated rally Tuesday.

Brent crude oil surged past $122 a barrelto approach its record high; silver prices briefly eclipsed $39and most traders believe $40 is only a matter of time; and gold plowed past $1,450 an ounce as the classic inflation hedge paid little heed to the chairman’s words.

Bernanke and other doves believe the blinding surge in commodities and associated input costs won’t pass through to consumers.

But with an increasing array of indicators suggesting otherwise, that viewpoint becomes harder to sustain.

Inflation deniers received a public scolding Tuesday from Bill Gross, head of bond giant Pimco, who told CNBC it’s naïve to keep thinking that the threat will pass.

Specifically, Gross took aim at the concept of “mean reversion,” which suggests that over time everything more or less finds a normal range and that’s what will happen to inflation once geopolitical turmoil comes to an end.

That view, he said, ignores the role that emerging markets are playing in the economy.

“The emerging and developing world is different these days. They’re less wage-sensitive and they’re more commodity-sensitive,” Gross said. “In other words, citizens are demanding more for their money and they’re reflecting that in the form of higher commodity prices. To expect that to revert over the next several years is a little pollyannaish.”

Indeed, in the age of increasingly common and impactful black swans, conventional models and the limited thinking they bring are coming under intense fire.

A good portion of the inflation debate is centered on whether the focus should be on the core or headline numbers. The latter includes food and energy costs, which are excluded from the core because, ostensibly, they are more volatile.

But Michael Pento, senior economist at Euro Pacific Capital in New York, earlier this week penned an essay—titled “Core Incompetency—arguing that the volatility argument would hold only if food and energy were volatile above and below core inflation.

Rather, he contends, the numbers are stripped out for a more nefarious reason—because the government seeks to obfuscate when inflation is heating up.

“Once you understand this,” Pento writes, “it becomes much more plausible to argue that the Fed excludes food and energy not because those prices are volatile, but because they are high.”

Consumers and others outside the Fed seem to know the difference between the two measures.

The Conference Board has reported that one-year inflation expectations are at 6.7 percent, against the record of 7.7 percent, while the University of Michigan Consumer Sentiment Survey has the number at 4.6 percent, near the 5.2 percent record.

Moreover, Hershey’s recently said it’s raising prices nearly 10 percent, and Wal-Mart’s CEO Bill Simon said consumer price increases will come “at a pretty rapid rate.”

Still, that doesn’t mean Bernanke is without allies.

Goldman Sachs economist Jan Hatzius, in a research note, said there is only “modest upside risk” to inflation despite the expectation surveys.

And Fed presidents Dennis Lockhart and Charles Evans said in recent days they are both in line with the chairman. New York Fed President William Dudley and San Francisco Fed President Janet Yellen also remain reliable allies.

“That’s a pretty powerful contingent,” said Gross, who believes the Fed’s hand eventually will be forced on the inflation question. “And so I suspect that they, along with a few others, will carry the day.”

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