Brernanke's Nightmare, Ron Paul, Chairman

Bernanke's worst nightmare: Ron Paul

By Chris Isidore, senior writerNovember 12, 2010: 8:11 AM ET

CNBC Ron Paul grills Bernanke, traders cheering 2008.02.27

CNBC Ron Paul grills Bernanke, traders cheering 2008.02.27

NEW YORK (CNNMoney.com) -- Ben Bernanke has had his hands full since his first day on the job as Federal Reserve chairman nearly five years ago. It's about to get even tougher.

His harshest critic on Capitol Hill, Rep. Ron Paul of Texas, is about to become one of his overseers.

With the Republicans coming to power, Paul, who would like to abolish the Fed and the nation's current monetary system, will become the chairman of the House Subcommittee on Domestic Monetary Policy.

If you've never heard of the committee before, you're not alone. But Paul promises you'll be hearing a lot more from it.

"It's basically been a committee that's dealt with commemorative coins. I'm going to deal with monetary policy," he said.

Paul doesn't think he'll be able to move his proposal to eliminate the Fed, or to allow Americans to use gold instead of paper money as currency. But he said he does intend to use his new position as "a mini-bully pulpit" to criticize Fed policy and call more attention to what he sees as its negative consequences. And he's confident that American voters are ready to delve into those monetary policy questions.

"Five years ago they wouldn't have listened. Now they will," he said. "We've gained a lot of credibility in making the Federal Reserve an issue since the market collapse."

And Paul vows to try again to authorize Congressional audits of the Fed's decisions on the economy, a proposal that passed the House last year but was essentially gutted from the final version of the financial regulatory overhaul legislation.

"It will never be easy; the Fed has a lot of influence," he said of the audit legislation. "But there's a lot of life to it. We got further along than I ever expected."

One way that Paul will bring pressure on Bernanke and his Fed allies is to hold hearings to give greater voice to Fed members -- like Kansas City Fed President Thomas Hoenig -- who disagree with the current monetary policy.

"Just getting someone there willing to discuss their viewpoint and why they might dissent, I think that would be interesting," Paul said.

A Fed spokesman did not respond to a request for comment for this story.

Some economists worry that Paul having that kind of pulpit will hurt the Fed, and diminish its ability to fix an economy that still needs help.

"From Ron Paul's standpoint, the Fed can't do anything right," said Lyle Gramley, a former Fed governor who is now senior economic advisor to the Potomac Research Group. "He can cause the Fed to lose a lot of public support. But it needs public support to do what it needs to do."

While the Fed policymakers will try to resist pressure from Paul, they won't be able to ignore it, said John Silvia, chief economist for Wells Fargo Securities. And he said there's a potential for that pressure to influence Fed policy.

"The Fed has a more balanced, nuanced position on its dual mandate to promote growth and keep prices stable," he said. "Ron Paul probably doesn't."

But other Fed watchers say Bernanke already faces plenty of criticismand doesn't have too much to worry about from Paul having control of an oversight committee.

"I think that Bernanke has been pretty cool under fire up to now. I can't imagine Ron Paul being someone who could shake him up," said Michael Bordo, a professor of economics at Rutgers University.

Paul also rejects the idea that he's Bernanke's greatest concern.

"He probably just thinks I'm a nuisance rather than a nightmare," he said.

And Paul doesn't think he'll be able to reverse Fed policy or force Bernanke to resign, as much as he would like to.

"I think psychologically, Bernanke is incapable of changing his mind," he said. "It's probably unlikely [Bernanke will resign] under today's circumstances. But you don't know what it will be like a year or two from now."

Paul argues the Fed is making a serious mistake by pumping more money into the economy to try to spur more spending and growth. He predicts it will only lead to further declines in value of the dollar, inflation and higher interest rates rather than the lower rates the Fed is shooting for.

Paul thinks that will bring about another economic crisis that will eventually force Bernanke to resign from office.

"That's more likely to happen than for Bernanke to think, 'Well, I guess I made a mistake for 35 years. I've misunderstood the Depression, and I'm going to change my policy.'"

