Wednesday, May 30, 2012

Is Ben Bernanke the New G. William Miller That Will Destroy the U.S Economy?

During the Jimmy Carter administration, G. William Miller became Fed chairman in January 1978 and was removed in August 1979 (A friend of Carter's, Carter made him Treasury Secretary, where he could do less damage).

In November 1978, only 11 months into his term at the Fed, the dollar had fallen nearly 34% against the German mark and almost 42% against the Japanese yen. Price inflation was soaring. In 1979, the CPI has climbed on an annual basis to over 14%. Miller was a disaster as a Fed chairman.

Miller's role in the out of control inflationary economy came about because he targeted interest rates, while at the Fed. This led to a boom in money supply. M2 money growth reached as high as 12% on an annualized basis.

When Miller was removed, Paul Volcker came in and announced that interest rates would no longer be targeted and that money growth would be targeted and slowed. This killed the Miller created price inflation.

It now appears that Bernanke is pulling a type of Miller act, but with more crazed twists and turns.

Under Ben Bernanke we have had some remarkable changes in money growth, already. Here's a chart of quarterly annualized money growth (M2) since Bernanke took over at the Fed.

Things are likely to get even more erratic from here, since Bernanke appears to be making the same mistake that Miller did. For all Bernanke's bells and whistles about Operation Twist and QE this and that, what Bernanke really appears to be doing is like, Miller, instead of keeping an eye on money supply, he is targeting interest rates.

Over the last month, the Fed appears to be targeting the Fed Funds rate at 0.15%.

What's odd about this is that there appears to be very heavy downward pressure on U.S. rates. The 10-year U.S. Treasury yield fell to an all-time low of 1.659% this morning. Some downward pressure might be attributed to Operation Twist, but most of the downward pressure appears to be hot money flowing out of the eurozone.

This comes from the Dow Jones wire:

The benchmark 10-year U.S. Treasury yield sank to an all-time low of 1.659% early Wednesday in New York as fears about the euro-zone debt crisis intensified.

The latest anxieties center around Spain's ability to support its banking system, piling on top of recent worries about Greece's future in the euro-zone bloc. This prompted global investors to seek out safer assets, pushing the 10-year yield below 1.672%, the previous low originally set in February 1946 and matched briefly last September.
So if rates are sinking, but the Fed Funds rate is not, that must mean the Fed has to be draining reserves from the system. And, indeed, they are. The Fed's H.3 release shows that total reserves have declined since mid_April, roughly the start of the latest intensity in the eurozone crisis.

This drain in reserves has been accompanied, as would be expected, by a dramatic slowdown in money growth (M2). According to the latest Fed H.6 release, annualized M2 money growth has declined from 9.8% over the last 12 months to 6.7% over the last 6 months to 4.0% over the last 3 months.

Last Friday, in the EPJ Daily Alert, I explained what is going on and the danger ahead:
What's behind all this? I suspect hot money.

Despite all the hullabaloo about Operation Twist and other Bernanke "tools', Fed policy is being run, the same as in the past, by targeting the Fed Funds rate. A glance at Fed data shows that the NY Fed has been targeting the effective Fed funds rate for some time at 0.15%.

If some hot money from the eurozone has been flowing into the United States (and it likely has), this would put downward pressure on rates in the U.S. Indeed, if you look at the numbers, it would make a lot of sense for this to go on. German government 6-month paper is yielding 0.06%. while comparable U.S. Treasury bills are yielding 0.15%. If you are a wealthy Greek, or Italian or Spaniard, what rate is going to look most attractive to you? Thus, the flow of money into the U.S. paper, which puts downward pressure on U.S. rates. However, if the Fed is targeting 0.15%, then they have to drain reserves to keep the rate at that level.

What's the problem with all this? Aside from the entire idea of the Fed manipulating interest rates in the first place, the manipulation is now being influenced by this overseas hot money. In other words, the reserve drain continues only as long as hot money is flowing hot into the U.S., a reversal of the hot money results in a reversal of Fed actions. As money flow heads out, the pressure on interest rates will reverse and be to the upside, which will cause the Fed to add reserves.

