No Exit for Bernanke

In a Wall Street Journal op-ed on Monday, and in congressional testimony later in the week, Fed Chairman Ben Bernanke reassured all that thanks to his accurate foresight and deft use of the Fed's policy toolkit, he could maintain near zero percent interest rates for an extended period without creating inflation. With supernatural powers such as these, one wonders if Ben would be better employed by the Justice League rather than the Federal Reserve.

Ben's game plan is apparently simple: once he determines that the economy is on solid ground, he will use the monetary equivalent of Superman's laser vision to strategically evaporate all the excess liquidity that he has recently created without endangering the recovery. Don't try this at home, kids.

In other words, as he did just a few years ago when the subprime fiasco began to emerge, Bernanke is assuring us that inflation is contained. He is just as wrong now as he was then.

The idea that the inflation genie can be painlessly rebottled has no historic precedent. Even mainstream economists, who've never met a fiscal stimulus they didn't like, agree that central banks must act preemptively with regard to inflation. Bernanke is making the case that the new set of liquidity tools, hastily developed in the panic of late 2008, will act just as well in reverse. But liquidity is a lot like liquid, it's a lot easier to spill than to un-spill. The Chairman believes that his new gadgetry will allow him to perform a feat of monetary magic no other central banker has managed to pull off. But given his history of getting it wrong, why should we assume that this time he will get it right?

The bottom line is that Bernanke has no exit strategy. He can talk about it all he likes, but when it comes time to actually pull the trigger, his nerves will buckle. The current communications campaign is simply an attempt to calm the markets. I doubt few citizens or members of Congress had any hope of understanding the exit strategy mechanisms that Bernanke described. Many likely place their faith in his seeming mastery of financial minutiae. Sadly, as with the mythical “strong dollar policy,” confident talk may be the sum total of the Chairman's strategy.

He senses that the villagers, in the form of currency traders and bond market vigilantes, are becoming a bit restless. To sooth their concerns, he must pretend that he has the situation under control. Like Jack Nicholson in A Few Good Men, he knows full well that markets simply “can't handle the truth.”

But make no mistake, in order to mop up all the excess liquidity, the Fed will need to raise interest rates substantially to attract buyers for all the bonds that the Treasury must sell. Fed officials know that our economy is completely dependent on cheap money and limitless government credit, and can't tolerate the loss of either. Of course, the longer the monetary spigot remains open, the more addicted to low rates we get, and the harder it will be to kick the habit. If the Fed could not remove the punch bowl during the years before the bust, how will they do so while the economy is far weaker? Even if they do start the process, the minute the “recovery” seems in jeopardy, look for the Fed to turn the showers back on.

Also, paring down the Fed's bloated balance sheet will require selling hundreds of billions of dollars of toxic assets, such as bonds backed by subprime mortgages, credit card debt, and auto and student loans, back into the market. Finding buyers for such sludge without crushing the market is a trick that Houdini himself would be reluctant to attempt.

The Fed's assumption that the assets will no longer be toxic by the time it sells them is farcical. The economy at large has not yet suffered the full weight of the recession because these assets have been largely quarantined at the Fed. Reintroduce these toxins back into the economy and the reaction could be lethal.

Bernanke also mistakenly expressed optimism that a strengthening global economy would aid our recovery. Unfortunately, a global resurgence will force Bernanke's anti-inflation hand, and will thereby cause more pain to the U.S. economy.

Few appreciate how the global panic of 2008 actually benefited the U.S. by causing a flight into U.S. dollars and Treasury bonds. The resultant flows put a lid on consumer prices and kept interest rates low. As growth overseas resumes, and these flows reverse, both consumer prices and interest rates will rise.

Further, as current policy prevents the structural imbalances underlying our economy from being corrected, U.S. unemployment will continue to rise. Combined with higher interest rates and rising consumer prices and the Misery Index (inflation + interest rates + unemployment) will be a big issue in the 2010 mid-term elections, and an even bigger one in 2012.

