the contrarian - BERNANKE UNDER FIRE

Earlier this week, the Federal Reserve Board declined to raise interest rates and, surprisingly, this may have been a factor in the Dow's 358 point drop today. It's surprising because generally the market is the first to celebrate a lower interest rate scenario.

In this case, the conventional wisdom is saying that Bernanke's principle concern should have been the threat of inflation, as higher and higher oil prices continue to send ripples throughout the economy. Indeed the central banks of many other countries are aggressively combating inflation by raising their key interest rates.

By going it more or less alone, Bernanke is raising the additional prospect that the dollar will fall further and such a development could cause even more upward pressure on domestic prices as foreign goods begin to cost more.

Critics are pointing out that no nation with a week currency for an extended period has ever had a vibrant economy. And Fox News is now reporting that the Wall Street Journal fell just short of calling for Bernanke to step down.

Meanwhile, as investors fled the equities markets today, deflating the value of every single stock in the Dow Jones Industrial Average, money surged into the investment sectors generally considered to be safe havens. The yield on the 10-year government bond is heading back towards 4% and the price of gold experienced its greatest one-day rise in history.

Even though it seems to be in vogue to pile on and pummel the daylights out of Bernanke, there is a contrarian viewpoint to consider.

First of all, those who spew the so-called "conventional wisdom" have rarely been right in the annals of economic predictions. Typically, these soothsayers continue to project whatever trend the economy is experiencing at the time. Personally, I can't recall a single instance when the "conventional wisdom" correctly anticipated a change in direction.

Secondly, we might well ask where these sages have been as we continued to steadily sink into the mire that now threatens to tear the global economy apart at the seams. I don't recall that the Wall Street Journal and the various other experts who are beating on Bernanke gave us any fair warning of the calamity that is now upon us. Most of the media was quite happy last fall, for example, to pass along without comment the straight-faced projection of President Bush that business conditions were just great.

So, how could Bernanke be right, and the current "conventional wisdom" be wrong? Well, consider this.

By not raising rates, Bernanke is saying that he is still more concerned about deflation than inflation. These are the two forever-battling forces in the economy, of course, and inflation almost always prevails.

Deflation - otherwise known as a period of "depression" - is the nastiest of business conditions and, as we well know, it has raised its ugly head on occasion.  A violent whirlpool is an apt comparison.

The vicious cycle of deflation can kick in at the end of an inflationary spiral as the economy falters and prices begin to fall. This causes industries to trim inventories to the bone, and even more importantly, it causes consumers to defer purchases as they anticipate lower costs down the road.

This begets layoffs which beget even lower sales which beget more layoffs and the cycle is off and running. In our brief experience with deflation we have learned one very important fact.  It is extremely difficult to break the cycle.

So you might well ask, at this point, isn't the prospect of falling prices rather remote, given all the talk of inflation?

The contrarian answer to this most important question is "no."

Normally inflation is driven upward by an overheated economy with higher wages in the forefront. That's not the case today. The current increase in prices is the symptom of a sick economy, not a hot economy. The impact of these higher prices is therefore deflationary. Their ultimate effect will be to stifle economic growth in exactly the same manner that higher interest rates would.

The contrarian view, therefore, is that, while his critics are looking at the situation as it exists today, Bernanke may be looking down the road - and it is there that he apparently sees extreme danger ahead.

The problem, however, is that he's getting so much pressure to join the herd of conventional wisdomites, he might just cave in and add higher interest rates to the other burdens that the economy is already struggling under.   In that event, hold onto your hat - or better yet - try to sell it.

Dave McGill, News Correspondent

Dave's column, "The Contrarian," generally published every Friday, to Gather Essentials: News will sometimes present a contrary view to various aspects of the news, or an alternate take on the conventional wisdom of the day, and will occasionally appear on another day of the week

Dave has been a senior officer of an eastern insurance company, involved in economic projections and investment strategy, president of a Midwestern mortgage banking company, and a financial consultant in Southern California, serving clients in the field of commercial real estate development.

You can find all of Dave's "The Contrarian" columns at: http://gather.com/thecontrarian...... Keep up with Dave's other postings and Gather activity by joining his Gather network - just click here: http://atadaskew.gather.com........ You'll find Dave and other News Correspondents, plus celebrity content and plenty of other News experts at News.gather.com.