Tuesday, December 15, 2009

Bernanke Responds to Bunning On Gold, Stock Manipulation, Quantitative Easing, China, etc.

Senator Jim Bunning submitted 70 written questions to Federal Reserve Chairman Ben Bernanke on December 8, 2009 as a follow-up to the Chairman’s renomination hearing that occurred. In response to those questions, Chairman Bernanke has provided Senator Bernanke with a 34 page document answering the questions. Here are a few snippets from the response (Questions are in italics):

6. Time and energy in macroeconomic analysis is spent attempting to measure business and consumer confidence. Confidence measures are part of macroeconomic forecasting and directly impact monetary policy decisions. Likewise, certain market movements reflect investor confidence or lack of confidence. Gold is at an all-time high because investors have lost confidence in policymakers' handling of fiat currencies. How is the Fed incorporating this market information into its analytical framework? Does the lack of confidence in fiat currencies have the potential to impact monetary policy?

Gold is used for many purposes, including as a reserve asset, as an investment, and for use in electronics, automobiles, and jewelry. Thus, fluctuations in the price of gold can reflect changes in demand associated with any of these uses, as well as changes in supply. In monitoring the price of gold, the Federal Reserve must attempt to interpret which of these factors is responsible for its fluctuations at any point in time. One of the ways we do this is by consulting other indicators of market sentiment. A number of measures of expected future inflation in the United
States, including measures taken from inflation-protected bonds and surveys of consumers and professional forecasters, have been well contained. Accordingly, increases in the price of gold do not appear to reflect increases in the expected future of U.S. inflation.

7. Paul Krugman recently wrote about the problem policymakers will face in the future because of the publi’'s lack of trust. The public backlash regarding what it sees as unwarranted bailouts of banks is well-known. What is the Fed doing to restore public confidence and what are the potential negative implications of this lack of trust on the Fed's ability to conduct monetary policy?

The public’s frustration with the support provided banks and certain other financial institutions is understandable. Unfortunately, withholding the support would have resulted in a substantially more severe economic recession with significantly greater job losses. My colleagues and I on the Federal Reserve Board are taking every opportunity, including through speeches and Congressional testimony, to explain to the public the reasons for the Federal Reserve’s actions.

Moreover, we fully support the efforts under way--in particular, strengthening supervision of systemically critical institutions and developing a regime to prevent the disorderly failure of systemically important nonbank financial institutions while imposing losses on the shareholders and creditors of such firms--to reduce the odds that similar support will be needed in the future.

Most critical for the Federal Reserve’s ability to conduct monetary policy is the public’s confidence in our commitment to achieving our dual mandate of maximum employment and price stability. The public’s confidence in our commitment should be bolstered by the Federal Reserve’s swift and forceful monetary policy response to the financial crisis and resulting recession and by our careful development of tools that will facilitate the firming of monetary policy at the appropriate time even with a large Federal Reserve balance sheet.

8. What are the limits on the ability of the Fed to engage in quantitative easing?

A central bank engages in quantitative easing when it purchases large quantities of securities,paying for them with newly created bank reserve deposits, to increase the supply of bank reserves well beyond the level necessary to drive very short-term interbank interest rates to zero.

The Federal Reserve’s large-scale asset purchases have been intended primarily to improve conditions in private credit markets, such as mortgage markets; the increase in the quantity of reserves is largely a byproduct of these actions. In any case, while large-scale asset purchases can help support financial market functioning and the availability of credit, and thus economic recovery, excessive expansion of bank reserves could result in rising inflation pressures.

Congress has given the Federal Reserve a dual mandate to promote maximum employment and stable prices. That mandate appropriately gives the Federal Reserve flexibility to engage in quantitative easing to combat high unemployment and avoid deflation while requiring that it avoid quantitative easing that would be so large or prolonged that it could cause persistent inflation pressures.

12. China is playing a larger and larger role in the growth trajectory of the global economy. And, China is one of the largest U.S. creditors. Yet, the macroeconomic data from China is notoriously untrustworthy. How is the Fed conducting its analysis of the Chinese macroeconomic outlook without access to good data?

While macroeconomic data from China vary in quality, their reliability appears to be improving,and they now provide a reasonable picture of what is going on. In addition to data from China,one can also examine Chinese international trade by looking at the statistics produced by its major trading partners, including the United States. At the Federal Reserve, we monitor a wide range of Chinese and international data in analyzing Chinese economic and policy developments.We also closely follow studies on China performed by independent experts, and keep regular contact with these experts, Chinese academics and authorities, and other U.S. agencies. Through all these means, we are able to put together a satisfactory assessment of the performance of the Chinese economy, allowing us to make an informed projection of the country’s economic outlook and its implications for the U.S. economy.

26. In response to a question posed by Chairman Dodd, you stated “we do not see at this point any extreme misvaluations of assets in the United States.” Does that mean you believe the price of gold is not artificially inflated or out of line with fundamentals? If so,what does the rise in the gold price signify to you?