Comments

[D. McHattie:]

"As growth overseas resumes... both consumer prices and interest rates will rise."

Exactly. Price inflation will come from abroad as our trading partners come to recognize the USD as the toilet paper that it is.

Jul 26 11:13 AM

[ScroogeMcduck:]

lol, I love your Sarcasim Peter. Just picture Bernanke in neon colored spandex with a cape fighting the evil of inflation.

Jul 26 11:46 AM

[Davewmart:]

Inflation will be a brick on a piece of elastic.
It will go down, down, down, seemingly forever.
But when it bounces, it will come all the way and hit the economy in the face.
Bernanke in control? Let's be serious.

Jul 26 12:38 PM

[msgtb:]

Has any one noticed that since Obama took office that no government officials are talking about Moral Hazard?

Good luck and good trading

Dave

Jul 26 02:07 PM

[437339:]

Re

Great article Peter ! Poborsky + leftfield are correct . Folks , see site 24hGOLD - go to commentaries column , far right , 3rd article down , by Robert Chapman , International Forecaster , is a MUST READ !

Jul 26 04:26 PM

[Fighting Yoda:]

Well said Peter: “ - Fed's assumption that the assets will no longer be toxic by the time it sells them is farcical.
- But liquidity is a lot like liquid, it's a lot easier to spill than to un-spill.”

This Fed’s and of course the predecessor’s record is dismal – nothing but populism. With Fed under so much public and congressional pressure – it will not do anything deemed even a little bit unpopular. We know what the Congress wants – print and spend. Fed will not tighten for a long time, and that is what they have officially stated – 0 APR for the foreseeable future. BB has been wrong about everything – firstly he continued the farcial policies of Greenspan, at the outset of the crisis he simply played from Greenspan’s playbook – easy money and inflate – that is what led to the commodity bubble. If not for the commodity bubble this recession would have been lot milder. Fed’s record with any kind of economic prediction so disgraceful – I wonder how these people even get their jobs, but now BB is being considered for reappointment.

Whether we end up with inflation or outright deflation – remains to be seen. Fed is trying to inflate despite Trillion injected – it has totally failed. We have deflation everywhere.

I am predicting a double dip – with the second dip lot worse than the first- the bubble would totally burst. The confidence would be lost – whatever confidence that still exists in the dollar would go. That is what would lead to total collapse.

Jul 26 04:27 PM

[Hot Richard:]

American taxpayers may soon realize that a majority of their taxes are going to pay off interest to foreign creditors. But, it won't cause them to pause on the march to build the great society (must plan, plan, plan...Road to Serfdom).

Maybe if someone started calculating the "Interest to Fer-ners" like they do "Tax-free Day" on the calendar. Nothing inspires Americans more than a wee-bit of fear-mongering with non-American threats.

Jul 26 05:20 PM

[Ergo:]

I've posted before about the fallacy of trying to refight the Great Depression in new circumstances. Reading this article, I notice a few things: (1) The media campaign may settle villagers in the U.S., but we're not the only audience. There are very sophisticated foreign parties who aren't so easily persuaded. They may evaluate their own incentives differently than Bernanke would like. Nevertheless, we're undermining world faith in our fiat currency, at a time when it takes world faith to support it. Surely the risk is apparent.

(2) Yellowhoard points this out: There is an incentive for crisis. The left wingers believe in shock doctrine, and some of them would be crazy enough to try it. Also, the ol' pump-and-dump could still happen; with certain entities (cough, GS, cough) profitting on the way down while trying to drive money back to treasuries.

(3) The other side of all this (QE, etc) is clearly going to be a mess. (rising interest rates, unemployment, taxes, government spending, and declining productivity and demographic shifts, etc.) And our particular leaders didn't plan that well in good times. The exit strategy may be simply leaving messes for other people to clean up.

Jul 26 05:35 PM

[perceptions...:]

Bernanke Defends Fed’s Response to Financial Crisis, Recession

“I was not going to be the Federal Reserve chairman who presided over the second Great Depression.”

