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Is B-52 Ben Bernanke Taxiing Down the Runway?

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December 01, 2008 – Comments (0)

 

I blogged last week about the massive amount of money that the Federal Reserve and Treasury have already spent trying to unfreeze the credit markets (see post: OK guys, new plan. Print money so fast that everyone loses track of how much we've spent.).  According to a Barron's article that ran this weekend, there's a very good chance that we ain't seen nuthin' yet (see article: Shopping Season for Uncle Sam).

Many analysts believe that the Federal Reserve will have to become much more active over the next year to unfreeze the credit markets and force interest rates to fall to more reasonable levels.  The article contends that even though the Federal Reserve has doubled the size of its balance sheet to $2.2 trillion over the past four months it may needs to grow it to a whopping $6 trillion to "stem the destruction of capital."  In fact, the Fed wouldn't even have to seek permission to grow this much, the emergency powers within its charter allow it to basically do as it pleases.

With both producer and consumer prices falling rapidly, it appears as though deflation is upon us (though this is debatable because a drop in food and energy prices does not necessarily lead to a drop in wages).  It has been well publicized that Ben Bernanke has repeatedly said in the past that governments must do everything in their power to fight deflation. 

In 2004, he published a paper on the subject which described the actions that the Federal Reserve should take during a period of "falling asset prices, serious recession, and central-bank rates approaching zero."  Hmmmm, that sounds a lot like what we are seeing right now.  This paper states that during such an event the Fed should engage in "quantitative easing," which essentially means targeted, well-publicized  asset purchases that will alter negative market psychology.

While the Fed certainly has already begun to engage in quantitative easing, it has the authority to do a lot more.  The Barron's article contends that Hank Paulson is a free-market fundamentalist who has held back Bernanke from taking all of the action that he wants (perhaps he was too busy giving all the TARP money to his friends).  Many members of Obama's new economic team, like Larry Summers and Tim Geithner may be more interested than Paulson in seeing the Fed purchase distressed assets, like CDOs, mortgage-backed securities, and non-investment grade corporate paper at a more rapid pace than it already has been.  Yikes.

I leave you with this quote from the Barron's article's final paragraph:

"It just might be time for Ben Bernanke to scramble the Fed bomber force and attack.  Then, Helicopter Ben - a nickname he acquired for once suggesting that money be dropped from helicopters, could become B-52 Ben.

If the Fed does indeed continue to expand its balance sheet dramatically, I don't see how this can be good for the U.S. dollar.  How long will foreign countries allow us to print money, pay them only 2% interest, and use the proceeds to buy up all of the garbage paper that is laying around?  That doesn't sound like a solid investment plan to me.  I certainly won't be using any of my hard-earned money to buy Treasuries.

Deej

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