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Ben Bernanke gave his second-ever press conference on June 22.
Before I offer my assessment, I think it is wise to make you aware of a long-forgotten film: a 1931 movie short by Robert Benchley, one of the supreme humorists of his era. Benchley came on-screen as an economist. He provided information on why the economy was about to turn around. (It wasn’t.) The depression was over. (It wasn’t.) The recovery was just around the corner. (It wasn’t.) Then he offered the appropriate evidence. The people in the theaters fully understood. Once you see this video, so will you. Professor Bernanke will never seem quite the same.
As soon as Bernanke’s press conference was over, the Dow fell 80 points. Asian stocks fell. European stocks fell. He isn’t as funny as Benchley.
There was no published transcript, but his remarks did not vary much from the press release issued by the Federal Open Market Committee, which had been meeting for two days. What was significant was this: he felt compelled to hold a press conference, yet he had nothing to say beyond what the FOMC’s press release said. Why? I think it was because he wanted to be there in person to calm the members of the press, because the FOMC’s words were not cheery.
What the FOMC said and Bernanke reiterated was this: economic growth is slowing. Yet the FED has pumped in $600 billion of fiat money since November 2010. He offered no assessment of the relationship between this huge increase in the monetary base and the slowdown in economic growth. The Keynesian textbook account, including Bernanke’s textbook, says that monetary expansion and low interest rates are supposed to increase economic growth. It’s not happening.
They don’t know why. They don’t say why.
A EUROPEAN HAY RIDE
There is an explanation, but no one at the FED is going to offer it. The anonymous “Tyler Durden” of the Zero Hedge site made the connection. The $600 billion never got into the economy. The money was used to increase excess reserves of the dozen international banks that make up the core of 20 banks that are the FED’s primary dealers — the large multinational banks that buy the assets ordered by the FOMC. The FOMC does not buy assets directly. It uses agents.
Durden speculated that these 12 banks were in trouble. They needed to increase excess reserves in order to offset the risk associated with the faltering debt structure of Europe.
In summary, instead of doing everything in its power to stimulate reserve, and thus cash, accumulation at domestic (US) banks which would in turn encourage lending to US borrowers, the Fed has been conducting yet another stealthy foreign bank rescue operation, which rerouted $600 billion in capital from potential borrowers to insolvent foreign financial institutions in the past 7 months. QE2 was nothing more (or less) than another European bank rescue operation!
He offered three graphs that show how the increase in QE2 was matched almost dollar for dollar by an increase in excess reserves at the FED held by foreign banks.
Furthermore the data above proves beyond a reasonable doubt why there has been no excess lending by US banks to US borrowers: none of the cash ever even made it to US banks! This also resolves the mystery of the broken money multiplier and why the velocity of money has imploded.
I feel compelled to add this: there is no evidence that U.S. banks would have done anything different. Given the unwillingness of American commercial bankers to lend the increased money provided by the FED since late 2008, I see no reason to believe that bankers would have lent this QE2 money. They still refuse to lend the money that the monetary base allows them by law to lend. If they did, we would be suffering from a doubled price level.
The accumulation of excess reserves by large European banks has created a problem for the U.S. Treasury. The FED will cease the QE2 program at the end of this month. Who will pick up the slack? Durden remarked:
. . . since the bulk of the reserve induced bank cash has long since departed US shores and is now being used to ratably fill European bank balance sheet voids, and since US banks have benefited precisely not at all from any of the reserves generated by QE 2, there is exactly zero dry powder for the US Primary Dealers to purchase Treasurys starting July 1.
This really is the question of questions for the summer. The Treasury is paying rates so low that nothing like this has been seen since the middle of the 1930s. This indicates that demand for Treasury debt remains strong. But will this continue? If not, then rates will climb, and the economy will stall. But it is already slowing. If rates rise, Durden’s comment will prove to have been accurate: “QE 3 is a certainty.”
The Treasury can sell its debt at low rates. The figures on excess reserves indicate that the FED’s purchases of assets have not led to a booming economy. The money winds up at the FED, not the Treasury. Then why are 90-day T-bills paying an incredible one one-hundredth of a percent per annum? The Treasury is borrowing at what is effectively zero. It is borrowing free money. This is the mark of an economy in which investors think nothing is safe, that the economy will falter, and that it is better to lend to the Treasury even though investors will be worse off at the end of the period, because price inflation is increasing. Investors are reading negative real yields.
In the Great Depression, prices fell by 30% from 1930 to 1933. Having money in Treasury debt at slightly above zero interest was a good move. You made 30% tax-free. But these days, rates as low as 1932 are not accompanied by falling consumer prices. Prices are rising.
This indicates real pessimism regarding the economy. Investors could buy corporate bonds or stocks. The ones who buy T-bills are convinced that losing purchasing power is preferable to putting money into the private sector. The government is absorbing this money and borrowing more. We are facing a bottomless pit of Federal debt, yet investors are funding the government. They know that these debts will never be paid off, only rolled over. Still, they will not stop lending money to the Treasury.