Bloomberg link -
www.bloomberg.com/apps...
===================

At this point, the only way I can see Ben getting his above wish, is for him NOT TO BE RE-APPOINTED.

Jul 26 09:21 PM

[Belome:]

Bernake must have that special button on the old Asteroids game, you know the one that lets you escape a collision with a meteorite and teleported somewhere else...... maybe a better place or maybe worse....

Jul 26 11:30 PM

[Moto:]

I walked away from the Reps a few years ago. I can only hope they are dead and now the Dems will join them. The only change I can believe in is if 98% of those in DC went over to Europe and helped them. I don't want to be to critical - Bill Moyers will accuse me of hate speech.


On Jul 26 03:44 AM LKofEnglish wrote:

> interesting analytic. there are solutions but as Mark Knopfler once
> said, "How Long?" I hesitate to call the USA a single "economy."
> States have a lot more power than the current crop of Federalistas
> have any clue about. Bailouts of California, New York and New Jersey
> at the expense of the heartland? Doubtful. These boys are from Chicago
> which is a booming metropolis and back to Chicago they will go with
> a big old "whoops" between their eyes and more than a few "sorry
> about that". Bottom line is without George Bush there is no policy
> and our government is simply adrift--LOST as it were. The fact that
> something that was once cheap now becomes expensive does not necessary
> equate with the end of the world. We've had a government created
> train wreck and the train was carrying radioactive waste and certain
> states and cities will never recover from the disaster. that does
> not mean the rest of this nation can't recover. It certainly does
> not seem to mean at all that certain private enterprises have no
> value apparently! Not every guy succeeds in crushing the girl when
> he sets upon the path of saying "if i can't have her then nobody
> can" and sometimes its the guy who ends up crushing himself when
> he sets himself upon this path. let the suicide play out if that's
> what it is and we'll see "what's next." Should the President's paranoia
> trump reason then i think cause for concern is in order. amazingly,
> though, even that I think could be spun as good news at least in
> the short term! Methinks the Democrats ought beware of celebrating
> the possible death of a political party too loudly since it is apparently
> their own.

Jul 27 05:06 PM

[Armando Mor...:]

Maybe some of you should read this

www.jpchevallier.com/a...

It is in french, but that website should be mandatory.

Jul 28 09:25 AM

[John Galt:]

The inflation camp believes that what the Fed is doing is inflationary (true). The deflation camp believes that the credit bubble we lived through has very deflationary forces ( also true).

Peter Schiff (inflation camp) would point out the increased money supply, while somebody in the deflation camp would point out the lack of credit, the slower velocity of money, the reduction in the money multiplier in a fractional reserve banking world... a fall in asset prices, declinging or stagnant at best wages, high unemployment... that's a classic deflationary cycle.

I see near term Deflation, but yes, eventually there will be inflation.... Once banks start lending, wages go up, and people borrow and spend money. I don't see that in a meaningful way anytime soon.

You say that low interest rates is inflationary? Sure, but why has Japan had a lost decade? Where was their massive inflation? They did tack on a huge percebtage of debt to GDP ( and we will too), but not inflation.... Because Japan had a HUGE credit bubble ... just like we did in the "roaring 20's, and just like we had now. You could try and manipulate away the pain, but the thing with economics is that there is always round 2!

Ludwig Von Mises, the famous Austrian economist said there is nothing we can do to stop the after effects of a credit bubble. Nothing! NA-THING! You could choose inflation ( German Weinmar republic) or you could choose a lost Decade or a Great Depression, but you WILL suffer pain one way or another. That's a law of nature.

Bernake was a student of the Great Depression and he is trying to take tremendous steps to slow down the pain, no doubt. But he also would rather "take away the punch bowl" late rather than early. In 1937 the fed raised reserve requirements because they were scared of the on coming inflation... That hit us with another recession within the Great Depression when banks were once again forced to hoard more money (legally)... If anything, Bernake ( or whoever follows) will be LATE to pull the plug and we should have inflation, but I don't see that any time soon. This is a freaking mess and even the biggest Bulls see slow growth in the future when things start to get better.


