Bernanke: The New "Death Star"

by Jack Crooks

Sometimes the most interesting remarks don't come from the pundits or the floating talking heads on CNBC. Instead, the really intriguing insights come from normal investors like you and me, who aren't afraid to tell it like it is.

I had such a reader write me recently. He wrote: "Ben Bernanke is like the death star. Destroyer of worlds."

In case you're wondering, the comment refers to the movie, Star Wars. In the film, the evil empire builds a moon-sized space station that can (and does) obliterate an entire planet with a single shot.

Of course, Bernanke's official job doesn't involve destroying planets, but some might argue that his official mandate has been destroying the U.S. economy lately.

Two Days before Congress, Two Days of Lip Service

In fact, last week Bernanke had to answer for his actions during two days of Congressional testimony.

Accompanied by Treasury Secretary Henry Paulson and SEC Chairman Christopher Cox, Big Ben paid lip service to the panel of Congressmen bombarding him with questions. Bernanke gave the normal reassurances about the state of the economy and inflation. He also asked for additional Fed regulatory responsibilities. That made for a heated discussion.

The best quote came from Senator Jim Bunning. When it was his turn to address the Fed Chairman, he noted, "The Fed is the systemic risk."

Both my Star-Wars-loving reader and that Congressional testimony basically say the same thing: People are sick and tired of the Fed's decision to fight fire with a lot of hot air.

Let the Good Times Roll...Even if the Economy Rolls Right Over Us

Almost any economist will tell you that every boom period is followed by a bust period. And typically, the larger the boom, the larger the bust.

But it seems like lately the Federal Reserve is disregarding the historical boom-bust cycle. Instead, Bernanke and his team are doing everything in (and beyond) their power to keep the good times rolling.

Sounds nice, but there comes a point when the economic system needs to cleanse itself. Hence the subsequent bust to every boom.

By making every effort to sustain the boom when it's already naturally run its course only delays the inevitable. The impending bust will be that much more painful, if you keep putting it off.

Many analysts, including myself, are beginning to believe the Fed needs to stop fighting the fire with bailouts and cheap money. Instead, they need to tighten up and let the market process work things out from here.

Right now, the Fed is no doubt in bailout mode. The Bear Stearns bailout is still fresh in investors' minds. (No doubt that bailout will go down in market infamy for quite some time.) Now we have the Fannie (FNM)/Freddie (FRE) fiasco. And who knows how many other firms the Fed has saved - so far - by opening up the vault doors to nearly everyone? 

Free Fed Money Anyone?

Check out the two graphs below. This first one shows how many banks borrowed from the Federal Reserve from 1980 until 2006:

You can see a major spike to roughly eight billion dollars of borrowing in 1984. That spike is probably from the economy's recovery from recession in years prior.

This spike in total borrowings was also coupled with a brief surge of inflation (of similar proportions to what we're experiencing today) after Fed Chairman Paul Volcker brought the inflation rate down from 13.5% in 1980 to as low as 3.2% in 1983.

Now, this next chart shows the exact same series of data, only it takes us through the present...

As you can see, the period up through June 2008 completely dwarfs how much the Fed lent out prior to that year. In fact, it makes all other periods look like a flat line!

The spike to more than $170 billion dollars of borrowings reflects the newly created auction facilities.

How Do the Fed's Actions Affect Your Savings?

Bernanke recently admitted that the U.S. dollar needed to work off some of the excesses from the rally that began in the mid 1990s. That's part of why the bear market has extended so deep for the buck.

The dollar has done that — and more. But the charts I just showed you prove that the dollar is not nearly out of the woods yet.

Bottom line: If the Fed doesn't change its attitude and stop feeding debt creation, asset prices will spiral higher, and more pain will be crammed into the closet until someone or something knocks the door open.

Comments

[MarvinMBA:]

Yes, this is right on...looking at M3 we can see the effect of the Fed action. But looking at M1 which is where the real world is at the average guy is treading water going nowhere. The Fed has to get the economy moving again to get the average guy the opportunity to work and pay off his mortgage instead of walking away. Cheap energy and innovation go togeather and so goes the economy...better to spend money developing energy resources then bailing out the investors with new money...thats the economy is all about.

2008 Jul 22 01:10 PM

[trader717:]

Thoughtful ideas on the Fed lending. I agree that it is disturbing why our Fed feels like they must bail out banks who have knowingly increased their leverage to maximize returns while not accounting for the risk when the markets turn south. Poor management needs to get flushed out. Consumers are and will continue to feel the pain of inflation combined with slower wage growth into 2009. Our economy, and thus our markets, have not recovered and will maintain this downtrend. The Fed needs to let this happen, if everytime a child (our financial firms) does something wrong (leveraging and lending freely), you forgive them and give them another toy (bail out, cash), they will never learn their lesson. I am a strong believer in discipline, something I consider when trading and investing, and something that the Fed should consider when dealing with the greedy executives on Wall Street.

