On July 13th and 14th, Federal Reserve Chairman Ben Bernanke testified on capital hill before the House Financial Services Committee and the Senate Committee on Banking, Housing and Urban Affairs offering a good opportunity to critically review many of his ideas. See the following critique of some of Bernanke’s major themes:
Bernanke: ‘We’re not Printing Money’
This month’s hearings were not the first time Bernanke has taken the line of thought that the Fed is not engaging in money printing. Despite following everything the Bernanke has said over the last decade, I cannot make sense of his reasoning here. The Fed itself includes its balance sheet expansion as part of their money supply calculations and these monetary aggregates are clearly growing:
Liabilities of the Fed are money themselves, just look at the Federal Reserve Act, and they have grown by over 2 trillion dollars since the crisis began. The Fed is purchasing assets with something, if not money, then who knows what.
The only sense in which Bernanke may be making a point, is that he contends the Fed plans to unwind their recent monetary stimulus eventually. Even if this is the case, it would still entail him factually printing money now and then detracting some of that money later, which has many real and disruptive effects. The fact of the matter is the Fed is not going to decline their assets, they never have. Even the most extreme part of the Fed’s merely conditional exit plan is to sell only 4% of total assets within years from now, leaving trillions remaining in the system.
What makes the view of the Fed not being a money printer even odder, is Bernanke’s constant self-induced-contradictions. During the House hearing Bernanke clearly said that monetary expansion was influencing commodity prices. Congressmen David Schweikert asked Bernanke “what are the costs into economy of some of the [Fed's] fairly rapid monetary expansion?” Bernanke responded saying, “there has been some contribution to commodity prices which we anticipated.” How can the money the Fed is not printing according to Bernanke, effect anything, let alone commodity prices? …Don’t hold your breath waiting for a satisfactory answer.
Another attempt Bernanke or his apologists might make at defending his position is to contend that broad money was collapsing during the crisis, and the Fed only filled this gap of credit destruction. If the Fed only printed enough to stop the collapse in credit production, no nominal change in broad money occurred. While this may seem to justify Bernanke’s statements, the fact is all that is occurring in such a case is a monetization of bank credit, which is still, most certainly, a money printing endeavor.
A last possible effort from Bernanke in defending the indefensible is to argue that the velocity of money has not picked up, so he’s only added to bank reserves, not circulating money. The flaw in this argument is that velocity of money is calculated by dividing nominal GDP by the money supply. The only reason velocity has fallen, is because massive money growth has occurred but nominal GDP has failed to keep pace. This argument by definition concedes money printing has taken place. Furthermore, the existence of money as reserves is a means of circulation, as banks are holding this against some obligation they plan to engage with in the future and their creditors, counterparties and investors all calculate under the assumption those reserves exist, so the real effects are plentiful.
Bernanke: Congress Must Not Cut Spending But Must Also Cut Spending
Bernanke was constantly asked by members of Congress what should be done about the budget going forward. Bernanke persistently replied with warnings against avoiding spending cuts, given the government’s long term financial instability. Simultaneously, Bernanke cautioned against cutting spending as this would derail the current “recovery”.
This “two prong approach” is difficult to comprehend as the strategy appears to be no different than one trying to have their cake and eat it too. Bernanke tries to square this circle by arguing that Congress should only cut long term spending and retain current record level spending. What mostly puts a nail in Bernanke’s prospects for future spending cuts is the fact Fed policy is encouraging current borrowing by the Treasury to soar. This means future spending will be ingrained as the non-discretionary portion of the Federal budget grows as a percent of the total.
Bernanke likes to say the current Fed is not monetizing US debt, despite statements to the contrary by Dallas Fed President Richard Fisher, and record Treasury purchases. Bernanke dances around the Fed’s Treasury holdings by claiming they have future plans to liquidate their recently acquired holdings, so the net benefit to Treasury is not existent. While the accuracy of this consequence and the authenticity of the willingness to act should be doubted, even if we trust these efforts this just means Treasury borrowing costs will rise dramatically down the line. This is obvious because the Fed purchases the majority of issuance currently and any halting of purchases will leave a supply overhang. For the Fed to stop purchases and moreover sell Treasuries will drive the Federal Government’s borrowing costs up significantly, and thereby increase even further the US’ governments future, non-discretionary budget requirements.