Here is the problem. It can end overnight. It did for Bear Stearns in 2008. It did for Lehman Brothers. One day, they could borrow. The next day, they couldn’t. This is the modern form of bank run. Depositors do not withdraw their funds. Lenders simply refuse to roll over the debts. There are no lines of frightened depositors in front of banks. There are simply no bidders for the debts of the issuers.
What would happen to the Treasury in such a scenario? The FED would buy. The public knows this, which is why the Treasury can roll over its debt.
We see fear, not optimism. We see a refusal to take risks, not entrepreneurship. We hear a giant sucking sound: the money going into the sink hole of the U.S. government and not coming out. That capital is lost forever. It will fund boondoggles that Congress and the President agree to bankroll. It will not fund economic growth. It will not be amortized by increased productivity.
With this in mind, let us consider the press release of the FOMC.
WHO’S IN CHARGE HERE?
Information received since the Federal Open Market Committee met in April indicates that the economic recovery is continuing at a moderate pace, though somewhat more slowly than the Committee had expected.
The committee, being Keynesians, all believe that a stimulus on the scale of QE2 is supposed to goose the economy. But the economy resembles a cooked goose. They have no explanation.
“Also, recent labor market indicators have been weaker than anticipated.” When the unemployment rate goes back up to 9.1% two years after the supposed recovery began, the Keynesians have a problem. They are beginning to sound like Robert Benchley.
The slower pace of the recovery reflects in part factors that are likely to be temporary, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan.
Energy prices are slightly lower this month, but food prices continue their steady upward move. As to the Japanese recovery, there is no evidence of it yet. How temporary is temporary?
However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed.
The “however” indicates that this factor will not be temporary. What about price inflation?
Inflation has picked up in recent months, mainly reflecting higher prices for some commodities and imported goods, as well as the recent supply chain disruptions. However, longer-term inflation expectations have remained stable.
Price inflation has picked up, true, but not to worry. Longer-term EXPECTATIONS have remained stable. In other words, while consumer prices are rising, Keynesian economists have not changed their assessment of lower price inflation ahead, one of these days, Real Soon Now.
Conclusion: They are all Robert Benchley!
“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.” I see. The Committee SEEKS to foster its mandate. And how well is the Committee doing? Not very.
The unemployment rate remains elevated; however, the Committee expects the pace of recovery to pick up over coming quarters and the unemployment rate to resume its gradual decline toward levels that the Committee judges to be consistent with its dual mandate. Inflation has moved up recently, but the Committee anticipates that inflation will subside to levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate.
So, the opposite of the Committee’s mandate is taking place: rising unemployment and rising prices. This was not considered possible four decades ago. The Phillips curve — the trade-off between price inflation and unemployment — was supposed to take care of that. Then came stagflation under Nixon, Ford, and Carter. It has reappeared.
The Committee says it ANTICIPATES that price inflation will subside. This raises a question: How is stable pricing compatible with an increase of $600 billion in the monetary base? The Committee did not ask this question, so there was no necessity of answering it.
To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent.
And how, pray tell, does the Committee keep the FedFunds rate this low? It increased the monetary base, 2008-9. It decreased the monetary base in 2010. It increased the monetary base in 2011. The FedFunds rate has not budged. So, monetary inflation keeps the FedFunds rate low. On the other hand, monetary deflation keeps the FedFunds rate low.
They are all Robert Benchley.
The FedFunds rate has not budged because it is the rate at which commercial banks lend overnight to any bank that has exceeded its reserve limit. But when the banking system is sitting on $1.5 trillion in excess reserves, no banks are borrowing overnight money from each other. So, the Committee cannot affect the FedFunds rate one way or the other. The Committee announces that it will keep the rate low. This is supposed to persuade the financial press that the Committee is still in charge. Amazingly, the announcements are taken seriously.
The Committee continues to anticipate that economic conditions — including low rates of resource utilization and a subdued outlook for inflation over the medium run — are likely to warrant exceptionally low levels for the federal funds rate for an extended period.
In short, the lousy economy is going to remain lousy. The QE2 pumping was accompanied by a reduced rate of economic growth. Now that QE2 will stop, the Committee thinks things will slow down even more.
Then what, exactly, does the Committee intend to do? It will reinvest earnings on its portfolio. That is to say, it will keep buying Treasury debt. But its policy will be in maintenance mode.
What else will it do? It will monitor its portfolio. It will keep an eye on its basket of debt.
The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.
Monitor. Watch. Observe.
“You can observe a lot just by watching.” ~ Yogi Berra
The Committee ended its press release with this inspirational sentence:
The Committee will monitor the economic outlook and financial developments and will act as needed to best foster maximum employment and price stability.
Presumably, it has been doing this all along. And what have been the results? Rising unemployment and rising prices.
Bernanke’s press conference added little to the Committee’s press release. So, the Dow sank 80 points.
The nation is being centrally planned by the spirit of Robert Benchley.
June 25, 2011
Copyright © 2011 Gary North