The Federal Reserve Open Market Committee concluded its two-day meeting without budging on its free money policy.
As expected, it kept unchanged its benchmark overnight rate, keeping it in an historically low range of zero to 0.25%, so as to keep applying novocaine to the frayed nerve endings of bankers who make money borrowing cheaply and lending long at higher rates.
The FOMC statement said that economic activity is "leveling out," an improvement from the "pace of economic contraction is slowing" that was said at its June meeting.
The Fed also said its extraordinary buying of mortgage-backed securities and Treasurys will continue--moves that have tested its credibility and independence. The only change in the Fed's plan is that it will spread out its purchases of Treasurys until the end of October, not September.
And now the parsing of the words in the Federal Reserve's statement has begun on Wall Street, an intense drama given the quantitative, or rather quantum, easing in the Fed's various bailout programs, in which its gross exposures in a worst case scenario of wholesale economic collapse stands at a gut-clenching $6.8 tn, out of $23 tn in overall government bailout exposures, according to the inspector general of the Treasury's Troubled Asset Relief Program.
A bazookanomics approach to deal with a meltdown that vaporized $11 tn out of American net worth.
The Fed, by most accounts, was instrumental in saving Wall Street and the banking sector, and stopping a plunge in the economy by ramping up liquidity to banks and parts of the fixed income markets.
The general consensus of economists surveyed is that Fed chairman Ben Bernanke will be reappointed as Fed chair by President Barack Obama. Incoming Presidents historically have re-invited sitting Fed chairmen, the exception in the last sixty years being Jimmy Carter when he named Paul Volcker to succeed G. William Miller as Fed chairman.
However, although Bernanke is now oddly, and to some monetary hawks prematurely, giddily talked about as a potential candidate for Time Magazine's Man of the Year and lauded as if he discovered a way to bottle lightening, Federal Reserve chairman Bernanke is not only blowing new bubbles.
Bernanke has also entangled the US central bank like never before in the economy and in government fiscal policy, at a time when the US Congress and the Administration have exploded the government's deficit spending.
This is dangerous, untrammeled ground, and the markets will be learning along with Bernanke how to dismount out of historic Fed lending programs, a lesson that will be like trying to learn how to drink water from a massive fire hose.
Though the markets have yet to really test Bernanke's credibility, signs of its unease are there, which doesn't bode well for investors and consumers who may see loan rates and prices go higher.
The dollar is hurting, it's now at a ten-month low, and the ten-year note has inched up about a point higher versus its lows just four months earlier in March, when the Fed announced its quantitative easing.
In turn, the average rate for a 30-year mortgage rose last week to 5.2% from a record low of 4.8% in mid-March, notes Peter Boockvar, managing director and equity strategist at Miller Tabak & Co.
And Boockvar notes that the implied inflation rate in Treasury inflation-protected securities, or TIPS, has also risen from 1.15% to 1.90% since March. The CRB index, the commodity price index which tracks 28 different commodities, is up 21% since then.
So now, instead of the Greenspan put, the markets face an elephantine-sized Bernanke put. A put is an option whereby a buyer gets the right to sell a security at a pre-agreed upon value if prices drop.
When the Fed under Greenspan dropped the Fed funds rate to record lows to deal with all sorts of crises, the markets had to deal with negative real yields on securities--hence the 'put' term. Greenspan hacked rates after the '87 crash, and he kept rates low after the Gulf War, the Latin American debt crisis, the Asian flu, also after the Long Term Capital fiasco, Y2K, the Internet bubble bursting, and after 9/11.
Where are the markets headed with the new Bernanke put?
Questions Mount
Can Fed chair Bernanke, up for reappointment in January, safely pull the central bank back from its massive monetary injections into the economy without triggering rampant inflation?
In the face of growing voter unease over job losses, can Bernanke withstand the political heat from Congress and the Administration and apply the needed coolants in the form of rate hikes to douse inflation, given the Fed's sizable assist in the government's fiscal spending?
Can Bernanke get the plumbing right to avoid a double dip recession?
And can the Federal Reserve at the same time be the systemic risk regulator to wind down lethally dangerous companies, as the White House, the Treasury Dept. and members of Congress now envision?
Unless Bernanke undergoes a sudden, miraculous backbone transplant, the answer to all of the questions above is no.
Which means investors and consumers should watch out"”rates and inflation are going up.
