Thursday, November 4, 2010

The Confusion in Ben Bernanke's Mind: Will It Cause Him to Lead Us into Hyper-Inflation?

Ben Bernanke is out with an Op-Ed in today's Washington Post, which proves the man is as confused about monetary policy as most WSJ reporters.

He writes (my emphasis):
Two years have passed since the worst financial crisis since the 1930s dealt a body blow to the world economy. Working with policymakers at home and abroad, the Federal Reserve responded with strong and creative measures to help stabilize the financial system and the economyAmong the Fed's responses was a dramatic easing of monetary policy - reducing short-term interest rates nearly to zero.
This is confusion number 1. Although I have criticized the late Milton Friedman and his current supporters for their calls for money printing, Friedman at least understood the technicals of how money is created. Despite Bernanke's belief that falling interest rates are an indication of an easy money policy, this is not always the case. Beckworth and Ruger correctly point out:
So what would Milton Friedman say about our current monetary policy?

First, low interest rates do not necessarily mean monetary policy is loose.

Friedman criticized the policies of the Fed in the 1930s and the Bank of Japan in the 1990s on this very point. Both central banks claimed to be highly accommodative at these times, pointing to low interest rates as evidence of easy monetary policy. Friedman countered, however, that low interest rates may reflect a weak economy rather than easy monetary policy.
This is exactly the mistake that Berrnanke is making by claiming low rates mean an easy money policy.

The real rate (i.e. the rate that would exist in the market without manipulation of the money supply) has to be higher than the Fed funds rate. Otherwise, banks have no incentive to borrow Fed funds, and thus the money supply doesn't expand. In the current environment, with Treasury bills ( a sort of proxy for real rates) below the funds rate, banks have, indeed, reduced loans, as one would expect. Thus for significant periods of the financial crisis (except Spt. 2009 to early 2010) the Fed has not been in an easing mode, despite the low rates.

Bernanke then tells us that:
Today, most measures of underlying inflation are running somewhat below 2 percent, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth in the long run.
He says this despite the fact that most commodity prices are soaring.

He then pretty much admits that the program to buy bonds is relatively new and therefore could have hidden time bomb elements:

While they have been used successfully in the United States and elsewhere, purchases of longer-term securities are a less familiar monetary policy tool than cutting short-term interest rates. That is one reason the FOMC has been cautious, balancing the costs and benefits before acting. We will review the purchase program regularly to ensure it is working as intended and to assess whether adjustments are needed as economic conditions change.

"[W]e will review... to ensure it is working as intended". Ha? That sure indicates Bernanke is far from confident he knows exactly what exactly will happen.

He goes on:
Although asset purchases are relatively unfamiliar as a tool of monetary policy, some concerns about this approach are overstated. Critics have, for example, worried that it will lead to excessive increases in the money supply and ultimately to significant increases in inflation.

Bernanke uses words in strange ways. He is calling the purchase of bonds "asset purchases", but so is the purchase of Treasury bills, "asset purchases". Weird. So to be technically correct, "asset purchases" are not a new "tool" of monetary policy. Long term bond purchases are.

But critics are not worrying, as Bernanke indicates, because it is long term securities that Bernanke is buying, rather critics are concerned that the purchase of any assets will be inflationary--short- or long-term assets.

Here is more from Bernanke, and it is truly scary, since it indicates he really has know clue. He writes:

Our earlier use of this policy approach had little effect on the amount of currency in circulation or on other broad measures of the money supply, such as bank deposits. Nor did it result in higher inflation.
To compare what was done in QE1 with what is being done now is just wrong and reflective of a dull, confused mind. In QE1, the mortgage backed securities that were purchased were purchased from the elite insider banks, to the tune of a trillion dollars plus. This money was immediately deposited with the Fed as excess reserves, where most of it sits to this day. This money was never in the system. The new purchases will not be of this type. The Treasury securities bought will be bought from a broad spectrum of the public, from pension funds, to farmers, to corporate treasuries. These sellers can't, and have no plans, to put the money with the Fed as excess reserves. They will use the money in the economy. It will therefore be in the system bidding up prices. Only the multiplier effect is inderterminate and will be based on what the banks do with the funds--once they go through the system once.

As for the money that did get out into the system in QE1, when Bernanke says it had "little effect on the amount of currency in circulation or on other broad measures of the money supply."   He is completely incorrect. As the chart below indicates, M2 grew by $600 billion over the period when the Fed started easing in September of 2008 and the first quarter of 2009. An anualized growth rate of 11%.

Bottom line: It is simply stunning to examine the facts and Bernanke's view of them. I have often thought that the only way a central bank in a highly industrialized country could be pushed into hyper-inflation is if those heading the central bank simply did not understand the controls they have in front of them and how they work. The Op-Ed by Bernanke adds further evidence that he is simply confused about money supply operations and the facts of the situation. In other words, we truly have at the Fed a man so confused that it is very possible he could take us into hyper-inflation without even realizing it, until it is too late.

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