Who Will Stop The Outrageous Zimbabwe Ben Bernanke?

While our Dear Leader, our erstwhile American Nero, left for India and Asia spending $200 Million per day on entertaining his Media Mogul friend and mouthpiece, CNBC owner and GE Chairman Jeff Immelt, in order to escape the unpleasantly painful aftermath of his face slapping in the mid-term elections, his putatively independent economic minion, Zimbabwe Ben Bernanke was busy planting the flag of his Moral Hazard Army firmly in the soil of a conquered America.

The Fed is trying to hoodwink the world.  Bernanke, in his Washington Post editorial, has come right out and said he is targeting higher stock prices.  Yes you read that right.  The Federal Government is now actually directly interfering in the markets for debt and equities in an attaempt to micromanage the economy to health.  You see, stock index price levels are one of the components of leading economic indexes like the ECRI.  So by raising the price level, they think that they can improve the ECRI, which in fact they have, and that this will cause people to believe all is well – particlarly as they see their 401k and other asset values rise –  and thus alter their behavior to consume and to undertake investment, thereby growing the economy and swelling employment, restarting the virtuous circle.  The Fed is gambling that it can trick people into having confidence.

This may work or it may not.  If economic actors were not already saturated with debt at every level – individual, corporate and government – I would assign a higher probability to a positive outcome.  But in fact the state of affairs is one of nearly universal insolvency.  In their efforts to stave off realization of this fact, the authorities have engaged in various undertakings to extend and pretend, like suspending mark to market rules for banks, QE1, HAMP, TARP, a steep yield curve withcentral bank guarantee that the curve will remain steep (code to borrow short and lend to the treasury long to banks in order to rebuild balance sheets), among others.  The problem with all of these programs are myriad.  The most important is it prevents markets from clearing.  Perhaps equally important is it sends all the wrong signals to society by rewarding those who made poor decisions and penalizing those who are doing the right thing.  Moral Hazard.  Privatizing gains while socializing losses.  Basically, shareholders and lenders to banks who lent foolishly will be allowed to keep their shares and will likely be repaid their loans in full.  They will not suffer for their foolishness.  At the same time, the Fed keeps rates at the lower bound so that banks can essentially gather new equity by borrowing at 0% and lending to the United States Treasury at 2% for risk free profits.  Savers and those on fixed incomes get nothing.

Now with the Fed intentionally devaluing the United States currency with the stated intention of creating inflation, those savers will see the value of their savings decrease.  Also, anyone who lent money to the US Treasury will see the value of their loans decrease.  By monetizing the debt, the Fed is attempting to default on behalf of the Treasury and Tiny Timmaaahhhh by inflating away the debt.  This is going to cause all kinds of problems.

1.  One of the primary benefits of having “free”  markets is that in the coming together of buyers and sellers transacting at arms length, out come prices which can be observed by others, which help them to assess the value of their own assets.   This function has been given the name of Price Discovery.  Well, with both the government and the Fed intervening all over the place, price discovery has become meaningless.  One cannot depend on the prices being thrown off.  This will have the effect of lessening the confidence of business people, the opposite of what is sought.  The more the government does, the more private enterprise, with the exception of those engaged in pure crony capitalism – e.g. Jeff Immelt – will hold back, refraining from investment and hiring.

2.  The place where price increases are being felt is in commodities.  For a great many people this will be a disaster.  The price of food and energy will be steadily increasing, while wages which are far sticker, lag.  This will actually act as a tax and lessen activity, a  la 2008.  Businesses, faced with higher input costs may not react as anticipated if they cannot raise prices to compensate.  Core CPI or Core PCE values will not rise, as they have a heavy dose of housing in them and housing will not benefit.  But the Fed will get headline inflation in spades.  As Gasoline prices rise to $4 or beyond, there will be pressure brought to bear politically.

3.  Foreign governments are not likely to take unilateral dollar devaluation too well either.  Already there is talk of US incompetence and capital controls and other impediments to open cross-border trade in goods and services.  Foreign governments will not react well to rising tide of protectionism such as the pre-election Smoot-Hawley type bill passed by the House.  The global system has thus been rendered less stable and more likely to cause problems which will rebound back at the US.  Also, there is a growing lack of respect for the US as the world now laughs at all representatives of US power from the President to the Treasury Secretary to the Fed Chairman.  One of the two things you do not hear the Fed Chairman talk about is the value of the dollar or any recognition of the effects of weakening it.

4.  The other thing you do not hear the Fed Chairman talk about is Debt saturation.  QE makes the debt saturation problem worse by shielding Congress and the Administration from the consequences of their profligacy.  By artificially depressing Long bond rates and keeping bond vigilantes at bay, they are sending a signal to lawmakers that they can spend with impunity.  This will make the problem more acute and heighten the level of the eventual fall.  The final reckoning, if the Fed fails, will be terrible to behold.

I see 3 possible outcomes.  If the Fed loses control and there is a crisis of confidence in the Dollar, then we could see massive inflation or Hyperinflation.  There would be a hopefully brief period of chaos where much wealth is wiped out, savings and debts are rendered worthless and the economy collapses.  Or maybe the Fed engineers a goldilocks scenario where things muddle along, debt levels are eventually worked off and we have slow growth for an extended period.  Finally if the Fed fails in raising inflation expectations altogether, then we could have a deflationary crash that has merely been postponed.  Debts would then be wiped out but savings would be worth much more.

Whatever the outcome, I wonder how long the Fed will be allowed to play this game.  The Fed was created in the aftermath of the Panic of 1907, one of many bank depositor panics which resulted in liquidity problems.  As there was no recourse to any governmental authority, and the alternative of appealing to private bankers like JP Morgan seemed ad hoc and unsustainable for an economy then breaking out into new qualitative levels of wealth and size, it seemed prudent to establish a government sponsored entity that could be depended upon to be the liquidity provider in such scenarios.  Never mind that the advent of deposit insurance obviated the need for such a liquidity provider at the retail level, but the Fed has now well exceeded the bounds originally envisioned for it.  Interfering in asset markets to directly set price levels (a permanent Plunge Protection Team as others have put it – put that debate to rest now) and managing the economy to have taxpayers and savers fund the recapitalization of banks to the benefit of existing shareholders and bond holders – including Saudi Princes – is a power grab of mythic proportions and an outrage so massive it should take one’s breath away.

The only official potential for putting a stop to this outrage is the US Congress.  Ron Paul has already stated that oversight of the Fed will be heightened in the new Congress.  If they fail, and any of the more extreme outcomes take place, Zimbabwe Ben is likely only to be stopped by a mob that carries his head out of the Marriner Eccles building on a pike.

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