In a letter dated August 1, 2012, Chairman of the House Oversight Committee Darrel Issa questioned Fed Chair Ben Bernanke about the effectiveness of the Fed's monetary policy and the wisdom of continuing to pursue similar policies going forward. Bernanke responded in a letter dated August 22. Jon Hilsenrath discussed the exchange in an article that ran Friday in the Wall Street Journal entitled "Bernanke Letter Defends Fed Actions" but it largely glosses over the important issues and in my opinion fails to accurately convey the gravity of the concerns originally expressed by Congressman Issa. Below, I highlight a few of the questions Mr. Issa asks that I feel are particularly important and discuss Bernanke's responses.
Issa makes it quite clear from the beginning of his letter that he understands the diminishing nature of the returns achieved by the Fed's policies, noting that despite "repeated actions" (asset purchases and yield curve manipulation) the economy is "in even worse financial shape" than it was at this time last year. The Congressman also notes that several individuals of "high repute" have openly questioned the wisdom of the Fed's policies and indeed have flat out suggested that the current course of action is detrimental to the long run health of the U.S. economy.
Specifically, Issa cites Allan Meltzer of Carnegie Mellon University who asserts (among other things) that the slow pace of the recovery cannot be cured by monetary policy, that the excess reserves on banks' balance sheets are "far more than enough" to stimulate lending, and that the market is exhibiting a "learned behavior" with regard to easing expectations.
Notably, Bernanke doesn't really answer the first question. While the original question was
"Given the extraordinarily low interest rates across the Treasury curve, can further easing cure the country's sluggish growth and stubbornly high unemployment rate?"
In response, Bernanke said the following:
"There is scope for further action...however because short term interest rates are already at very low levels additional monetary accommodation requires the use of nontraditional policy tools such as balance sheet actions or communication about the likely future course of policy."
Notice that Bernanke has avoided the question by drawing a dubious distinction between setting interest rates and "balance sheet actions" and/or "communication about the course of policy." Since balance sheet expansion in the form of Treasury purchases affects interest rates, and since what the Chairman means by "future course of policy" is likely "the signaling of where interest rates are going," there really is no distinction between the "unconventional measures" described by the Chairman and the what the Congressman was asking in the first place. Issa wanted to know if manipulating the yield curve and rates further could really provide a meaningful boost to the economy. Bernanke did not answer the question.
As to whether banks need anymore capital on top of the $1.5 trillion in excess reserves they already have, Bernanke simply provides no answer:
"The volume of excess reserves currently on the balance sheets of banks is a consequence of the Fed's asset purchases. By putting downward pressure on long-term interest rates and contributing to a broader easing in financial market conditions, these asset purchases have helped to promote a stronger recovery...and to forestall a slide into deflation."
There simply is nothing in that response that could be in any way interpreted as an answer to the original question about banks' excess reserves being sufficient to stimulate lending.
As for the idea that the Fed is giving in to the market's insatiable desire for more easing, Bernanke simply says that the market comes to its own conclusions and the Fed's analysis is -- of course -- completely independent and not influenced by market expectations. While this is the expected boilerplate answer, it really fails to address the heart of the issue which is whether the Fed is propping up the stock market.
Congressman Issa also notes that the former director of the Office of Management and Budget David Stockman has accused the Fed of "destroying the capital market" by rendering interest rates and the yield curve meaningless (thus eliminating their ability to send meaningful signals about growth, inflation, etc) and taxing savers in order the assist the government in paying its bills.
Bernanke addresses the first part of the question by simply stating that the Fed doesn't see inflation running above the rate that is consistent with its mandate of promoting price stability and that the Fed is "keenly attuned to the risks of inflation". Of course the Congressman didn't ask whether the Fed was monitoring the situation. The Congressman asked whether the Fed's actions were inhibiting the ability of outside parties to monitor the situation.
As to whether the current low interest rate policy was contributing to a situation wherein savers are taxed in order to promote a transfer of wealth from savers to borrowers, Bernanke says this:
"It is in everyone's interest to have an economy that is performing at the highest level of its capacity. The returns on long-term investment depend critically on the vitality of economic activity, the pace of inflation, and the stability of the financial system."
Again, Bernanke has not addressed the question and in this case, his failure to provide guidance on the issue is particularly worrisome. Investors are increasingly worried that the Fed is promoting a policy whereby the government gets to pay down its debt and borrow on the cheap by keeping real interest rates very low or negative. In other words, savers are being penalized for the government's inability to contain its spending habits and negative real rates are in effect allowing the government to pay its own debt off by skimming money from savers. This is part and parcel of a policy called 'financial repression' and Bernanke's failure to address the issue seems to indicate that it is indeed alive and well in America today.
Issa goes on to craft a series of questions regarding the risks inherent in the Fed's position in Treasuries which I intend to cover in more detail in a forthcoming article, but for now, note that the whole thing culminates in one straightforward question:
Issa: "Is a bond market correction likely when the Federal Reserve reduces the size of its portfolio?"
This of course is a particularly sensitive issue for many as there are certainly those who believe that U.S. Treasuries have been in a bubble for quite some time. Bernanke's response is far from comforting:
"[The Fed] will normalize the size of its balance sheet through gradual, pre-announced sales in order to ensure that markets have an appropriate amount of time to make adjustments. Nonetheless, yields on longer term assets are lower now than they will be once the economy has returned to a cyclically more normal position."
To me, this is an emphatic "yes". I can't see how having "appropriate time to adjust" will mitigate the situation much, if at all. At the end of the day there will be enormous upward pressure on yields that could indeed be destabilizing.
While this discussion is by no means exhuastive, I hope to have conveyed the noncommital and vague nature of Bernanke's responses to what I feel are some very important questions posed by Congressman Issa. Investors are encouraged to read the full letters (links provided) and judge for themselves. For my part, this back and forth between the Fed and Congress further substantiates the notion that there is very little in the way of evidence that more QE will do anything to spur economic growth.
Furthermore, it seems the Fed is not willing to discuss the fact that its policies are contributing to a transfer of wealth from savers to borrowers and contributing to an uncertain environment regarding inflation and the future course of the U.S. economy. Lastly, it appears that the bursting of the bubble in U.S. Treasuries is all but inevitable. In light of these concerns, I repeat my recent recommendation that investors stay long gold (GLD) and add that a short position in long-term U.S. Treasury bonds (TLT) seems almost guaranteed to pay handsomely over time. They say you can't fight the Fed. Ultimately however, the Fed cannot fight reality.