Bernanke Has Gone Rogue

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The Federal Reserve is in damage-control mode. Last week’s announcement by Bernanke unilaterally scrapped the official unemployment rate target of the Federal Open Market Committee (FOMC), which sets monetary policy. I reported on this on June 25.

He raised the target from 6.5% to 7%. This indicated that the FOMC has decided that it could stop inflating earlier than previously reported. This is what Bernanke said: QE3 may “taper off” this year.

His announcement sank stock markets around the world. It created a panic-driven crisis based on the idea that the FOMC might stop the printing presses early.

Mortgage rates are up by a third from last December, when the Federal Reserve adopted QE3. The FOMC said at the time that it did this to keep mortgage rates down. The policy has blown up in the FED’s face.

To the rescue comes the #2 Federal Reserve official, William Dudley, the president of the Federal Reserve Bank of New York, which is the most influential of the 12 privately owned regional FED banks. Before he was president, he was the chief economist for Goldman Sachs. In short, he is the #2 person of influence in the Federal Reserve System.

The Bloomberg headline said it well: “Federal Reserve officials intensified efforts to curb a growth-threatening rise in long-term interest rates, seeking to clarify comments by Chairman Ben S. Bernanke that triggered turmoil in global financial markets.”

Clarify, my foot. They are seeking to rein in Bernanke, who on his own authority changed the targets. Dudley is the Vice Chairman of the FOMC. They are trying to put out the interest rate fire that Bernanke’s comments last week produced in the bond market and mortgage market – the targets of QE3.

Bernanke has gone rogue. Dudley is trying to bring him under control. He is trying to persuade investors that QE3 is here to stay, and that the FED’s monetary inflation will continue to prop up the faltering U.S. economy.

Bloomberg reports that he insisted that any reduction of asset purchases would not represent a withdrawal of stimulus.

How’s that again? A reduction of money creation to buy government bonds and Fannie Mae/Freddie Mac mortgage bonds would not be a reduction in the stimulus? I am afraid I do not understand. The FOMC announced the program in December by announcing an increase in purchases. That is how the FOMC creates the supply money: by purchases of assets. If it ceases to purchase assets, it automatically decreases the stimulus.

Dudley also insisted that an increase in the Fed’s benchmark interest rate is “very likely to be a long way off.” He said bond purchases – this is stimulus – will continue if economic performance does not meet the FED’s forecasts.

But what are these forecasts? He did not say.

He was joined by FED governor Jerome Powell and the Atlanta FED president Dennis Lockhart. Bloomberg said they “sought to damp expectations that an increase in the benchmark interest rate will come sooner than previously forecasted.”

The word “damp” means “put out fires.”

The FED is in damage-control mode. Bloomberg quotes Dudley: “Such an expectation would be quite out of sync with both FOMC statements and the expectations of most FOMC participants.” This is what I reported on June 25. Bernanke’s announcement was a unilateral scrapping of the FOMC’s official boilerplate statement, which it publishes word for word every six weeks.

The FED’s regional leaders are dealing with Bernanke, who is clearly preparing for his departure on February 1. Bernanke is asserting his independence. Dudley and others are trying to put out the fires until he departs.

Their approach is to say that the markets misunderstood Bernanke. The markets in fact heard Bernanke loud and clear. The FED officials are doing their best to pull Bernanke back into the pen. They are trying to make it look as though he has not gone rogue. A rogue Chairman would indicate dissent in high places. That would rattle the markets. So, they pretend that investors misunderstood Bernanke. It papers over what has happened.

We will now see who is in charge.

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