Was Bernanke Lying About Printing Money?

Includes: GLD, SPY, TLT
by: Tim Ayles

I am pretty sure that this article will cause an uproar amongst the doom and gloomers. It is fun to work ourselves up into a tizzy talking about the the collapse of America. Anyone who doesn't seem to admit America is bankrupt and the dollar is about to collapse is an idiot who just doesn't understand the economy. Everyone knows China will stop buying our bonds and rates will skyrocket. Everyone knows bonds are in a bubble and you have to own gold. Stocks will collapse with the financial system, so it might even be wise to only own hard assets.

The problem with this that I see is it creates never ending fear because on the surface, it seems logical. Guys like Schiff can forever call for the inevitable collapse of America, but because he never has to put a date on it, he can never be wrong. We can for another decade (he has been talking about it for more than one so far) be told that it is just around the corner.

Now that Bernanke had another "60 Minutes" interview, the froth is starting yet again. The Fed is losing credibility because Ben is lying, so the saying goes. In the first interview, if you have seen it, Ben says through the open market operations, that he is "effectively" printing money. In the second interview, he says, " We are not printing money."

So which is it?

Well, if you are a doom and gloomer, America will die any day now kind of person, then you have to believe Ben was telling the truth in the first video (of which you have to be given credit because you truly don't believe anything he says), and lying in the second. If you are less conspiracy theory bent, you will believe he is telling the truth in the second.

What do I think?

I think he told the truth in both. I think Ben is not guilty of lying, only being wrong. You see, the current floating exchange rate system is somewhat new to most who were in college during the fixed exchange rate era. Before Nixon abolished the standard, most economic textbooks did not teach these guys the current monetary system. Unfortunately, as PragCap.com has done a fine job explaining, Ben is learning on the job.

So 21 months ago when he stated that we were "effectively" printing money, I believe he truly thought he would be creating money by increasing banking reserves. Almost everytime in the past three decades when bank reserves increased, lending happened. When loans are made in a fractional reserve banking system, New money is created. For a better understanding of how $100 can turn into $500 in money in a 20% reserve banking system, please read this - especially the section titled: Example of deposit multiplication. So I can honestly say that Ben was telling the truth in the first interview because he truly thought that all the reserves he was creating would turn into money printing as the banks turned those reserves into new loans.

But something funny happened on the way to the printing press.

The money multiplier broke down.

All of those reserves did not in fact turn into new money like Ben thought it would. The monetary base is exploding, but the money supply is not. That is not the way Ben had planned it. You see - the monetary base is not money. Hoisington Management gets it right when they explain this on page 4 of their quarterly report:

It is obvious the fed authorities would like to see money, income, and output rise, but they cannot control private sector borrowing. If banks were forced to recognize bad loans and get the depreciated assets into stronger more liquid hands, it could be debated on how much reserves should be in the banking system. Until that cleansing process is completed it will be a slow grind to cure the one factor which makes the fed "impotent" and unable to "print money" ... overindebtedness.

Morgan Stanley gets it, too, when they say that reserve creation is not money printing. It is only potentially inflationary. As has been stated by others, you can lead a person to the bank and offer near free money to entice them to borrow, but you can't force them to take on debt, nor can you force the bank to give them money.

Currently, both borrowers and banks don't have as big of an appetite for the lending process as the Fed estimated they would. The Federal Reserve as a whole is now coming to the understanding that reserves do not in fact turn into new money as they thought, if in fact the money multiplier breaks down, which they did not expect to happen: In this white paper, which was written after Ben's first interview where he is accused of lying, they state:

We argue that the institutional structure in the United States and empirical evidence based on data since 1990 both strongly suggest that the transmission mechanism does not work through the standard money multiplier model from reserves to money and bank loans. In the absence of a multiplier, open market operations, which simply change reserve balances, do not directly affect lending behavior at the aggregate level. Put differently, if the quantity of reserves is relevant for the transmission of monetary policy, a different mechanism must be found.

So if anything, Ben Bernanke was guilty of incompetence in the greatest and miscalculation at a minimum when he effectively thought that the reserve creation ability of the Fed would "effectively" turn into new money because it would get lent out. All those who are putting all their eggs into the hard asset basket awaiting the collapse from all the printing going on may be setting themselves up for quite a bit of pain when it doesn't work out that way. All one has to do is study Japan as an example that it is not inevitable that we will fall apart over night:

I thank PragCap.com for the education in changing my thinking and helping me better understand what is truly taking place in the monetary system we now have. I would highly recommend that you spend time there in educating yourself. If nothing else, if you find Cullen is wrong, you will have more reason and assurance that your all in trade of real assets is wise.

Disclosure: I am long TLT, SPY, GLD