Bernanke: 'We Have Lost Control'

Economist Recounts Talk with Fed Chairman

By Joshua Boak
Chicago Tribune
Wednesday, September 17, 2008

http://www.chicagotribune.com/business/chi-wed_oilsep17,0,4833605.story

NAPLES, Florida -- Several months ago, economist David Hale had a private meeting with Federal Reserve Chairman Ben Bernanke, who was trying to ward off a recession by lowering interest rates and increasing the money supply in the economy.

The problem with that approach is that the value of the dollar plunged against foreign currencies, causing crude oil prices to skyrocket because oil is pegged to the dollar. It affected food prices, gasoline, and family budgets.

"Ben, you are playing a very unique role in world economic history," Hale recalled telling Bernanke, an expert in the Great Depression. "You are the first central bank governor of the United States to preside over a recession with no decline in commodity prices."

Bernanke could hypothetically limit inflation in commodities by raising interest rates, a policy that would restrict the flow of money but potentially lead to an avalanche of bank failures. At a financial conference in Florida on Tuesday, Hale, a Chicago-based economist for investment managers, hedge funds and multinational companies, paraphrased the Fed chairman's response.

"We have lost control," said Hale, quoting Bernanke. "We cannot stabilize the dollar. We cannot control commodity prices."

If efforts to stop a recession sent commodities to record levels through July, then the realization that a recession could be imminent has sunk oil prices by almost 40 percent during the past two months. For all the debate about foreign demand and financial speculators, one overlooked aspect of commodity prices is the health of the American economy.

With investment banks collapsing under the weight of subprime mortgages and the recent government bailout of Fannie Mae and Freddie Mac, commodity prices have retreated as the market predicts demand for oil will fall. October futures closed down $4.56 Tuesday, at $91.15 a barrel. And in response to inflationary concerns, the Federal Reserve responded Tuesday by holding the overnight federal funds rate steady at 2 percent as it has since April.

Hale believes the recessionary turns could keep oil below $100 a barrel, a consensus shared by many analysts who see oil staying in the $80 to $100 range.

But a problem for America is that much of the power it wields over oil prices is based on the strength of the dollar and economic demand. Russia, Venezuela, Ecuador, and others have nationalized their reserves, stripping ownership rights away from private firms and complicating the global market for oil.

"While every other country is practicing natural resource nationalism, this country still pretends there is a free market in energy when, in fact, there is not," said John Hofmeister, the head of Citizens for Affordable Energy and the former president of Shell Oil Co.

If there is any relief for American consumers to come from global markets, it might emerge from China, a country that has successfully wrestled down inflation. China insulates its population from the market price of oil, a policy shared by Malaysia, Thailand and India.

As inflation in China dropped to 5 percent from 8 percent, the government has begun to pass actual commodity costs onto the public, said James McGregor, a consultant and author of the book "One Billion Customers: Lessons From the Front Lines of Doing Business in China."

"I think you're going to see them squeeze down subsidies," McGregor said. "They don't like them either because they distort the economy."