In about a week, “Helicopter Ben” Bernanke will launch a new assault in America’s war on thrift. The Federal Reserve is expected to begin carpet-bombing our bond markets with cheap cash, without first having defined either an objective or an exit strategy.
The Fed’s much-anticipated round of “quantitative easing” will put downward pressure on the dollar and upward pressure on the prices of gold, oil and other commodities. It might even give the stock market a boost, if the easing is more substantial than people have assumed. By artificially pushing down long-term interest rates, after having cut short-term rates to near zero, Bernanke and his co-enablers will encourage pension funds, insurance companies and other institutional investors to get over their fears of another stock meltdown like the one we saw two years ago.
If Martians are watching our economic policy making, they must be thoroughly confused by now. Just last week, at a meeting of G-20 finance ministers in South Korea, Treasury Secretary Timothy Geithner warned leaders of major economies against manipulating and devaluing their currencies to gain trade advantages. Countries such as the United States that have large current account deficits should increase their savings, Geithner said, while countries with large surpluses should stimulate domestic demand.
As any Martian knows, if you want people to save more, you increase the interest you pay on their savings – you don’t cut it to practically nothing. And if you want people to stop blowing all their money on cheap imported goods, you don’t encourage them to borrow more cash without paying a steep price.
Yet the Fed’s easing will do exactly what Geithner says a country like ours should not do.
It is a let-tomorrow-take-care-of-itself approach, the sort of thing that makes sense in a crisis such as World War II or the financial market meltdown of 2008. It does not make sense during a tepid recovery from a serious but not disastrous recession, particularly when private and government finances all over the country are wildly skewed. Federal, state and local governments are up to their eyeballs in bonded debt and off-the-books unfunded commitments. Artificially low rates will allow them to put off dealing with their problems while the debt bubble gets ever larger. At the same time, institutions and individuals with cash are afraid to put it to use for fear of tax hikes and interest rate increases that will surely come when the cheap-money party ends.
Bernanke and his supporters on the Federal Open Market Committee, which sets monetary policy, are neither stupid nor deliberately destructive. They are not purposely sabotaging the long-term financial health of America or the global economy. They do not want to stoke the runaway inflation that their easy-money policy clearly has made possible.
They have simply worked themselves into a lather about the risk of a deflationary trap that, to me and apparently to the financial markets, seems unlikely. Bernanke, a respected student of the Great Depression, has worried about deflationary traps for most of his professional life. He is the author of the “Bernanke Doctrine,” which holds that in the face of collapsing demand, massive government stimulus – figuratively dumping money out of helicopters – is the correct policy response.
I believe in the old saying, “If all you have is a hammer, everything looks like a nail.” When Bernanke looks at a weak economy, with consumers and corporations reluctant to spend, he sees the deflationary trap he has always feared – and he reaches for the response he has kept at the ready. But he is seeing the wrong problem, so he is reaching for the wrong solution.
He is trying to fix an abnormal situation by making it more abnormal.
The markets are telling him he is wrong. The price of gold, at over $1,300 per ounce, is a sign that the people who buy gold – notably central banks – are worried about the value of the dollar and other paper currencies. Chinese demand for U.S. government debt is down. The prices of many commodities are rising. Other nations are scrambling to depreciate their currencies along with the dollar, which just drives the price of tangible goods higher.
Some Fed policy makers are calling for a period of inflation higher than the Fed’s nominal 2 per cent annual target. There is no sign that they know how to put that genie back in the bottle if it should get out.
Thomas Hoenig, the Kansas City Federal Reserve Bank president who has dissented from the easy-money policy all year, warned last week that the forthcoming flight of the cash helicopter will be a misguided mission. So did Dominique Strauss-Kahn, the head of the International Monetary Fund, who further cautioned that the U.S. soft-money policy has the potential to destabilize global finances. So have many others.
But to no avail. Bernanke and his platoon see a threat, and they are determined to respond the only way they know how. We can hear the engines revving.
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