Ben Bernanke and the Honey Pot

When my two girls were a few years younger, they were huge fans of Winnie the Pooh, one of the true children’s classics. At bedtime I would read them episodes from Pooh’s adventures in the hundred-acre wood nearly every night. They just couldn’t get enough.

One Pooh story in particular comes to mind this week. In this tale, Winnie the Pooh is so intent on licking the last drop of honey out of the pot that he gets his head stuck in the jar.

Ben Bernanke apparently never heard this story as a child – or certainly didn’t take the lesson to heart. That’s because Bernanke and the Fed are now “stuck.” It’s an unenviable position, but it's of their own making.

The Fed has been all over the map in response to the credit crunch that began last year. First they ignored it in the summer of 2007, keeping rates steady at 5.25%, while saying the fallout from subprime would be limited.

Later, after $400 billion in Wall Street write-offs, the Fed decided to slash rates to the bone, and bail out Bear Stearns with $39 billion in taxpayer money.

More recently, inflation is the Fed’s main concern. The Fed hinted strongly that rates must go higher to backstop the value of the slumping U.S. dollar, and to keep inflation in check. Yesterday, however the Fed did nothing, leaving rates unchanged. More empty talk from the Fed.

In its official policy statement the Fed said on the one hand: “Recent information indicates that overall economic activity continues to expand...”

But on the other hand: “uncertainty about the inflation outlook remains high...” due to “increases in the prices of energy and some other commodities.”

So in conclusion: “Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased.”

Bernanke’s in a box. The Fed is stuck in a honey-pot of indecision while the twin threats of asset-price deflation and commodity-price inflation take a heavy toll on the economy.

When you net out all the Fed’s double-talk, they appeared to adopt a tightening bias yesterday, but of course didn’t raise rates. So the worst of all worlds continues: stagflation!

In a TV interview yesterday Warren Buffett shared his views on the economy and inflation. He said: “I think the `flation' part will heat up and I think the `stag' part will get worse.”

When asked what he’d do if he were in Bernanke’s shoes he said: “I'd probably offer my resignation.”