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Everything is getting a little harder for Ben Bernanke. Since 2008, his goal has been to keep asset bubbles from breaking, keep asset prices from sliding. A continuing slide in housing prices would render US banks insolvent. His plan has been to weaken the US Dollar. He knows that a weaker Dollar causes anything traded in dollars to rise in price. To preserve the prices of risk assets (housing, stocks, commodities) he needed to wound the US Dollar. Between 2000 and today, the Dollar's value is down some 20%.

Of course, his policies of QE, ZIRP, ITBB (infinite Treasury Bond Buying) are Dollar-negative. His 'printing' (this is a metaphor) new money to buy toxic assets -- essentially have the taxpayer buy the toxic assets -- that no sane investor would touch -- is also Dollar-negative and requires his own tilting of the playing field toward zero interest rates or his $3+ trillion balance sheet would turn to dust.

Last week his own friends in a Chicago University think tank wrote a paper for the Fed about American sovereign-risk on his massive balance sheet. The authors of this paper included Frederick Mishkin, former right-hand-man for Bernanke at the Fed -- so this team was decidedly NOT anti-Bernanke.

This paper jolted the Fed Board -- and minutes released last week were a response to this jolting. An instablog I wrote last week covers this instance more deeply:

This paper caused British Telegraph writer Ambrose Evans-Pritchard to essentially throw in the towel on QE, admit is not working, and that it is significantly dangerous -- Evans-Pritchard was quite sanguine a year ago about QE 'fixing' the global economy -- he has supported Bernanke's spending plans for the beginning. He now says QE is done.

From Pritchard's review of the think-tank paper in question:

[The paper] argues the Fed is acutely vulnerable because it has stretched the average maturity of its bond holdings to 11 years, and the longer the date, the bigger the losses when yields rise. The Bank of Japan has kept below three years.

Trouble could start by mid-decade and then compound at an alarming pace, with yields spiking up to double-digit rates by the late 2020s. By then Fed will be forced to finance spending to avert the greater evil of default."Sovereign risk remains alive and well in the U.S, and could intensify. Feedback effects of higher rates can lead to a more dramatic deterioration in long-run debt sustainability in the US than is captured in official estimates," it said.

Europe has its own "QE" travails. The paper said the ECB's purchase of Club Med bond amounts to "monetisation" of public debt in countries shut out of global markets, whatever the claims of Mario Draghi.

"We see at least a risk that the eurozone is on a path to become more like Argentina (which of course is why German central bankers are most concerned). The provinces overspend and are always bailed out by the central government. The result is a permanent fiscal imbalance for the central government, which then results in monetization of the debt by the central bank and high inflation," it said.

In America, the Fed would face huge pressure to hold onto its bonds rather than crystallize losses as yields rise -- in other words, to recoil from unwinding QE at the proper moment. The authors argue that it would be tantamount to throwing in the towel on inflation, the start of debt monetisation, or "fiscal dominance". Markets would be merciless. Bond vigilantes would soon price in a very different world.

Investors have of course been fretting about this for some time. Scott Minerd from Guggenheim Partners thinks the Fed is already trapped and may have to talk up gold to $10,000 an ounce to ensure that its own bullion reserves cover mounting liabilities.

What is new is that these worries are surfacing openly in Fed circles. The Mishkin paper almost certainly reflects a strand of thinking at Constitution Avenue, so there may be more than meets the eye in last week's Fed minutes, which rattled bourses across the world with hints of early exit from QE.

If it wasn't enough to have his own former partner point out the fallacies of his approach, then Europe began to come apart at the seams again. Italy voted out the party that was going along with QE/Austerity in Italy, and handed more than 50% of the vote to two convicted criminals, an old face in Silvio Berlusconi, who wants to punish the Germans and Europe and get out of the Euro, and a new face, in comedian Beppy Grillo, who wants a referendum to get out of the Euro, perhaps also the EU, who wants free national internet, and who wants to cap all executive pay and require much higher taxes on the rich. Berlusconi and Grillo almost agree on things; except Grillo wants to punish the rich; and Berlusconi wants to reward the rich with more and more tax cuts...

