Should the Fed begin raising rates and extracting excess reserves? In late 2008, our minders diagnosed a credit crunch prescribing massive liquidity injections to make credit flow again. Unfortunately, the credit crunch was more symptom than disease and masking the symptom has only delayed the necessary surgery. The real economic infirmity was declining capital caused by inflation-induced overconsumption and malinvestment.
Bernanke's Fed operates on the wrong symptom after misdiagnosing the patient. We're not suffering a crunch slowing the credit he believes to be the lifeblood of capitalism. We're hemorrhaging credit after engorging on too much debt. Our debts are staggering. We need additional savings to replenish capital rather than borrowing to keep spending it frivolously. Bernanke would serve us better with a tourniquet rather than these excessive credit transfusions.
Bernanke may have us all borrowing and spending again. GDP appears to be recovering. Unfortunately, the market's corrective medicine was stunted and these interventions bear inflationary consequences. Despite Bernanke's assertion that, "The US government has a technology, called a printing-press, that allows it to produce as many dollars as it wishes at essentially no cost," the costs are real and painful.
Since last September, they have created trillions of dollars to backstop crumbling financial markets by purchasing worthless bank assets and lending freely. Short-term interest rates barely hover above zero. They have also been monetizing treasuries to reduce long-term rates. This was done ostensibly to make mortgages more affordable.
Not only are these false cures to what ails us; they also reveal the futility of staving off asset deflation while facing an inevitable correction. The Fed's customary interventionist practices taken to their extremes failed to stanch the bleeding. Bernanke has authored numerous intrusions beyond his customary treatment manual because his usual cures were rendered ineffective.
We monetized treasury debt during WWII, but that enabled our survival and had a definite end. Now we play this check-kiting fraud to fund self-perpetuating welfare programs. Welfare won't end. These programs accelerate. We once traversed this monetary high-wire for a legitimate purpose requiring economic risk. Now we finance society's moral rot.
This fights a symptom of inflation (rising LT rates) with an inherently inflationary cure. The longer Bernanke persists, the more pent-up inflation gets unleashed when he stops. Nonetheless, Bernanke claims he can undo these policies without endangering us.
Today, much of the excess liquidity remains essentially book-keeping entries. These monies replenished bank reserves decimated by faulty lending. Bernanke intends to prevent banks from lending them out by paying additional interest.
No value was created in conjunction with these new dollars. To the extent they have any value; it reflects an enormous transfer of wealth from the rest of us to Wall Street. Or, if they have no value, these banks are still failing. It's either theft or fraud?
Supposedly, if these freshly printed dollars never circulate, they will not raise the price level and thus there is no inflation. This idea mistakes one painful symptom with the disease itself. The CPI does not measure inflation. It measures consumer prices which is usually the last symptom to arise.
The CPI is like a stock price after a company issues additional equity. The price may rise despite its dilution as there are scores of factors impacting equity markets. But even more factors influence consumer prices. Unlike a stock investment, where its return is likely our primary concern, the consequences of monetary dilution are numerous. But prices will rise as confidence in the dollar erodes reversing last fall's flight to safety.
Bernanke misses on three points:
a) This equates to stealing someone's lawnmower in the dead of winter and claiming that it's not really theft if you return it before spring. Even if we never feel the pinch of higher prices, our government just bestowed colossal sums of money on its politically-connected friends. Shifts in monetary policy take time. The prices of oil and other commodities have risen substantially. Just because these haven't yet increased the price of bread doesn't mean your lawnmower wasn't stolen.
b) This is uncharted territory. Never has so much money been created so quickly. Nobody, Bernanke included, knows if it's even possible to extract these funds before the price level surges. Dr. Bernanke's patient lies exposed in the operating room, but he's never performed this procedure before. He plays a dangerous game with our financial health.
c) He walks a tight-rope. Even if you ascribe to his faulty logic, this procedure requires uncanny balance between inflation and growth. If the Fed's over-heated printing-press served as an antibiotic; what happens if the treatment ends before the infection is contained? If he moves quickly to avoid inflation, he may instead undermine our fragile recovery.
Bernanke faces a dilemma. He must manage interest rates and the proliferation of new dollars by walking a very thin line. If he moves too slowly, inflation will spiral out of control. If he acts too soon, he may dash the recovery. This highlights one of many fallacies in the statist argument extolling government intervention. Once recovered, we still depend on the programs that turned things around. Then what?
It is virtually impossible to manage these dials effectively. Bernanke will likely err on the side of inflation. Upending the recovery will embarrass politicians leaving him a scapegoat. Inflation makes the massive debt incident to their deficits relatively cheaper. Painful consumer price inflation won't be felt for some time allowing political cover.
Meanwhile, the cheap money will trigger an artificial boom. Dr. Bernanke will look brilliant and politicians will take credit for saving us. The press will authenticate this falsehood before equilibrium catches us from behind yanking us back to reality. When price inflation hits, it will hit hard.
Bill Flax works in the banking industry. This column reflects his views and not those of his employer. Please contact him at billflax2@yahoo.com.
Read Full Article »