US interest rates at zero are 7% too high!

The Fed's impending blunder

By Ambrose Evans-Pritchard Economics Last updated: October 27th, 2010
http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100008351/the-feds-impending-blunder/

OK, I’ve calmed down after a week of Jamon Iberico and Rioja in Granada’s Albaycin, so I will try to be polite about the US Federal Reserve. Try, that is, not necessarily succeed.

For a good insight into the thinking of the New Keynesian priesthood that rules our money and our lives, it is worth reading “QE2: How Much is Needed?” by Jan Hatzius from Goldman Sachs.

His argument – crudely – is that US interest rates at zero are 7pc too high given the Taylor Rule on output gaps, et cetera (not that Professor Taylor himself happens to agree, but let us not quibble).

Since rates cannot be minus 7pc, the Fed would need to launch a $4 trillion blitz of fresh bond purchases to fully compensate, such is the mess that America’s leadership has inflicted on the Great Republic. I have over-simplified: Goldman Sachs relies on a “policy gap” concept, which factors in fiscal tightening et al.

This would push the Fed balance sheet to $6.3 trillion, above the $5 trillion pencilled in as the upper limit during the Great Crash.

Mr Hatzius is not saying the Fed will do this, or should do this. His forecast is that the Fed will start off with baby steps of $500bn spread over six months or so, rising over time to meet the bank’s “dual mandate of low inflation and sustainable employment”.

(Actually the Fed’s mandate is “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Stable prices are not the same as low inflation. It takes Ben Bernanke’s maniacal obsession with the doctrine of inflation targeting to twist this into a mandate for printing large sums of money at a time when the Dallas Fed’s `trimmed mean’ measure of annual inflation has jumped from 0.5pc in May, to 0.8pc in July, and 1.5pc in August. But again, let us not quibble).

Mr Hatzius said the Fed sees “tail-risks” in using QE to the full, but may nevertheless do another $2 trillion in the end.

I have no doubt that this report reflects thinking at the Fed Board in Washington, and among Bernanke allies at the San Francisco Fed and Boston Fed – though not of course at the Dallas Fed where Richard Fisher confesses: “In my darkest moments I have begun to wonder if the monetary accommodation we have already engineered might even be working in the wrong places.”

What we have is a glimpse into the Sanctum Sanctorum of money creation, a glimpse of Jesuitical fanaticism.

Now, I put my hand up and confess to having supported QE when the financial system was imploding in late 2008 and early 2009, and I continued to do so as the M3 money supply collapsed at 1930s rates earlier this year. I persist stubbornly in thinking that it was the right thing to do, AT THAT TIME.

But we are no longer in a systemic financial crisis, and the Fed’s motives have become subtly corrupted. Having argued during the boom that it was not the business of central banks to stop asset bubbles – and specifically that any fall-out could “safely” be cleaned up later – Bernanke now seems to determined to validate this absurd doctrine, bending all the sinews of the US economic and financial system to this end. One error leads to the next.

In a sense QE has worked all too well. M3 has stabilized. The M2 gauge used by the Fed – which was still contracting in May – has been growing annual rate of 8.4pc over the four weeks to mid-October. The pace has been accelerating for months.

OK, 8.4pc is not Weimar, but it is not imminent deflation either.

And what about velocity, the other part of the monetary cocktail? It is coming back from the dead as you can see below?

Simon Ward from Henderson Global Investors said his measure of velocity is rising at a robust rate of 8.7pc. “QE1 was justified during the crisis because monetary velocity was collapsing at that time. But now that velocity is recovering further QE is not needed. In fact it is potentially very dangerous,” he said.

Exactly.

This is the theme of Chapter 17 entitled “Velocity” in Jens O’ Parsson’s book Dying of Money, the cult text of our brave new world.

If I may recycle a passage from a column I wrote about the book in July: “Each big inflation – whether the early 1920s in Germany, or the Korean and Vietnam wars in the US – starts with a passive expansion of the quantity money. This sits inert for a surprisingly long time. The effect is much like lighter fuel on a camp fire before the match is struck.

