Bernanke’s Choice

Federal Reserve Chairman Ben Bernanke delivered a bleak new assessment of the U.S. economy to lawmakers on Tuesday but remained guarded about what, if anything, the Fed would do about it.

Chairman Bernanke remains guarded because he’s run out of “arrows” in that metaphoric quiver that reporters use to refer to Fed policy options. The above lede from the Wall Street Journal also reflects the doubt that pervades the Fed about what to do next. It is apparent that the Chairman has run out of policy options and he will be forced into unleashing another round of quantitative easing. When is difficult to say, but I believe he will cave in to political pressure to do this as we get closer to November.

In his testimony to the Senate, Dr. Bernanke is quoted as saying:

We haven’t really come to a specific choice at this point … . We are looking for ways to address the weakness in the economy should more action be needed.

The Chairman noted that economic indicators aren’t positive, so he is hoping (wishing) that the economy stops its decline and unemployment goes down. He hopes against hope, because like most of the prognostications he has made about the economy since the recession began in 2008, his wishes are unlikely to come true.

That leaves him with what? Here is a hint:

“Get to work, Mr. Chairman,” Sen. Charles Schumer, (D-N.Y.), said after pushing Mr. Bernanke to concede that unemployment was too high and inflation posed little risk. 

Most investors and economists believe that creating money out of thin air to buy Treasurys or other securities will boost economic activity. They have yet to provide any real objective evidence that it has worked other than driving up the prices of securities. In fact this recession persists despite the assurances our leaders have given us about policy actions they have undertaken. While Chairman Bernanke mentioned extensions of his current Twist policies, they have done absolutely nothing to boost growth.  One could even say that the economy’s decline may have something to do with Fed policies, as I believe they do. But failure doesn’t seem to deter the Fed.

The problem for the Chairman is that none of the Fed’s policies have worked out as they have expected. Pre-2008 then Professor Bernanke expressed his confidence that the Fed could fine tune the economy so that we would not suffer calamities like the Great Depression. I believe his confidence in the Fed’a ability to do anything constructive is shaken. The problem is that he doesn’t understand anything else.

I will rely on the history of central banking to state that they will do what all central banks do when faced with calamity: ZIRP (no surprise here; they’ve extended it out to 2015); more Twist (an extension of ZIRP); and more QE.

If you wish to see the future, keep the experience in Japan in mind. Despite 20 years of stagnation, each successive government does the same thing: fiscal stimulus followed by BOJ financing the resulting debt with borrowed money. Not only have these policies not revived their economy, they perpetuate it, and they are now running out of domestic savings to borrow (i.e., they have spent most of the country’s savings).

So, when Senator Schumer says, “Get to work” he means the Fed should embark on another round of QE as soon as possible. While the Chairman protests that ”We will act in an apolitical, nonpartisan manner to do what’s necessary for the economy”, he is likely to do just what the Senator wants him to do, because the Fed, as a money creating machine, knows how to do that. Don’t believe that the Fed is “independent.” Chairman Bernanke will act like his predecessors and accommodate his political overseers.