By now you have heard all of the fears of the inflation spectre.  After printing money, buying up hundreds and hundreds of billions of billions worth of securities, and bailing out the banks and the auto sector… It had to lead to far higher prices.  Didn’t it?  So what happens when oil prices go through the floor and the price pressures are not just soft?  That pesky word of deflation arises.

John C. Williams, President and CEO of Federal Reserve Bank of San Francisco made a presentation to the Western Economic Association International today and it is possible that if this message becomes unified then other so called Fed-heads will start to echo about the worries of deflation rather than inflation.

Williams noted that the Federal Reserve has more than tripled the monetary base and many commentators “have sounded an alarm that this massive expansion of the monetary base will inexorably lead to high inflation.” With inflation running at 2% or less for the last four years and expected to remain low for at least the next ten years, you can probably guess where this going…

He said, “In my view, recent developments make a compelling case that traditional textbook views of the connections between monetary policy, money, and inflation are outdated and need to be revised. As always, my remarks represent my own views and not necessarily those of others in the Federal Reserve System.”

OK, so this is not Fed policy nor Ben Bernanke’s outlook now buy it is one voice. Williams said that U.S. currency holdings have risen about 35% and nearly two-thirds of U.S. currency is held outside our borders as a safe haven.

What is interesting is that the word deflation is never mentioned once in the entire presentation’s prepared remarks.  It is something that you have to read in between the lines about as you can see below:

“As I noted earlier, inflation and inflation expectations have been low for the past four years, despite the huge increase in the monetary base. Of course, if the economy improved markedly, inflationary pressures could build. Under such circumstances, the Federal Reserve would need to remove monetary accommodation to keep the economy from overheating and excessive inflation from emerging. It can do this in two ways: first, by raising the interest rate paid on reserves along with the target federal funds rate; and, second, by reducing its holdings of longer-term securities, which would reverse the effects of the asset purchase programs on interest rates.”

The good news is that Williams gives a clearer picture of the ‘exit strategy’ that the FOMC will need to make when things merit higher rates and holding less in securities.  In this case it is the same tools as before in what he called taking away the punch bowl but monitoring the timing and the extent: “Of course, getting the timing just right to engineer a soft landing with low inflation is always difficult. This time, it will be especially challenging, given the extraordinary depth and duration of the recession and recovery. The Federal Reserve is prepared to meet this challenge when that time comes.”

FULL PRESENTATION

Any time that analysts, economists, and market pundits start putting words into the mouth of a Fed-head it can be dangerous. Still, in his comments after the presentation Williams said that the one thing that the Fed has been pretty successful at is keeping inflation low and avoiding deflation.

Oil has risen back well above the $80 mark after the jump from the European Central Bank’s pledge to directly aid banks rather than nations.  Still, oil was above $105 per barrel at the end of April and $110 at the end of February.  When oil prices fall, the cost of producing goods and delivering those goods comes way down.  It is probably too soon to make the case that the Fed is now suddenly growing fearful about systematic deflation taking hold.  Still, when you hear a speech that is all about inflation being under control after a huge increase to the monetary base, it is impossible not to think that if prices remain soft that “the D-word” of deflation will become more targeted.

JON C. OGG

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