People’s willingness to hold money can change suddenly for a “psychological and spontaneous reason” , causing a spike in the velocity of money. It can occur at lightning speed, over a few weeks. The shift invariably catches economists by surprise. They wait too long to drain the excess money.”

“Velocity took an almost right-angle turn upward in the summer of 1922,” said Mr O Parsson. Reichsbank officials were baffled. They could not fathom why the German people had started to behave differently almost two years after the bank had already boosted the money supply. He contends that public patience snapped abruptly once people lost trust and began to “smell a government rat”.

Hmm!

No doubt the Bernanke Fed views monetarism with contempt, despite paying lip service to Milton Friedman. This is a grave error. Surging M3 gave forewarning of the credit bubble from 2005-2007, and then rang alarm bells before the banking crash in late 2008. Ignore money and velocity at your peril.

The immediate effect of the Fed’s QE2 rhetoric has been to drive up commodity prices, negating much of the benefit. “How this possibly helps out the moribund US economy is anyone’s guess,” said David Rosenberg from Gluskin Sheff.

“If there is an `imbalance’, it is in the US pretending it can solve structural headwinds, overextended balance sheets, chronic unemployment and a massive housing inventory backlog with untested Fed policy tools,” he said.

Nor is it clear that Bernanke’s aim of driving down interest rates serves any useful purpose at this stage. As GMO’s Jeremy Grantham argues, this policy is reducing pensioners to penury. “Lower rates always transfer wealth from retirees (debt owners) to corporations (debt for expansion, theoretically) and the financial industry. This time, there are more retirees and the pain is greater, and corporations are notably avoiding capital spending and, therefore, the benefits are reduced. It is likely that there is no net benefit to artificially low rates.”

If you crunch everything in the mixer you can perhaps claim that QE2 will be a net plus of sorts. But is it really wise policy to embark on such a contentious adventure at a time of deep misgivings among the public and in Congress, and in the face of blistering criticism from China, Germany, Russia, as well as a lot of Western economists?

I hate to cite Alan Greenspan but he is right this time to warn that the Fed is playing a “dangerous game”, whatever the claims of New Keynesian economic theory. Politics matter.

Yes, the Fed is right to worry that protracted deflation would be lethal in an economy with total debt at 350pc of GDP. Those who call for a liquidationist policy of mass bankruptcy and default are an even greater danger to political stability than the Bernanke Fed. That policy was enacted from 1930-1932, with observable results.
But I suspect that something else is happening at the Fed. Bernanke is refusing to accept that the US must go through the slow painful cure of debt-deleveraging. He is trying to air-brush away the consequences of 20 years of debt creation and Fed error.

The proper role for the Fed from now on is to steer a narrow course between the Scylla of deflation and the Charybdis of inflation, for year after, for as long as it takes, until America is properly purged. AND THEN NEVER COMMIT SAME IDIOTIC MISTAKE AGAIN.

"Deflation: Making Sure It Doesn’t Happen Here"

RBS tells clients to prepare for 'monster' money-printing by the Federal Reserve

As recovery starts to stall in the US and Europe with echoes of mid-1931, bond experts are once again dusting off a speech by Ben Bernanke given eight years ago as a freshman governor at the Federal Reserve.

By Ambrose Evans-Pritchard, International Business Editor
Published: 5:11PM BST 27 Jun 2010
Economist

Entitled "Deflation: Making Sure It Doesn’t Happen Here", it is a warfare manual for defeating economic slumps by use of extreme monetary stimulus once interest rates have dropped to zero, and implicitly once governments have spent themselves to near bankruptcy.

The speech is best known for its irreverent one-liner: "The US government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost."

Bernanke began putting the script into action after the credit system seized up in 2008, purchasing $1.75 trillion of Treasuries, mortgage securities, and agency bonds to shore up the US credit system. He stopped far short of the $5 trillion balance sheet quietly pencilled in by the Fed Board as the upper limit for quantitative easing (QE).

