Friday, June 25, 2010

Is Bernanke Preparing to Double the Money Supply?

On June 15, I wrote a post titled, Federal Reserve Very Concerned About Double Dip Recession.

It was a riff off a WSJ reporter Jon Hilsenrath piece. The Hilsenrath piece sounded to me like the Fed was very concerned about the economy.

Three days later I reported on the drop in the ECRI Index and wrote:
The ECRI continues to be one of my favorite indicators for tracking the economy. It tends to be much more timely and accurate than government data. This sudden drop in the index suggests imminent trouble over a broad swath of the economy.
Based on a new report from Ambrose Evans-Pritchard, my analysis does not appear to be that far off from the reality of the situation. Pritchard writes:
Fed watchers say Mr Bernanke and his close allies at the Board in Washington are worried by signs that the US recovery is running out of steam. The ECRI leading indicator published by the Economic Cycle Research Institute has collapsed to a 45-week low of -5.7 in the most precipitous slide for half a century. Such a reading typically portends contraction within three months or so.

Key members of the five-man Board are quietly mulling a fresh burst of asset purchases, if necessary by pushing the Fed's balance sheet from $2.4 trillion (£1.6 trillion) to uncharted levels of $5 trillion.
To date, Fed asset purchases have not had much impact on the economy since banks have simply kept the money on deposit with the Fed as excess reserves. However, an addition of another $2.6 trillion in assets by the Fed would most certainly see some of, if not all of the funds, enter the system. Further, as these Funds enter the system, it could very well cause banks to start to put to work the trillion they have sitting on the sidelines. The money supply (M2)would explode.

If Pritchard is anywhere near accurate on his reporting here, and keep in mind that my analysis of the situation earlier this month seemed to be heading in the direction of Pritchard's report, then we may very well be about to head into one of the most inflationary periods in American history.

The only drag on Bernanke's mad money printing plan seems to be the presidents of the Fed regional banks, but Bernanke is doing what he can to dilute their influence. Here's Pritchard again:

[Bernanke and other Fed governors] certain to face intense skepticism from regional hardliners. The dispute has echoes of the early 1930s when the Chicago Fed stymied rescue efforts... Mr Bernanke is so worried about the chemistry of the Fed's voting body – the Federal Open Market Committee (FOMC) – that he has persuaded vice-chairman Don Kohn to delay retirement until Janet Yellen has been confirmed by the Senate to take over his post. Mr Kohn has been a key architect of the Fed's emergency policies. He was due to step down this week after 40 years at the institution, depriving Mr Bernanke of a formidable ally in policy circles.
Bottom line: If such an asset purchase campaign is launched, the inflationary ramifications would be extremely severe. You would see near immediate upward spikes in the stock market and gold. Housing would follow. Then the consumer price inflation would start. Severe double-digit inflation.

How likely is Bernanke to begin such a campaign?

I have argued in the past that Bernanke does not have the "trader's touch" that Greenspan had. Greenspan's money manipulations are largely responsible for the current overall downturn and the housing crash, but on a short-term basis, Greenspan had the "touch" to add just enough money to fuel the economy and not go stark raving mad on the money printing side.

Bernanke does not appear to have this touch, he swings from near zero money printing, as is the case now and also in the summer of 2008, to extreme money printing as was the case between September 2008 and March 2009, when the money supply (M2) climbed at annual rate of near 15%. Thus, a $2.6 trillion asset purchase by the Fed under Bernanke would not surprise me. The man swings extreme, and the current negative numbers on the economy, which I am sure he understands means major problems ahead, must scare the bejesus out of him.

The Fed has not started any major asset purchases, yet. But the situation needs to be monitored closely. Any indications that Bernanke is indeed conducting massive quantitative easing operations will mean that its time to get in aggressive inflation protection mode.

6 comments:

  1. With out wage increases its very hard to get inflation. The wages have been stagnant or productivity-rate-of-increase is high to mask off any incentive/reason to increase wage.

    the wages have been literally stagnant for 10 years or more. If there is money infusion, there is not much appetite in private business or consumer. Unless they figure out a way to blow another bubble - which they have been trying to do for past 2 years unsuccessfully.

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  2. First Anonymous, prices can rise without wages going up. Wages not going up or even going down exercises downwards preasure over prices, but its not the only issue that influences prices. You can check how after the fascist FDR devaluated the currency in 1933, prices started rising in question of weeks and unemployment was not getting better and wages were not going up. It was all because of the monetary devaluation.

    Now the USA is not on a gold standar like it was back then, but the government is executing a monetary devaluation as well. The way it plays out will be somehow different because the systems are different, but its prove that you can have prices going up without wages going up. You have a lot more historic evidences.

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  3. "I have argued in the past that Bernanke does not have the "trader's touch" that Greenspan had. Greenspan's money manipulations are largely responsible for the current overall downturn and the housing crash, but on a short-term basis, Greenspan had the "touch" to add just enough money to fuel the economy and not go stark raving mad on the money printing side.

    Bernanke does not appear to have this touch, he swings from near zero money printing, as is the case now and also in the summer of 2008, to extreme money printing as was the case between September 2008 and March 2009, when the money supply (M2) climbed at annual rate of near 15%."

    Not trying to defend Bernanke here, but Greenspan never faced anything similar to what Bernanke is facing. The economic situation now is more extreme than anything Greenspan saw during his mandate.

    "Maybe" that is why Bernanke is having to proceed much more extremely than Greenspan ever did.

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  4. Greenspan faced a 25% plus drop in the stock market in October 1987 and the internet bubble bust. The reasons these weren't worse is because Greenspan new whne to step on the peddle.

    Bernanke would have crashed the economy in those cases.

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  5. @Robert, but the economy was in better shape and that is why the easing in monetary policy worked then. Over the years more and more inflation kept distorting the capital structure, to the point where the economy did not go into bubble mode again. And here we are.

    Greenspan was only able to get away with its monetary easing for so long because Volcker cleaned the economy in the 80's raising interest rates and bringing the necesary deflationary correction.

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  6. Print baby print.... the way to go bernanke!!!(NOT). In about another 12-18 months we will be asking this question?
    What is the differance between toilet paper and MONEY??, it cost more money to wipe your arse than what the money is worth!!.We will be doing what they did in Germamy in the 1920's, burning it to keep warm.........By the bail!!! ,a wheel barrow full of hundreds for a weeks pay ($1.00 now equals $0.0000000003 later).If we are lucky!!

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