The thing that REALLY bothers me is who made Ben Bernake Economic Czar? It can be argued that the President of the Fed is the most powerful man in the world... even more so than the President of the United States. Government set interest rates? Interest rates effect the prices (current and future) of everything in our economy. They have the ability to distort reality... It's like having a compass that doesn't point North and going hiking in the woods. You call that free market? What's the point of the Fed, to make sure this stuff doesn't happen, to try and manipulate the business cycle? They have done a horrible horrible job at it. It's a shame of all the pain and suffering for so many people and those people have no idea even why ( just blame the easy target of George Bush if you are a Democrat or Bill Clinton/Congress if you are a Republican). A lot of economists don't even understand the Great Depression ( or what's going on now), nevermind the American Idol watching public.

I hope Peter Schiff reads this because I feel like it all goes to deaf ears when I or any of the other peons say something. Peter, you have power... At least I and many other people believe so. PLEASE raise the question to the media as to why on earth we give so much POWER to one man at the Fed!

What happens if we had somebody even worse than Bernake? What happens if we had a President with no formal economic training... say a community organizer or a lawyer who gave orders to Bernake?

They asked Jim Rogers what he would do if they made him President of the Fed. He responded, " I'd fire everybody, and then I'd quit"!

Jul 28 01:55 PM

[Poborsky:]

Take a look at a dollar yen chart to see why Japan didnt suffer inflation when the govt interfered in the markets. The market gave its verdict on the state of the Japanese economy. The problem for the US is that the economy is now too weak to withstand pressure on the dollar. When import prices start going through the roof and anyone with any dollars left in their pockets decide to spend them before its too late then........


On Jul 28 01:55 PM John Galt wrote:

> The inflation camp believes that what the Fed is doing is inflationary
> (true). The deflation camp believes that the credit bubble we lived
> through has very deflationary forces ( also true).
>
> Peter Schiff (inflation camp) would point out the increased money
> supply, while somebody in the deflation camp would point out the
> lack of credit, the slower velocity of money, the reduction in the
> money multiplier in a fractional reserve banking world... a fall
> in asset prices, declinging or stagnant at best wages, high unemployment...
> that's a classic deflationary cycle.
>
> I see near term Deflation, but yes, eventually there will be inflation....
> Once banks start lending, wages go up, and people borrow and spend
> money. I don't see that in a meaningful way anytime soon.
>
> You say that low interest rates is inflationary? Sure, but why has
> Japan had a lost decade? Where was their massive inflation? They
> did tack on a huge percebtage of debt to GDP ( and we will too),
> but not inflation.... Because Japan had a HUGE credit bubble ...
> just like we did in the "roaring 20's, and just like we had now.
> You could try and manipulate away the pain, but the thing with economics
> is that there is always round 2!
>
> Ludwig Von Mises, the famous Austrian economist said there is nothing
> we can do to stop the after effects of a credit bubble. Nothing!
> NA-THING! You could choose inflation ( German Weinmar republic)
> or you could choose a lost Decade or a Great Depression, but you
> WILL suffer pain one way or another. That's a law of nature.
>
> Bernake was a student of the Great Depression and he is trying to
> take tremendous steps to slow down the pain, no doubt. But he also
> would rather "take away the punch bowl" late rather than early.
> In 1937 the fed raised reserve requirements because they were scared
> of the on coming inflation... That hit us with another recession
> within the Great Depression when banks were once again forced to
> hoard more money (legally)... If anything, Bernake ( or whoever follows)
> will be LATE to pull the plug and we should have inflation, but I
> don't see that any time soon. This is a freaking mess and even the
> biggest Bulls see slow growth in the future when things start to
> get better.
>
>
> The thing that REALLY bothers me is who made Ben Bernake Economic
> Czar? It can be argued that the President of the Fed is the most
> powerful man in the world... even more so than the President of the
> United States. Government set interest rates? Interest rates effect
> the prices (current and future) of everything in our economy. They
> have the ability to distort reality... It's like having a compass
> that doesn't point North and going hiking in the woods. You call
> that free market? What's the point of the Fed, to make sure this
> stuff doesn't happen, to try and manipulate the business cycle?
> They have done a horrible horrible job at it. It's a shame of all
> the pain and suffering for so many people and those people have no
> idea even why ( just blame the easy target of George Bush if you
> are a Democrat or Bill Clinton/Congress if you are a Republican).
> A lot of economists don't even understand the Great Depression (
> or what's going on now), nevermind the American Idol watching public.
>
>
> I hope Peter Schiff reads this because I feel like it all goes to
> deaf ears when I or any of the other peons say something. Peter,
> you have power... At least I and many other people believe so. PLEASE
> raise the question to the media as to why on earth we give so much
> POWER to one man at the Fed!
>
> What happens if we had somebody even worse than Bernake? What happens
> if we had a President with no formal economic training... say a community
> organizer or a lawyer who gave orders to Bernake?
>
> They asked Jim Rogers what he would do if they made him President
> of the Fed. He responded, " I'd fire everybody, and then I'd quit"!