Investors basking in Wall Street's V-shaped rally had assumed that this bizarre episode was over. So did the Fed, which has been shutting liquidity spigots one by one. But the latest batch of data is disturbing.

The ECRI leading indicator produced by the Economic Cycle Research Institute plummeted yet again last week to -6.9, pointing to contraction in the US by the end of the year. It is dropping faster that at any time in the post-War era.

The latest data from the CPB Netherlands Bureau shows that world trade slid 1.7pc in May, with the biggest fall in Asia. The Baltic Dry Index measuring freight rates on bulk goods has dropped 40pc in a month. This is a volatile index that can be distorted by the supply of new ships, but those who watch it as an early warning signal for China and commodities are nervous.

Andrew Roberts, credit chief at RBS, is advising clients to read the Bernanke text very closely because the Fed is soon going to have to the pull the lever on "monster" quantitative easing (QE)".

"We cannot stress enough how strongly we believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe) and for the global economy. Think the unthinkable," he said in a note to investors.

Roberts said the Fed will shift tack, resorting to the 1940s strategy of capping bond yields around 2pc by force majeure said this is the option "which I personally prefer".

A recent paper by the San Francisco Fed argues that interest rates should now be minus 5pc under the bank's "rule of thumb" measure of capacity use and unemployment. The rate is currently minus 2pc when QE is factored in. You could conclude, very crudely, that the Fed must therefore buy another $2 trillion of bonds, and even more if Europe's EMU debacle goes from bad to worse. I suspect that this hints at the Bernanke view, but it is anathema to hardliners at the Kansas, Richmond, Philadephia, and Dallas Feds.

Societe Generale's uber-bear Albert Edwards said the Fed and other central banks will be forced to print more money whatever they now say, given the "stinking fiscal mess" across the developed world. "The response to the coming deflationary maelstrom will be additional money printing that will make the recent QE seem insignificant," he said.

Despite the apparent rift with Europe, the US is arguably tightening fiscal policy just as hard. Congress has cut off benefits for those unemployed beyond six months, leaving 1.3m without support. California has to slash $19bn in spending this year, as much as Greece, Portugal, Ireland, Hungary, and Romania combined. The states together must cut $112bn to comply with state laws.

The Congressional Budget Office said federal stimulus from the Obama package peaked in the first quarter. The effect will turn sharply negative by next year as tax rises automatically kick in, a net swing of 4pc of GDP. This is happening as the US housing market tips into a double-dip. New homes sales crashed 33pc to a record low of 300,000 in May after subsidies expired.

It is sobering that zero rates, QE a l'outrance, and an $800bn fiscal blitz should should have delivered so little. Just as it is sobering that Club Med bond purchases by the European Central Bank and the creation of the EU's €750bn rescue "shield" have failed to stabilize Europe's debt markets. Greek default contracts reached an all-time high of 1,125 on Friday even though the €110bn EU-IMF rescue is up and running. Are investors questioning EU solvency itself, or making a judgment on German willingness to back pledges with real money?

Clearly we are nearing the end of the "Phoney War", that phase of the global crisis when it seemed as if governments could conjure away the Great Debt. The trauma has merely been displaced from banks, auto makers, and homeowners onto the taxpayer, lifting public debt in the OECD bloc from 70pc of GDP to 100pc by next year. As the Bank for International Settlements warns, sovereign debt crises are nearing "boiling point" in half the world economy.

Fiscal largesse had its place last year. It arrested the downward spiral at a crucial moment, but that moment has passed. There is a time to love and a time to hate, a time for war and a time for peace. The Krugman doctrine of perma-deficits is ruinous - and has in fact ruined Japan. The only plausible escape route for the West is a decade of fiscal austerity offset by helicopter drops of printed money, for as long as it takes.

Some say that the Fed's QE policies have failed. I profoundly disagree. The US property market - and therefore the banks - would have imploded if the Fed had not pulled down mortgage rates so aggressively, but you can never prove a counter-factual.

The case for fresh QE is not to inflate away the debt or default on Chinese creditors by stealth devaluation. It is to prevent deflation.

