Bernanke Way Ahead of Krugman

In a recent NYT column, Paul Krugman raises a potential problem point with the Federal Reserve buying longer-term treasury securities that, I'm guessing, Fed Chairman Bernanke recognized as a problem point about 10,000 light years ago. Further, Bernanke has come up with a solution to the problem, which it appears Krugman doesn't recognize.

The gist of Krugman's point is that with the longer-term Treasury securities that the Fed is about to buy, it will cause inflation which will eventually push interest rates up and the price of the bonds the Treasury has bought will go down in price. Thus, Krugman makes the correct point that, with the bonds lower in prices, when the Fed chooses to sell them the Fed will not get back as much money as they put in, thus they will not be able to completely drain the reserves they initially pumped in, by simply buying the Treasury securities back.

BUT, this is the same problem the Fed is going to have with some of the flaky assets the Fed has bought from banks. They will never get what they paid for them. I covered Bernanke's solution for this late last year. It also applies as the fix for the lower priced Treasury securities, i.e. the Fed will sell new debt to drain reserves. (Note: Another technical way to drain money from the system would be for the Treasury to issue more debt and then simply deposit it with the Fed. The only problem with this solution is that it will be too obvious to spot as increased debt if the Treasury increases its debt this way.)

Thus, the Fed desire to for even more new "tools."

In a mysterious paragraph at the bottom of a press release, the Fed recently said they plan to seek legislation for some new "tools." I suspect it is the legislation to allow the Fed to issue debt. The Fed won't provide me with any info on the legislation or if they are still considering the plan that has been mentioned to issue debt.

Krugman, also, suggests that what Bernanke is doing is "qualitative" easing rather than "quantitative".

I suspect that what Krugman is thinking is that because Bernanke is targeting certain assets to buy, it is "qualitative", but while that may be technically true as a way to classify what Bernanke is doing, it is taking the eye of the ball. What is most important is not what he is targeting, but the quantity of the money he is printing. And, in terms of the "quantitative" printing Bernanke is doing, he must consider Zimbabwe's Robert Mugabe a role model.

Specifically, Bernanke is calling it "quantitative" easing, as a contrast to "interest rate" easing. Bernanke gets, as very, very, few do, that cutting interest rates is not the same thing as easing the money supply. And, he knows that at rates still near zero, he can "quantitatively" ease any damn amount he wants, including, ahem, a trillion dollars.