Bernanke: Gold is Not Money
A shocking exchange (see video above) occurred between Congressmen Ron Paul and Bernanke when Paul asked flat out whether or not the Fed Chairman considered gold money. Bernanke, after a brief and awkward pause, answered with a less than confident “no”.
What Bernanke appears to be ignoring is the majority of American history, and human history for that matter, where gold played a role as the forefront of monetary exchange. The state of Utah has proclaimed gold is money and the constitution grants them this right:
Article 1 Section 10 states “No state shall make any Thing but gold and silver Coin a Tender in Payment of Debts”.
Furthermore, almost all governments around the world own gold including international organizations like the IMF {{1}}[[1]]See this chart of official gold reserve holdings.[[1]]. If these governments issue currency as a liability and hold gold as an asset then in many respects gold is the underlying money, and the paper currency is just the money substitute.
Bernanke: Central Banks Hold Gold for Tradition Only
To say that gold is held for traditional purposes is not untrue but certainly not the only reason precious metals are held. One way we can disprove this argument is to show that central bank’s gold account activity correlates with global financial events. Central banks are presently net accumulators of gold, though much of the action has come from China, and it is unlikely their extensive and expensive purchases are just for ornamental value.
Furthermore, central banks explicitly disagree with Bernanke since they have reaffirmed the ‘Central Bank Gold Agreement’, a contract among central bank restricting gold transactions, which states that “gold remains an important element of global monetary reserves”. This language was present in all the past Central Bank Gold Agreements as well.
Bernanke: The Fed is a Highly Profitable Institution
Bernanke explains to Ron Paul that the Fed is not only being paid back for their investments but also earning a positive interest on their purchases which they are remitting to the Treasury, after covering the Fed’s expenses, which works against the US deficit. What Bernanke fails to mention is that with zero interest rates the Fed can print money at no cost, so any yield for them is a positive return. Much of this interest comes from the Treasury in the first place too as the Fed’s largest holdings are Treasury bonds.
The even more important fact is that the Fed is the creator of all money, so any nominal profits they earn must arise out of their own printing. The Fed is doing no more than paying themselves back when they earn “profits” on a technical level. If the Fed creates the first $100 in existence and buys a bond offering to pay $110 by the time of maturity, where can the extra $10 come from? The Fed being the only money creator need to take no glory in the fact they earn a positive interest rate. Congressmen Ron Paul was given an opportunity on CNN to readdress the issue and he made a good point by stating the obvious, “”If I had absolute control of the printing press I could make money too!”
There is also a chance the Fed doesn’t make money, and some of their assets turn sour on them, as will be the case with some of their Bear Sterns purchases. The possibility of a Treasury default also would spell more doom for the Fed’s balance sheet than anyone, given the fact they are the largest holder of such debt.
Bernanke: People Use Gold Against Tail Risks, Not Fed Action
Bernanke in the past has stated that he does not understand movements in the price of gold, but apparently he feels he has since learned enough to make statements about why gold is rising. “People use gold against tail risks” Bernanke explains, and those risks have been increasing in past years, hence the rise in the price of gold.
What Bernanke fails to realize is the tail risk most concerning to gold investors is Bernanke and the Fed itself. Bernanke fails to acknowledge the obvious correlation between movements up in the price of gold and the markets growing lack of confidence in the Fed. As the House hearing was underway, gold prices shot up and for no reason other than the fact Bernanke was talking, driving up inflation expectations. The same effect happened after the Fed released their recent minutes.
Bernanke likes to think gold and other commodities are making new highs in all currencies, not just dollar so it can’t just be the result of the Federal Reserve he reasons. Gold’s positive performance against all currencies is true, but the dollar is the world’s reserve currency for the most part, and all other central banks are practicing similar monetary policy to the Fed. The price of gold certainly reflects the inflationary actions of these government banks, as any gold investor can attest to.
Bernanke: Dollar Not Falling Because of Fed Policy
According to Bernanke the dollar is falling because of government deficits, not Fed action. The missing link here is the connection between government deficits and money printing. Currently the Federal Reserve is by far the largest owner of US Treasury securities, holding over $1.6 trillion in direct government obligations, not including agency debt. This level of financial borrowing support for the US government must influence the size of government borrowing and by proxy the Fed must be in part responsible for US deficits.