When this hot money reverses itself is difficult to determine. It will depend upon perceived risk in the eurozone, if the panic calms down, then the hot money flow stops and could even reverse itself.

Assuming, the hot money flow continues, this at some point will result in very slow money growth and a return to a very weak economy and stock market in the U.S., which I then anticipate the Fed would counter with more money printing.
Bottom line, Bernanke, like Miller, by tying monetary policy to interest rate targeting is causing wild moves in money supply. Miller's money supply moves were all to the upside. Bernanke's are more erratic. The hot money inflow is causing him to drain reserves and slow money growth at present. It's possible that the drain could result in enough of a slowdown to cause the stock market and economy to head lower once again and cause President Obama to lose in his re-election bid. On the other hand, if things calm down and in the eurozone and the hot money flow stops or reverses itself, the manipulated boom continues with accelerating price inflation.

The eventual outcome is likley to be more money printing by the Fed, but a dip may occur first as a result of the way Bernanke is managing monetary policy. Brace yourselves, the Bernanke roller coaster ride is not over.



  1. RW:

    "So if rates are sinking, but the Fed Funds rate is not, that must mean the Fed has to be draining reserves from the system."

    Can you explain that statement to me like I'm a 5 year old? I don't understand why reserves have to be draining from the system. Where are they going? Why would their absence lead to falling rates?

  2. RW, could you also explain why FED policy leads to different results depending on whether they are targeting interest rates rather than just the money supply? Aren't they directly tied?

  3. Don't be sucked in by following the Fed's "seasonally adjusted" M1 and M2

    See these links for the monstrous inflation under way:

  4. Hi Roger,

    I'll default to RW if he responds with something different. - If I understand your question correctly, it is my understanding evidence exists that reserves are draining based on the link RW points to in the following sentence. Where is that money going? Not into, for example, the stock market, as those prices are not being bid up; but, since US treasury yields are falling (their prices, thus, rising) it is logical to think the reserves are being funneled into treasuries. The treasury price is being bid up with reserve money; the treasury rate (the yield or profit margin) is falling as the price rises.

    The Federal Funds rate, the overnight rate at which banks lend money to one another, is about 0.15% (the target is somewhere between 0.00 - 0.25%). Its rate is manipulated by the Federal Reserve by raising or lowering the money supply. Larger supplies of money make it cheaper for banks to borrow/lend money to one another. Six months ago, when the money supply was a little larger, the rate was 0.07. Today, when the supply is lower, the rate is 0.16.

    For the Fed Funds rate to be sinking, the supply of money (the reserves the bank have on hand) would normally be rising. That is not occurring right now, as is seen in the H.3 link.

    Hope that helps!

  5. News flash. The dollar is strong and Mish is right about debt deflation. I don't expect this comment to be published as my last one defending Mish's view of inflation wasn't. Credit continues to collapse and debt is being destroyed faster than money is being created. No inflation here, nor coming for awhile. Rates at all time lows and commodities collapsing.

    1. sure, it may be for now. But when do politicians ever take the easy way out? It will be a blessing in disguise if they let debt liquidate.

  6. Rob,
    ive said it before i say it again. You should write a book on all this and how to read and understand all this stuff. It would be great read. "reading money supply numbers like an Austrian and interpret it to business cycle" something like that.
    with that being said i have looked for that first chart you posted M2 SA and NSA year over year change. where you find that on the st loius fed website i could never find it.

  7. Let's see...
    This is a replay of what happened with Japan and the US back in the 80' devaluing the USD, one could say that Miller broke Japan Inc's currency games (which are now being played on a grander scale by China). A strong dollar is relative unless the US is willing to start a currency war which perhaps could lead to a real war with China.....
    How do we keep China from stripping the US and other nations capital by artifically (and continually) lowering the value of the Yuan v the other world currencies??? (They've been doing it for years) Pay with a devaluing currency (and hence change the USD/Yuan ratio) and passing inflation that is built into our currency to China... The dollar the Chinese took from us last week is worth less this week...but the euro Hot Money flows force the dollar to stay up. Ben must loosen: either interest rates or printing. Japan companies know it is coming and they are out buying other companies in other nations with the Yen while it is still relatively high because it will (and must) be devalued (or no exports) as will the Eurozone....