Meanwhile, all sorts of new taxes are being proposed.
They include cap and trade, payroll taxes to pay for health care reform, taxes on health care benefits, more gas taxes, "and, if you happen to be a successful small business owner, higher income taxes and an insurance mandate that has to be funded out of profits (or higher prices),"notes the National Federation of Independent Business.
Why the Answer is No
As to whether Bernanke can pull back when needed, economists point out that for one, Bernanke is a student of the Great Depression, in which he has criticized central bankers back then for not being generous enough with its powers to ease that crisis, and for yanking monetary support too early, thereby lengthening the crisis in the "?30s.
Because Bernanke has publicly said he is averse to having any disaster akin to a Great Depression on his watch, that is the reason why the Fed has signaled in its recent FOMC statement that it won't tighten rates, because "economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."
Fed Doublespeak
Watch how the Federal Reserve is now tossing smoke bombs by calling its various lending programs "credit easing" versus "quantitative easing", a phrase usually denoting a boosting of the money supply. Ignore that language, because, as Richard Bernstein, former chief investment strategist for Merrill Lynch warns, the Fed is still blowing bubbles.
Because it's difficult to pull monetary levers when rates are effectively at zero, the Fed under chairman Bernanke has made a quantum leap in its balance sheet, and the markets fear Fed officials cannot stop this science project from exploding into inflation.
Put it into perspective. One trillion is now the new billion, analysts say. A trillion is greater than the GDP of Australia, $1 tn is enough to buy the Toronto stock exchange, it is twice the cost of FDR's New Deal, and $1 tn could buy every home foreclosed in 2007 and 2008, estimates show.
And now, the bond market is bracing for trillions of dollars in government debt issuances within the next 12 months to pay for the government's spending programs, the $787 bn stimulus package and the $3.6 tn budget.
The Fed has created its own inflationary threats to the economy, as it has gone full throttle on its own bailouts at a time when the US government has embarked on its own massive stimulus and budgetary deficit spending.
However, GDP forecasts for the second half of the year have economic growth at 2%, double what some members of the FOMC predicted in June. Productivity is also picking up speed, setting the stage for a rebound in corporate profits, which should revive business hiring and spending.
If growth is returning, then why the need for all of the fiscal and monetary stimulus?
A good deal of autopilot thinking can be found in DC on the need for such massive, inflationary spending, in which the President, his officials and Democrats in Congress, when questioned or opposed, tend to descend into a tedious orgy of self-righteousness. Meanwhile, it's your money that's at stake.
According to ProPublica.com only $70 bn out of a total $787 bn (from the February stimulus bill) has been spent Keynesians. So why not stop this spending now before its inflationary effects are felt?
Even Bernanke quietly chided Congress at his last appearance on Capitol Hill to do more to rein in deficit spending, as the budget deficit now approaches $1.8 tn for the year. That sum doesn't count the costs for the bailouts for AIG, Fannie Mae, and Freddie Mac, as well as Social Security and Medicare, which are all "?off-budget.'
The Fed's Quantitative Easing
Before it hikes rates, Bernanke has indicated he plans to unwind the Fed's various bailout programs.
That could take more than a decade to do.
While the Fed more than doubled the size of its balance sheet to over $2 tn, its balance sheet has dropped back to $1.8 tn. Even so, by the end of July, it held $695 bn in Treasurys, more than triple the $216 bn in July 2008.
The Fed also hit the computer button and created a massive $782 bn in reserve balances at its member banks, about a seven-fold increase before the crisis began. That money could come flooding into the system, creating inflation, which is too much money chasing too few goods.
Bernanke says not to worry, the Fed will give banks an incentive to keep that money parked at the central banks because it will pay interest on those reserves. And he plans to sell Treasurys to the banks to remove that cash from the system.
But is that enough of a safeguard? And wouldn't even more Treasurys mean more bonds competing with other bonds for investors, driving yields higher?
The Fed says it has nearly hit its target of buying $300 bn in Treasurys, with about $236 bn already purchased. The Fed wants markets to rest assured that it is buying Treasurys in order to keep consumer borrowing rates low, as loan rates are typically tied to the long bond.
The last time the US central bank bought Treasurys was in the late "?40s, to help the US government recover from World War II. The Fed's Treasury program should finish in September, and it now says it will put off that deadline until October, as noted.
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