Unfortunately, Chairman Bernanke was not content to reject a price rule; he tried to mimic Greenspan's famous Oracle-like mumbo jumbo: "Rather (than a price rule), the Federal Reserve, together with all modern central banks, has found that the successful conduct of monetary policy requires painstaking examination of a broad range of economic and financial data, careful consideration of the implications of those data for the likely path of the economy and inflation, and prudent judgment regarding the effects of alternative courses of policy action on prospects for achieving our macroeconomic objectives." Huh? In other words, "The Oracle is dead; long live the Oracle."
Here is the lesson the new Fed chairman must learn immediately if he is not to allow himself to be whipsawed trying to adjust to contemporary inflationary impulses over which he has no control by using backward-looking models and non-rigorous impressions, which will only intensify the turbulence and reinforce problems by untimely actions.
The rule is simple: too much liquidity, inflation; too little liquidity, deflation. The best way the monetary authority can know whether it is injecting the right amount of liquidity is to watch price-sensitive indicators, like the price of gold.
As economist Donald Luskin at Trend Macrolytics pointed out recently, inflation from excessively loose monetary policy during the past couple of years is now baked in the cake, and "there will be a great deal more inflation than anyone expects now - and a lot more market turbulence." Chairman Bernanke must come to terms with the fact that there is little beyond instilling confidence in his future leadership of the Fed that he can do to dampen that turbulence through monetary policy but there is a great deal he can do to amplify it. We must ride it out with an eye to smooth sailing on the other side.
As the inflation wave begins to crest, the Bernanke Fed scrupulously must resist the temptation to clamp down on monetary policy. The central bank can't stem the inflation wave that was generated in the open seas of excessively loose monetary policy a couple of years ago. Instead, the Fed should keep its eye on price-sensitive indicators that convey the inflationary outlook for after the wave hits. Right now, it appears, we could be right on the cusp. If the price of gold has indeed peaked, now is the time to set monetary policy by what Jude Wanniski used to call the "Golden Polaris," the price of gold.