Bernanke blundered........

…….but it all depends on your perspective of course.

If you believe, like I do, that the FED has been orchestrating (since this financial crisis erupted) the biggest wealth transfer and theft of hard assets from the hapless 99pc to the elite 1pc before an inevitable collapse, then his latest move is just another step in his brilliant surreptitious efforts to achieve that objective.

If however you belong in the large segment of the population who believes that Bernanke is acting in the best way possible to meet his mandate (price stability, low unemployment) and help everything muddle along, then I think he just made a big blunder.

By conducting open ended operations to buy $40bn of MBSs, Bernanke claims it will help employment. He never really elaborated on how exactly this move promotes higher employment, and true to form he was never asked about it, but one has to assume that he meant that can be accomplished in two ways. 

One, by taking on the FED balance sheet more of the mark-to-fantasy toxic paper (note: Bernanke never elaborated from whom the MBSs will be bought or at what price, but going by the FED's previous actions in all the Maiden Lane series backstops, we can safely assume these will be bought at par) that is clogging bank balance sheets and replacing it with freshly minted greenbacks, banks will start lending again. Wrong. Banks are already sitting on a mountain of liquidity as excess bank reserves with the FED which they are not lending out for a number of reasons. They are better off collecting free interest from the FED than taking risks lending this money in a recessionary economy, they would also need quick access to this money in case someone else unexpectedly blows up in the financial system placing everyone in this highly interconnected financial system at risk, there is not enough credit worthy customers, there's not enough demand from those who are credit worthy because they are petrified to invest in a recessionary economy are just some of the reasons that banks are not lending. By increasing their liquidity all the FED is doing is pushing on a string. Steve Keen has written extensively about this, I would highly recommend a regular visit to his website.

Two, the housing market will be energized again with lower mortgage rates that in turn will translate in increased economic activity through the building of new homes. Wrong. First of all mortgage interest rates are already at an all-time low in the US but that has failed to revive the housing sector. Until the massive inventory of foreclosed homes held by the banks clears the system home prices will continue to drop (and yes, I do understand that is not the case with all real estate markets in the US, I'm just making a general comment here). Higher unemployment is not conducive to supporting rising home prices period. People need jobs in order to commit buying a home. People need to be confident about keeping their jobs to commit buying a home. And last but not least, watching real inflation put a serious dent in their disposable income through increases in energy and food prices (which now will certainly head even higher) doesn't exactly built confidence in buying a home. The US housing bubble burst but was never allowed to capitulate; that means home prices will continue to trickle lower for years.

I don't know for sure as I'm still researching this but I believe the reason the FED is buying this massive amount of MBSs ($40bn every month open ended has a tendency to pile up) is not only to provide another bailout for the banks but also a bailout for Fanny & Freddie, in other words a stealth bailout of the USG. The USG not only implicitly but now explicitly guarantee the liabilities of the GSEs. Piling on the risk of bad paper onto the back of Fanny & Freddie is the only thing that is presently preventing the US housing market from totally collapsing. If the FED didn't bail F&F and those liabilities that are now souring up needed to be picked up directly by Treasury this would add an enormous strain on the USG's $100bn per month incremental debt with repercussions on their credit rating and the US dollar. Have a look if you want to understand this far better than I'm able to explain: http://www.fas.org/sgp/crs/misc/RL34661.pdf

More blunders:

1. Inflation Risk: Wages don't go up during periods of a slack labour market, input costs though do due to increasing commodity prices as newly created money ends up in hard assets. This leads to margins being squeezed which inevitably lead to more layoffs. If we just assume for a moment that the FED was indeed successful in revitalizing the economy, employment picks up, production and economic output rises, credit creation increases which all lead to one thing…..INFLATION. How does the FED rein in inflation when it can not possibly raise rates without bankrupting the USG and just about every other indebted nation on the planet along with it, or even bankrupting itself, and also not blowing up a $700 trillion derivatives market. ZIRP is not until 2015, the FED knows ZIRP is forever. The FED has painted themselves in a corner.

2. The markets: The equities markets are in my opinion now at risk. The FED's own research concluded that the equity markets were rising more in ANTICIPATION of QE, not actual QE. This market pavlovian conditioning is now broken. I'm fully aware that the FED said that they are prepared to do additional asset purchases if the US employment situation doesn't improve but at some point diminishing returns become evident even to the layman's eye and credibility in the FED policies is lost. Perhaps now the FED, who has been manipulating the market higher up and using it as a policy tool, faces the risk that bad news will now be priced in as actually bad news for a change, not as good news because the FED will act. The FED has already acted. All the cards are on the table.

3. Oil : Oh, Oil, that little nasty thing that central bankers can't print. . In some sense some might argue that in view of the global economic slowdown and as a result a much lower demand/consumption out of the US, the EZ and China, an Oil price collapse was imminent. Bernanke's latest action prevented that for happening for now. Bernanke doesn't want a price collapse for a number of reasons. For starters, it signals collapsing economies and demonstrates how the FED's and CB's actions/policies have been ineffective and a failure. But also this major monetary policy transmission channel breaks down. The FED wants to fight deflation but "manage" inflation at the same time. Runaway or collapsing Oil prices are in direct conflict with this objective. Bernanke therefore wants the price of Oil range bound. It also satisfies the Arabs who need $100 Oil to meet their own budget requirements, it supports the continued exploration for new crude deposits, and it makes tar sand oil viable. The danger in what Bernanke's monetary madness might lead to is an acceleration of the vicious circle that sees Oil prices increase due to money printing causing DEFLATIONARY effects in the economy, precisely what Bernanke's money printing is trying to prevent. When consumers are spending more on energy, and food whose prices are very closely linked to Oil, they have less disposable income to buy iPads. It's that simple.


I've always held the position on this forum that hyperinflation is how this ends. I've seen nothing to make me change my mind, in fact recent CB actions with UNLIMITED free money only strengthens my conviction. Yesterday we took another big step in that direction. Because if there was any doubt at all Bernanke yesterday erased it by shouting from the top of his lungs that the world's cheapest asset now is…………drum roll please......MONEY.