2008 Jul 22 03:00 PM

[Jason Rines...:]

Exactly. As a researcher (probably why my comments are long, should be in education I guess) of history I can state without doubt every empire must invest in energy and innovation. The Romans had slaves (energy), advanced medicine and modern military inventions. They receeded in there empire as early as 10 AD (lack of slaves). Hence the Roman term "we expand or we die".

Now, the market firesales are beginning to happen no matter what the Fed attempts to do. Firesales in the market occur from bad management at the top in government. We will all share the pain and burden to fix it. No different then how my business operates or yours. But in our businesses, I would wager we take accountability and eat the loss of our mistakes and learn from them.

Main St. has had a few months of pain and has begun to adjust, willing to work extra jobs for dirt pay to make the mortgage and put bread on the table.

Some like myself are doing special projects on my own dime to change Washington, I work 15 hour days to juggle operating my business and do this. But what is NOT changing is the attitude in Washington about the seriousness of this economic situation and sharing the pain, putting it out to the American public and asking for us all to step up and help solve the problems. America is now a nanny state.

And in Washington all I am seeing is chronie capatalism what truly brought down the Roman empire. Congress will see there coffers run dry and when they do, they MIGHT begin to change, that is if they get off there fat behinds and do what is hard to understand some complex financial instruements, fundamentals vs credit economy in other words. The other comments were great as well.

2008 Jul 22 04:05 PM

[Jim A:]

Raise short term rates to 8%, stop all bailouts of Wall Street firms and banks . Start building nuclear plants and start offshore drilling. Cut government spending 20%.

2008 Jul 22 09:26 PM

[Joyful Alte...:]

Yes, Mr. Big, it's tough times for us businesses out here on Main Street. Working harder, working smarter, having less satisfactory results, worrying how the country can solve problems like quickly going green when it's bankrupt.

And still the administration sings "Happy Days Are Here Again," with no mention of challenge or effort. Just keep shopping.

2008 Jul 23 08:35 AM

[ACCOUNTANT:]

From what i have read, Bernicki didn't have much of a choice. The securities / banking industry is so extremely interlinked with each other that, had the government not opened the vault, we could potentially have completely lost wall street, creating another massive ripple effect through the non-security banking industry.

He is asking for more regulatory oversight authority - i think in order to give the government the ability to avoid this type of mess in the future.

2008 Jul 23 08:48 AM

[xsuddensam:]

There is no future if we don't get rid of the Fed. Reasonable thinking people should understand that the Fed is just a vehicle for banks and other financial institutions to make money. It is not regulated by the government nor anyone else. It has a specific mandate to control inflation and promote economic growth. The problem is it has the uncontrolled power to print money.

With a weak and moronic Fed chairman like Bernanke, who will cave in to market whining (the 75 pt. emergency cut, followed with a 50 pt. cut one week later), there is no future nor hope.

2008 Jul 23 10:22 AM

[Emerald:]

Yes we now have an obvious nanny state run by and for the wealthy fat cats on Wall Street. Many posts complain about bailing out the consumer when this is a rounding error. I'm still waiting for Franklin Raines (FNMA), Chuck Prince (Citi) and others to apologise and give back most of their "retirement" packages that were stolen from their stockholders. I know, it's wishful thinking. In case it goes unmentioned, the bailout of Fannie and Freddie will not come from new taxes and cuts in government spending. It will be added to our national debt, according to Congress. Remember that when voting out encumbents in November.

2008 Jul 23 11:06 AM

[Joyful Alte...:]

The first step is to repeal the repeal of Glass-Steagal to straighten out the banking system. Phil Gramm's Senate pension should also be repealed. (Well, he ought to be punished for stacking this house of cards and for so vastly profiting from his actions, and I don't believe in the death penalty. That's the best I could come up with off the cuff.)

2008 Jul 23 11:22 AM

[ain't no fo...:]

Darwin's Origin of the Species is correct and still operates. It is an immutable law that in nature, the strong survive... by eating the weak. Unfortunately, this administration and its pom-pom waving hucksters in the Fed and Treasury have tried to apply their "Creationist" theories to real world economics and wrongly believe that they can save the weak, corrupt and broken financials by fiat, market manipulation and smoke & mirrors. Nature will have its way with these misguided fools, and we will all be poorer for it in the short term, but out of the ashes will come a stronger economy and, therefore, markets. Darwin rocks!

2008 Jul 23 11:33 AM

[flow5:]

How stupid. Volcker used a non-borrowed reserves procedure and ignored borrowed reserves.

Bernanke uses only borrowed reserves.

But under Volcker at times 10% of all reserves were borrowed. I.e., Volcker let the commercial banks decide if there was to be an increase in money & credit.

Under Bernanke borrowed reserves = total reserves. Bernanke has made the decision as to whether there was to be an increase in commercial bank credit.

Volcker was responsible for 22.4% FFR. Volcker was responsible for eliminating usury rates. Volcker was responsible for + 10% rate of inflation in the first quarter of 1981. Volcker was stupid.

2008 Jul 23 03:13 PM

[Dan Walker:]

Volcker brought inflation under control. Bernanke, so far, has just kicked it into double digits and then tried to jawbone it down.

2008 Jul 25 05:22 AM