Gold is used for many purposes. It is an input into the production of electronics, automobiles,and jewelry; it is held as reserve asset by governments; and it represents an investment for private individuals. With fluctuations in the price of gold reflecting changes in demand associated with any of these uses, as well as changes in supply, it is extremely difficult to gauge whether or not price changes are consistent with fundamentals. The most recent increases in the price of gold likely reflect diverse influences, including investor concerns about the many
uncertainties facing the global economy; however, it is also the case that the rise in gold prices has not been much out of line with the increases in other commodities. According to the Commodity Research Bureau, after fluctuating in a broad range for the previous 1-1/2 years, the price of gold has risen 22 percent since early July, while the CRB’s index of overall commodity prices has risen 17 percent. These increases appear to reflect the recovery of the global
economy, and it is not clear they have been out of line with fundamentals.

47. What does the surge in gold mean to you? At what price level would it begin to worry you, if it doesn't already? Does gold have any impact on the Fed's policy deliberations?

As mentioned in response to questions #6 and #26, gold is used for many purposes. Movements in the price of gold are determined by changes in the demand for gold for its various uses and changes in supply conditions. Therefore, assessing why gold prices have recently risen and whether the increase is consistent with fundamentals is very difficult. Accordingly, it is also difficult to specify a particular level of the price of gold which, if exceeded, would indicate particularly worrisome developments. As also mentioned earlier, the Federal Reserve looks at a wide array of indicators of market sentiment and inflation expectations. Among those indicators
is the price of gold, but for the reasons just noted, its movements are often harder to interpret than those of some of the other indicators. Nonetheless, we will continue to monitor the price of gold going forward.

50. Before the financial crisis there was a widespread sense, especially on Wall Street trading desks, that the stock market was strangely resilient. This encouraged excessive risk-taking in various types of assets. Do you have direct or indirect knowledge of the Federal Reserve or any government entity or proxy ever intervening to support the stock market (or any individual stock) via futures or in any other way? If yes, who decides the timing of such intervention and with what criteria? How is it funded? Which Wall Street firm handles the orders, and who sees them before they are executed?

The Federal Reserve has not intervened to provide support to the stock market or individual stocks by trading in futures or any other financial instrument. I have no knowledge of any other U.S. government entity providing such support.

61. Some observers see a new asset bubble forming in the stock market. Does it concern you that under some measures the current price to earnings ratio on the S&P 500 is considerably higher than the ratio when Alan Greenspan gave his "irrational exuberance" speech?

While assessing the fundamental values of financial assets is inherently very difficult, there is not much evidence to suggest that the stock market is currently in a bubble. Broad stock-price indexes have increased markedly since their troughs early this year. However, share prices have yet to retrace all their losses since September 2008, and are substantially below their peaks in 2007. Even more to the point, measures of risk premiums on broad stock-price indexes, despite having narrowed substantially relative to their record highs in late 2008, are still very wide by historical standards, suggesting that investors are not overly sanguine about the risks of investing in the stock market. Consistent with that view, implied volatilities on broad stock-price indexes have hovered at elevated levels in recent months, even as the economy has begun to recover.

All that said, stock values ultimately depend on the evolution of company earnings, which in turn depend on the path of the economy. Because economic forecasts are inherently very uncertain, the appropriate valuations of stocks are also uncertain.
A few comments.

1. Nouriel Roubini's recent report on gold can possibly be viewed in a new light given Senator Bunnings focus on the commodity in his questions to Bernanke. Was it just coincidence that he came out with a report dissing gold, and a day later Bernanke disses gold (though with a lighter touch)? It is not the first time Roubini has appeared to have exquisite timing and/or knowledge on topics. The guy is tied in to the Summers/Bernanke/Geithner clique real close. I think he gets word. It appears he knew non-public information about the bank stress test ratings and also knew that Bernanke was going to be re-nominated by President Obama in advance.

2. Bernanke has finally given us a definition of "quantitative easing" and it has nothing to do with growth in the money supply, only with increasing reserves, apparently even if those reserves end up as excess reserves that are not lent out by banks.

Is this curious use of "QE" confusing Bernanke into thinking he is maintaining an "easy" money policy?

3. The answer to question 50 suggests that the Plunge Protection Team has not intervened directly in the stock market. Bernanke is under oath and I don't think he would lie on the point. I am willing to take his word on it, subject to significant evidence to the contrary.

4. In his answer to question 61, I think he is setting himself up for another embarrassingly way off analysis of the current situation.

Here is Bernanke's full response.


  1. Wenzel,

    I thought Bunning's questions were poorly-worded softballs that gave Bernanke too much slithering-room. I almost am beginning to wonder if Bunning is part of the paid-for controlled opposition now. Highly disappointing stuff.

    Honestly, what do we know now that we did not know before Bunning submitted his questions? It's the same "We have the authority and the precedent to do X" and "We're just trying to save the markets" and "We did this 'within reason" stuff we've heard before, nonsense and lies.

  2. Despite all of the rhetoric from Bernanke and questions from Bunning, the price of gold sends a price signal from the markets on the concerns of future inflation and declining value of the USD.