Jul 29 10:37 AM

[gksmar:]

The best unbiased comment I have read.


On Jul 28 01:55 PM John Galt wrote:

> The inflation camp believes that what the Fed is doing is inflationary
> (true). The deflation camp believes that the credit bubble we lived
> through has very deflationary forces ( also true).
>
> Peter Schiff (inflation camp) would point out the increased money
> supply, while somebody in the deflation camp would point out the
> lack of credit, the slower velocity of money, the reduction in the
> money multiplier in a fractional reserve banking world... a fall
> in asset prices, declinging or stagnant at best wages, high unemployment...
> that's a classic deflationary cycle.
>
> I see near term Deflation, but yes, eventually there will be inflation....
> Once banks start lending, wages go up, and people borrow and spend
> money. I don't see that in a meaningful way anytime soon.
>
> You say that low interest rates is inflationary? Sure, but why has
> Japan had a lost decade? Where was their massive inflation? They
> did tack on a huge percebtage of debt to GDP ( and we will too),
> but not inflation.... Because Japan had a HUGE credit bubble ...
> just like we did in the "roaring 20's, and just like we had now.
> You could try and manipulate away the pain, but the thing with economics
> is that there is always round 2!
>
> Ludwig Von Mises, the famous Austrian economist said there is nothing
> we can do to stop the after effects of a credit bubble. Nothing!
> NA-THING! You could choose inflation ( German Weinmar republic)
> or you could choose a lost Decade or a Great Depression, but you
> WILL suffer pain one way or another. That's a law of nature.
>
> Bernake was a student of the Great Depression and he is trying to
> take tremendous steps to slow down the pain, no doubt. But he also
> would rather "take away the punch bowl" late rather than early.
> In 1937 the fed raised reserve requirements because they were scared
> of the on coming inflation... That hit us with another recession
> within the Great Depression when banks were once again forced to
> hoard more money (legally)... If anything, Bernake ( or whoever follows)
> will be LATE to pull the plug and we should have inflation, but I
> don't see that any time soon. This is a freaking mess and even the
> biggest Bulls see slow growth in the future when things start to
> get better.
>
>
> The thing that REALLY bothers me is who made Ben Bernake Economic
> Czar? It can be argued that the President of the Fed is the most
> powerful man in the world... even more so than the President of the
> United States. Government set interest rates? Interest rates effect
> the prices (current and future) of everything in our economy. They
> have the ability to distort reality... It's like having a compass
> that doesn't point North and going hiking in the woods. You call
> that free market? What's the point of the Fed, to make sure this
> stuff doesn't happen, to try and manipulate the business cycle?
> They have done a horrible horrible job at it. It's a shame of all
> the pain and suffering for so many people and those people have no
> idea even why ( just blame the easy target of George Bush if you
> are a Democrat or Bill Clinton/Congress if you are a Republican).
> A lot of economists don't even understand the Great Depression (
> or what's going on now), nevermind the American Idol watching public.
>
>
> I hope Peter Schiff reads this because I feel like it all goes to
> deaf ears when I or any of the other peons say something. Peter,
> you have power... At least I and many other people believe so. PLEASE
> raise the question to the media as to why on earth we give so much
> POWER to one man at the Fed!
>
> What happens if we had somebody even worse than Bernake? What happens
> if we had a President with no formal economic training... say a community
> organizer or a lawyer who gave orders to Bernake?
>
> They asked Jim Rogers what he would do if they made him President
> of the Fed. He responded, " I'd fire everybody, and then I'd quit"!

