If you had to choose between an economic depression today and the risk of inflation sometime down the road, what would you do?
The answer is obvious but it is not always the same. If you are American or British, you probably will do whatever it takes to avoid the massive unemployment, rising poverty and other ills a depression would bring. We have seen inflation before. It was not that bad.
If you are German, you see things differently. Your country experienced hyperinflation in the past. People’s savings were wiped out. Industry stopped functioning. Eventually, high inflation led to depression anyway, with the same poverty and unemployment. It also paved the way for Hitler. Never again, say the Germans.
This is one reason German Chancellor Angela Merkel this week lambasted American and British central bankers for pouring a torrent of cash into the world’s financial system in recent months. She reportedly expressed “great skepticism” at the Anglo-American approach and called for a return “to a policy of reason, otherwise we will be in exactly the same situation in 10 years’ time.”
U.S. Federal Reserve Chairmen Ben Bernanke promptly retorted that he believes central bankers can extract themselves from inflationary quicksand before they sink too deeply. But he told Congress yesterday that U.S. lawmakers need to start bringing down the enormous federal budget deficit. The Fed will not monetize the debt, Bernanke said — meaning it will not simply print money to keep the Treasury from defaulting when the credit card maxes out.
Neither Bernanke nor Merkel are telling the full story.
If it comes down to a choice between printing new money and letting the U.S. Treasury go bankrupt, the Fed will indeed monetize the debt. It will have no other option, just as — after the experimental bankruptcy of Lehman Brothers blew up in everybody’s face last autumn — there was no choice but to support other big institutions. On our current path, the U.S. Treasury is going to be the world champion in the “too big to fail” contest.
Like everyone else in her country, Merkel understands full well the costs of a debased currency. This is why Germany has worked tirelessly to prevent the European Central Bank from becoming as loose with the checkbook as other central banks. If the Germans have their way, the euro, at least, will still be worth something even if the dollar is not.
But that is exactly why Merkel is so unhappy with the Fed. Germany’s economy runs on exports. A devalued dollar will make American exports much more competitive with Germany’s, even as it makes it harder for U.S. customers to buy German and other eurozone goods. With its costly social safety net, Germany has as much reason as America — maybe more — to favor a robust greenback. The price protection afforded by overpriced American products is a sturdy umbrella for Europe’s economy. Merkel’s uncharacteristic outburst hints that she knows full well that more storms are likely to follow the current one. She wants her country to stay dry.