You Can Still Game The System: Ben Bernanke

by: John M. Mason

Fed Chairman Ben Bernanke told the US Congress that Federal Reserve asset purchases will continue. Quantitative easing is to continue.

According to the Financial Times, Mr. Bernanke was "in a combative mood." Well, when you have to be on the defensive…you are generally in a combative mood.

The article presents several problems that Mr. Bernanke is facing, problems he says must be taken into consideration when judging the Fed's current monetary stance. First, there are gasoline prices. These higher prices are "hitting family budgets," and this is of particular concern since there is the expiration of the payroll tax break, something that was already squeezing consumers.

Second, is sequestration. Mr. Obama's idea of sequestration is rapidly becoming a reality as the deadline to deal with these cuts is approaching.

Third, there is the eurozone. What can one say here. The comedy continues on. Haven't politicians observed how silly their behavior has become?

And, then, there still is the weakly growing economy. The risks of continued quantitative easing? Well, Mr. Bernanke replies that there is little evidence that price inflation is heating up. (More on that later.)

So, the smart investors can still continue to "game" the system.

This "gaming" of the system is blatantly suggested by Bill Gross, the founder and co-chief investment officer of Pimco. He takes a little different path…he brings in all central banks that have been pushing quantitative easing.

"Today's quantitative easing policies - at least in G-10 countries - are not really currency wars against each other. Instead, they are rather uniform expressions of artificial asset pricing and financial repression in a rather obvious attempt to reflate their respective economies."

What should an investor do? Mr. Gross suggests, "don't fight the central bank in the intermediate term."

Damn! This sounds like something I wrote a month ago…"Don't Fight the Fed: the Continuing Saga" And I followed this up this week with "Bernanke is Underwriting the Wealthy."

The point of all this fuss is that the Federal Reserve, in its efforts to "do good" is setting up those who can, with a "gimme putt!"

The Federal Reserve has been running a monetary policy of excessive ease for several years now. In Mr. Bernanke's inability to understand financial markets, he has persistently strived to have the financial markets understand what monetary policy is trying to do through additional press conferences and "clearer" policy statements.

Mr. Bernanke stands in front of the press…and Congress…and others in making speeches…and pleads…"Please Understand Me!"

Well, Mr. Bernanke, Mr. Gross understands you…and Mr. Soros understands you…and Mr. Kravis understands you…and Mr. Roberts understands you…and Mr. Schwarzman understands you.

We have seen this kind of official behavior at the White House and at the Treasury…we have to keep unemployment really low and we have to make sure that every American owns their own home. And, this must pursue this goal year in and year out through government spending and tax reduction. Well, Mr. Gross and Mr. Soros and Mr. Kravis and Mr. Roberts and Mr. Schwarzman understand this as well. This debt creation policy is what I have referred to as credit inflation.

It really bothers me that economists can stand around and state that the problems in the economy are due to the reductions in market restrictions and the greater economic freedoms that have been granted to the economic system.

They don't take into consideration that an overt policy of credit inflation conducted for more than 50 years is not going to change the behavior of people. Yes, employment may have been higher than it otherwise might have been and more people have owned their own homes. However, these too have created structural problems in the economy and misallocations in the housing market and the financial system.

Still, to me the most dominant effect of 50 years of continually supplying the US economy with credit inflation is that investment behavior changed. The credit inflation basically gave some people a "sure thing" bet. How dumb does the government think some investors are? If you are going to create a policy and steadily apply it…through Republican as well as Democratic administrations…for 50 years, how long do you think it will take some "savvy" investors to catch on to what you are doing and begin to "game" the system?

Why do you think that the income/wealth distribution became so skewed over the past 50 years? Why do you think that General Motors (NYSE:GM) and General Electric (NYSE:GE) were earning more than 50 percent of their profits from their financial subsidiaries? Weren't GM and GE supposed to be manufacturing firms? And, people are worried about manufacturing jobs going overseas.

And, why do you think that the financial interests and other individuals with access to either money or to financial expertise seem to be raking in the money in the current renewal of credit inflation?

Irving Fisher, the Yale economist who wrote in the early 20th century, discussed the velocity of money. But, there were two components of the velocity of money…the component related to the real economy…and the financial component. You can have money moving around the real economy and this can contribute to consumer price inflation. But, you also can have money moving around in the financial markets in something we can call credit inflation.

In the latter part of the 20th century credit inflation accelerated and so did the velocity of money flowing through the financial stratosphere. Every dollar of high-powered money produced by the Fed went into more and more and more debt creation, derivatives, swaps and CDOs, and CLOs, and so on.

This credit inflation is speeding off right now and it appears that over the last six months or so that the "financial" velocity of money has been accelerating. The velocity of money circulating in the real economy, however, seems to be staying relatively constant or even slowing. And, under-employment remains remarkably high.

And one might add that the figures on Consumer Prices have been so altered by those in Washington that it is hard to tell what is happening to prices in the current environment.

Do you think that there is any chance that the income/wealth distribution might increase even further? I certainly think there is more "gaming" to go on: "Bernanke Eases Fears Over Early End to QE3."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.