Jul 29 10:51 AM

[Leif Peterson:]

Great article Peter. It would be human nature to think that during a large economic downturn there's dissemination of false information. Ever try to model and understand inflation based on CPI and Gov't dept-to-GDP ratios? Although it is helpful to view the recent debt-to-GDP charts from time to time. [ref: US public debt at en.wikipedia.org/wiki/... ]

What's difficult to fathom is that if US debt was similar to your own family budget, then you'd stop taking on so much debt. However, because we never hear statements like "The US is going to stop doing xxx and yyy simply because the budget can't handle it." The US Gov't got us into the subprime mortgage crisis (definite HUD laws which *required* ~40% of new mortgages in the 90's be given to families whose income is below the area in their area -- and these mortgages had easy initial terms, and were adjustable rate), is now trying to get us out of it through quantitative easing (printing money-->fiscal and monetary policy), but can't ever stop spending and going into more debt.

This is what the military calls "smoke and mirrors," that is, when everything is a haze with no focus and no goals/plan. Personally, I like "dog and pony show." Certainly, it is laudatory to prevent market crashes through Gov't intervention -- so that most of us can safely retire, but the effect of such mismanagement and fiscal irresponsibility on younger generations will be disastrous. There are also strong programs in Gov't called Fraud, Waste, and Abuse. So why doesn't someone start looking at the abuse part of the equation.

Jul 30 09:31 AM

[Dr. O:]

Central banks are blowing up new bubbles to cushion the fall from the collapse of the old ones. Chinese stocks are soaring in spite of a lack of rebound in their economy (or anyone elses). Same with stocks in many markets world wide.

I'm not a student of the history of finance, but has there ever been a time when so many central banks had interest rates at or near zero? Cushioning a deflationary collapse. Sure. But the other side of this is bubbles in stocks and commodities and inflation and a rise in interest rates.

Doesn't it strike you as odd that with all the deflationary pressures in the world and problems in the credit markets and weak economic conditions that gold is sitting around 900 dollar per ounce, and oil is still in the 60s.

Just use your imagination about where gold and oil will be when the economic machinery of the world resumes functioning more normally.

Jul 30 11:42 PM

[Poborsky:]

The fact that gold and oil are where they are now and not moving up should tell you something about where markets are expecting the economy to go.

On Jul 30 11:42 PM Dr. O wrote:

> Just use your imagination about where gold and oil will be when the
> economic machinery of the world resumes functioning more normally.

Aug 01 10:55 AM

[puravidavid...:]

How will the centenial of the Fed be recognized? With celebration or a funeral? I suspect the latter. The reason for derision? Not because of the ineffectiveness of the post crash remedies, but because of the previous creation of credit in excess of wise-use needs.

2013: Fed = RIP

Aug 04 11:24 AM

[puravidavid...:]

"But make no mistake, in order to mop up all the excess liquidity, the Fed will need to raise interest rates substantially to attract buyers for all the bonds that the Treasury must sell."

Sorry, you're making the mistake, Peter. Much of the funds created will be dissipated as they were used to purchase "assets" that will crater as deleveraging renews with the next round of insolvencies in residential & commercial real estate, and as corporations see top lines challenged by continuing decreases in employment and consumer spending, here and abroad.

There is no certainty that monetarists will be any more successful predicting the future than they were in the dot com era or the realty bubble years. Nice try, but no pizza.

Aug 04 02:18 PM