Bernanke’s problem might be the fact he doesn’t even realize the Fed is the largest holder of Treasuries, as he seemed ignorant to the fact when directly asked the question. Senator Jack Reed asked Bernanke who was the largest holder of US Treasury debt and he responded, “the Chinese I think is probably right”. Well its not even probably right, its factually, 100% wrong. The Fed is largest holder of Treasury securities by far and this margin is likely to grow going forward.
Money printing, the Fed’s expansion of their balance sheet, clearly causes the dollar to fall relatively, since as they increase the price of the assets they purchase, by definition they are lowering the value of the currency. A purchase which serves to increase a price means less of the asset is required to exchange for a given amount of dollars. The increase in currency supplies must relatively weigh on the value of the currency, so Bernanke’s point that the Fed’s massive purchases do not impact the market falls flat on its face with no more than a simple econ 101 analysis.
Bernanke: Don’t Blame Me for Low Treasury Rates
You can’t make this stuff up. Bernanke is questioned by Senator Pat Toomey as to the extent the Fed is effecting borrowing rates by the Treasury and Bernanke answers by denying the Fed plays a role. Bernanke simultaneously wants credit for making borrowing rates more affordable without taking credit for the low Treasury yields which is about as hypocritical as one can get. The Fed, the largest buyer of US Treasuries, must be affecting the price of Treasuries as they are making real bids which are outweighing market demands, which is how the Fed has accumulated so many securities.
As can be seen in the above chart, there are periods where rates rise or fall despite Fed purchases are or sales. None of this negates the fact however that yields across the board would be greater if the entire $1.6 trillion supply of Treasuries held by the Fed were to reenter the market place.
Bernanke: Deflation Risk Not Currently Present
After giving markets the impression QE3 was around the corner in Bernanke’s House testimony, the Fed Chairman signaled in the other direction before the Senate saying deflation would need to be a substantive risk to preempt such action. In today’s economy, according to Bernanke, deflation is not a relevant risk so QE3 is not presently on the table.
The trouble Bernanke runs into here is a theoretical one which should really challenge his economic understandings. The models Bernanke adheres to dictate that inflation rises during periods of high capacity utilization and unusually low unemployment. Today’s environment however represents an extremely high unemployment rate and low capacity utilization. If these facts are the case, how and why can inflation be trading above the Fed’s target?
The reason Bernanke gives is the typical “new Keynesian” response, which argues that supply shocks can cause inflationary trends while the economy remains weak simultaneously. However, if Bernanke believes current supply shocks are temporary and transitory as he often argues, then he must be expecting a significant deflation threat around the corner. The lack of such a threat should shed doubt on Bernanke’s theoretical models, and we can only hope such falsifying evidence will cause them to be abandoned.
Bernanke: Congress Must Deal with Housing Overhang
When asked by Senators what can be done further to solve the housing markets ailments, Bernanke said congress should take measures to address the housing supply overhang. What specific measures Bernanke advocates is not clear, but being a student of the Great Depression, we can only hope is not referring to the crop burning and cattle massacre techniques of reducing supply undertaken during that period. Aside from burning down the supply of houses, its difficult to imagine what measures Congress could take to reduce such a supply without artificially propping up demand.
This seems to be Bernanke’s strategy and he fails to see the connection between the housing overhang and the Fed’s stimulative policy. The odd part of this is Bernanke takes pride in the Fed’s efforts to reduce mortgage rates but never takes credit for bubbled nature of the market. How does Bernanke expect the oversupply of homes to be liquidated without prices falling, and how can prices fall when Bernanke is propping up mortgages via massive mortgage-backed security purchases?
Bernanke could learn a thing or two from Kansas Fed President Thomas Hoenig who, on July 26th testifying before Ron Paul’s domestic monetary policy subcommittee, said the Fed is most certainly responsible for the housing bubble and even today’s high unemployment. Dr. Hoenig went even further and endorsed Austrian business cycle theory outright, and despite his clear shortcomings, this is evidence that not everyone at the Fed is as bonkers as the chairman.
Conclusion
After reviewing the above there is one conclusion to be found: Bernanke is ignorant, hypocritical, senseless, and constantly wrong.