Bernanke warned in that speech eight years ago that "sustained deflation can be highly destructive to a modern economy" because it leads to slow death from a rising real burden of debt.

At the time, the broad money supply war growing at 6pc and the Dallas Fed's `trimmed mean' index of core inflation was 2.2pc.

We are much nearer the tipping today. The M3 money supply has contracted by 5.5pc over the last year, and the pace is accelerating: the 'trimmed mean' index is now 0.6pc on a six-month basis, the lowest ever. America is one twist shy of a debt-deflation trap.

There is no doubt that the Fed has the tools to stop this. "Sufficient injections of money will ultimately always reverse a deflation," said Bernanke. The question is whether he can muster support for such action in the face of massive popular disgust, a Republican Fronde in Congress, and resistance from the liquidationsists at the Kansas, Philadelphia, and Richmond Feds. If he cannot, we are in grave trouble.

China is accumulating gold. Should you follow?

For a more detailed look at the chart, go here.

China, Bernanke, and the price of gold

By Ambrose Evans-Pritchard Economics Last updated: September 7th, 2009

Telegraph

China has issued what amounts to the “Beijing Put” on gold. You can make a lot of money, but you really can’t lose.

I happened to see quite a bit of Cheng Siwei at the Ambrosetti Workshop, a gathering of politicians and global strategists at Lake Como, including a dinner at Villa d’Este last night at which he listened very attentively as a number of American guests tore President Obama’s economic and health policy to shreds.

Mr Cheng was until recently Vice-Chairman of the Communist Party’s Standing Committee, and is now a sort of economic ambassador for China around the world — a charming man, by the way, who left Hong Kong for mainland China in 1950 at the age of 16, as young idealist eager to serve the revolution. Sixty years later, he calls himself simply “a survivior”.

What he said about US monetary policy and gold – this bit on the record – would appear to validate the long-held belief of gold bugs that China has fundamentally lost confidence in the US dollar and is going to shift to a partial gold standard through reserve accumulation.

He played down other metals such as copper, saying that they could not double as a proxy currency or store of wealth.
“Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not stimulate the market,” he said.

In other words, China is buying the dips, and will continue to do so as a systematic policy. His comment captures exactly what observation of gold price action suggests is happening. Every time it looks as if the bullion market is going to buckle, some big force steps in from the unknown.

Investors long-suspected that it was China. We later discovered that Beijing had in fact doubled its gold reserves to 1054 tonnes. Fait accompli first. Announcement long after.

Standing back, you can see that the steady rise in gold over the last eight years to $994 an ounce last week – outperforming US equities fourfold, even with reinvested dividends – has roughly tracked the emergence of China as a superpower in foreign reserve holdings (now $2 trillion).

As I have written in today’s paper, Mr Cheng (and Beijing) takes a dim view of Ben Bernanke’s monetary experiments at the Federal Reserve.

“If they keep printing money to buy bonds it will lead to inflation, and after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies,” he said.

This line of argument is by now well-known. Less understood is how much trouble the Fed’s QE policies are causing in China itself, where they have vicariously set off a speculative boom on the Shanghai exchange and in property. Mr Cheng said mid-level house prices are now ten times incomes.

“If we raise interest rates, we will be flooded with hot money. We have to wait for them. If they raise, we raise.”
“Credit in China is too loose. We have a bubble in the housing market and in stocks so we have to be very careful, because this could fall down.”

Of course, China could end this problem by letting the yuan rise to its proper value, but China too is trapped. Wafer-thin profit margins on exports mean that vast chunks of Chinese industry would go bust if the yuan rose enough to close the trade surplus. China’s exports were down 23pc in July from a year before even at the current exchange rate, and exports make up 40pc of GDP. “We have lost 20m jobs in this crisis,” he said.

China’s mercantilist export strategy has led the country into a cul-de-sac. China must continue to run its trade surplus. It must accumulate hundreds of billions more in reserves. Ergo, it must buy a great deal more gold.

Where is the gold going to come from?