Part of Bernanke's plan is to keep the Euro strong as a way of keeping the Dollar weak. But that plan hit a couple of bumps in the road this week. After Italy's election, bond yields jumped in Italy, and the Euro sank.

A month ago I wrote an instablog suggesting a correction in the OEX was at hand, and a rally in the US Dollar. I cannot compete with Bernanke's trillions. Ben wants the Dollar to go down. He can spend billions a week to make this happen. I don't have that kind of leverage.

How does this chart look today? Well, the OEX has been hit. The Dollar (UUP, Bullish Dollar ETF) is rallying. In an ordinary world, this would mean stocks are going to correct. We know Ben Bernanke does not want stocks to correct. He has built a second housing bubble. He is trying mightily to inflate commodity prices, and inflation all over the world. But he is not, apparently, omnipotent.

If the Dollar rises, stocks will fall -- as will housing prices and commodity prices, and inflation. Why is that so bad? Why is more affordable housing, natural resources, and stocks, and food being fought so voraciously by Mister Bernanke? Is there more to this than meets the eye? Is he not the Mister Scrooge, who hates the world's poor, as I am seeing him to be?

Yesterday, Bernanke appeared before Congress -- and he appeared snappy and tired. If he does not keep the Dollar down, his whole bubble-building plan will collapse, and with it most of America's banks. But if he keeps spending like a drunken sailor to try to keep the Dollar weak, he will own a worthless balance sheet of assets that will implode in value when interest rates rise. He is like some Promethean figure who must, for the rest of eternity, spend money he does not have in order to keep inevitable reality (God's punishment of hubris?) from occurring.

The Mishkin et al paper concludes, putting it into my own words, that Fed purchases CANNOT GO ON BEYOND 2013. If purchases by the Fed stop in 2013, the Fed's balance sheet will probably result in catastrophic losses when interest rates rise in 2016 or 2017.

This paper concludes:

We then conduct(ed) a detailed analysis of the Federal Reserve's balance sheet and the implications for the Fed's future cash flow of a realistic exit strategy from its current expanded balance sheet. As interest rates rise, the Fed will need to pay more to persuade banks to hold any remaining large balances of excess reserves. And, should it sell assets to shrink its balance sheet as it has indicated is likely, the Fed will realize a capital loss on long-term securities that it bought when interest rates were lower.

In our baseline assumptions, these forces would result in losses equal to a significant portion of Fed capital by 2018, after which these losses could gradually be worked off.

But departures from the baseline, such as large-scale purchases continuing past 2013, or a more rapid rise of interest rates (a distinct possibility given the analysis presented in Section 3) would saddle the Fed with losses beginning as early as 2016, and losses that in some cases could substantially exceed the Fed's capital. Such a scenario would at very least present public relations challenges for the Fed and could very well impact the conduct of monetary policy.

QE is running out of room, out of time. Bernanke is hitting the wall. His suppression of interest rates to weaken the Dollar to support asset bubbles and the appearance of prosperity returning...CANNOT WIN -- this is what the Mishkin paper is suggesting. No wonder the Fed Board was boiling at their last meeting. Even those Fed members who do not support Bernanke's policies have tried to put a good face on all of this, fearing a meltdown in global markets.

Is the punchbowl going away? And if it goes away, what then? How low might stocks go? Ben Bernanke has painted himself into a corner; and now things are getting hard for him.

Watch the Dollar. If it continues to rally, Ben Bernanke is losing his power.

A note: there is a long-standing argument on Seeking-Alpha between those arguing American (the global economy and markets) are in a secular bull market or a secular bear market. My view of this is that the secular bear market started in 2001 and will continue until 2019. Keep in mind: A secular Bull Market is defined by increasing stock prices AND increasing US Dollar strength. A Secular Bear Market is defined by the decreasing value of the US Dollar, and by stocks that either go generally sideway or decline. ANY TIME the central banks have to pump trillions of dollars into the market to keep it from deteriorating, this is the unmistable sign that it is not a secular Bull Market.

Michael J. Clark, CGTS