- Money Morning Australia

Bernanke’s Excuse for Mass Looting


Written on 22 December 2012 by MoneyMorning

Bernanke’s Excuse for Mass Looting

Bernanke said that to remedy the unemployment problem he will continue the Fed’s program of asset purchases. Specifically, the Fed will continue to buy and hold mortgage-backed securities (yes, they are still sloshing around the banking system) and US Treasury securities – $40 billion-plus per month. Plus, he will keep the federal funds rates at near zero.

The great change, he said, is the intense focus on the policy objective of unemployment. The committee sees no inflation threat, so it might as well turn its attention to the labor markets. The Fed loves the unemployed, you see, and wants to help them.

But here’s the disconnect. What the devil does buying bad debt from zombie banks have to do with getting people jobs? The relationship between assets purchases and policy goals is murky at best.

‘I need a job, so I hope the Fed buys more bad mortgage debt’ – said no unemployed person ever.

Yes, I know about ancient Keynesian theories. There is tradeoff between unemployment and inflation. But those theories have not really explained much at all for the last 40 years. In fact, they blew up in the 1970s with the emergence of ‘stagflation’. An affliction where unemployment remains high even as inflation roars ahead.

You might be able to explain Bernanke’s outlook through the normal intuition. Low rates spur growth. Growth leads to new businesses. New businesses hire new people. Problem solved.

But the problem here is that the last five years have provided scant evidence that low and even zero interest rates have actually spurred economic growth. You can point to some measure of improvement in the data. But the cause-and-effect relationship between higher growth rates to zero interest rate policy is… less than persuasive.

And here is where we get to what has long bugged me and others about the Fed’s policies since 2008. These guys are not idiots. They read the same economic reports we do. The history is surely somewhat as plain to them as it is to us. The policy is not working as it should. Bernanke has conceded as much.

So Why Does the Fed Persist With this Policy?

This is where you need to look beneath the surface to find the answer. What is the purpose of the central bank? Looking back historically, the central bank has served one primary purpose and one second purpose that is the source of its power.

It is there to keep the banking industry solvent, providing liquidity when necessary and papering over the errors that are revealed in the course of economic crises. And secondarily, it is there to provide a market for government debt when governments get in trouble.

There is a quid pro quo here. Governments are willing to back the banking cartel with legal status provided the banking cartel serves government when it is needed.

Government is more willing to enter into such a deal with banks, rather than the salt or shoe industry, because, well, banks are where the money is. Government needs that stuff because they typically want more money than taxpayers are willing to cough up.

That’s all you need to know to understand why the Fed is willing to create some $85 billion each month to buy more mortgage-backed securities and more Treasury debt.

The banking industry is still holding the stinking bag of you-know-what that was first exposed in 2007. The mess is still there. The banks are in continuing need of shoring up their balance sheets. Offloading bad assets on the Fed and writing them off the books is the best path from here to there.

That the Fed is still doing this after all these years provides us an indication of just how bad the crisis really was and just how vulnerable the banking system was and is to finding itself completely insolvent.

As for the government’s needs right now, say no more. Our rulers have created a horrible mess of astronomical and unpayable debt, and even rating agencies are taking note. There is the fiscal cliff. There are the unfunded liabilities. There is the unsustainable empire. There is the utter impossibility of a rational political solution to this problem.

Thus does the Fed come to the rescue, guaranteeing a market for government debt and helping its friends in the bond-selling business at the same time.

Now let’s consider the effects. Zero interest rates policies amount to a complete perversion of market signalling. The effect on savers like you and me has been disastrous. Average people in the past depended on the banking system to park their money for eons, but now only chumps do that.

But there is another angle here too. The banks can no longer rely on loan markets to be the main source of their profitability. Since 2008, the main activity of the industry has completely changed in response to zero interest rate policies.

In what we might describe as a ‘lending cliff’ the commercial banking sector has slowed lending, dramatically at first, and then crawling backing more recently and seeming to plateau at a much lower rate of expansion than the historical average.

bank Credit of All Commercial Banks

This represents a change in the way banks work and the way money has traditionally been created in a fractional-reserve lending system. Picking up the slack have been non-bank lending institutions, which are in a boom stage of development right now.

The lending standards in the nonbank sector, stung by 2008, are more strict than in traditional banking. They maintain a level of soundness that banks never have. And they sure as heck don’t go along with the zero interest policy.

The banks themselves have always been the creative engine of new paper money to flood the system. If banks are creeping away from loans markets, effectively outsourcing them to the nonbank sector, this trigger mechanism is no longer in place.

This is why there is a gigantic disconnect between Bernanke’s claim to have a ‘highly accommodative’ policy stance and the monetary reality on the ground.

Close observers have noted this trend for many years. The Fed doesn’t seem to have the level of direct control over money creation that it once had. Here is a chart of ‘Money of Zero Maturity’ that chronicles percentage change from a year ago.

Most notable is that you see a dramatic rise in the early part of the 2008 crisis and then a precipitous fall once the crisis was in full swing. Pumping efforts showed some promise in 2009 but faltered. The subsequent plunge continued through 2010, the very time frame in which the Fed claimed to be pulling out all the stops to flood the economy with money.

MZM Money Stock (MZM)

What’s up with this? If the Fed is creating massive amounts of money, why are we not seeing it appear very dramatically in money aggregates, and why isn’t this feeding the markets in the conventional way?

How Bernanke Distorts Banking and Finance

To ask the question a different way, even if price inflation is higher than the government admits, why have we not yet seen signs of Weimar Germany or Zimbabwe? The clue comes from looking at the reserve balances at Federal Reserve banks themselves, where the commercial banking sector is actually parking its new-found fake wealth.

They are doing this because the Fed has made it possible for the banks to earn interest from their deposits. Leaving money in the vaults make a lot more sense than trying to navigate Dodd-Frank regulations and risk violating Basel III capital requirements.

Reserve Balances with Federal Reserve Banks

Putting all of this together, we can see that what Bernanke has done is fundamentally changed the function of banks and the role of the Federal Reserve.

In seeking to save the banks, he has essentially nationalized them, disabling their lending function relative to the past and turning the Fed from being a clearinghouse to being a holding tank for newly created money. This is why he can stand up there at press conferences and so confidently claim that inflation represents no great threat right now.

To be sure, Bernanke’s policies are not harmless. They represent a massive distribution of wealth from the productive sector to the banking system and the financial sector, solely for the purpose of keeping the Fed’s clients solvent.

Another danger comes from the many creative ways that banks have learned to make money in the age of Bernanke by playing recklessly in the derivatives market, holding on to infinitely guaranteed demand deposits, and manipulating every marginal opportunity for speculative trading that comes along.

This could be the banking bomb that will blow up in the years to come. But this explosion is going to take a new and unpredictable form from any that has come before. A bubble pops first at the weakest part of the balloon. Where that is precisely is known through experience.

The end of banking as we’ve known it is probably good news, and, in bringing this about, Bernanke has probably done the world a favor. Finding the right path forward is the great challenge that every holder of dollars will face in the years ahead.

Jeffrey Tucker,
Contributing Writer, Money Morning

Publisher’s Note: This article originally appeared in Laissez Faire Today

From the Archives…

Why Small-Cap Stocks Could Be Your Best Investment in 2013
14-12-2012 – Kris Sayce

How the Global Oil Grab Affects You…
13-12-2012 – Byron King

The Price of Risk in the Stock Market
12-12-2012 – Murray Dawes

Why Silver Could Be the Best Investment in 2013
11-12-2012 – Dr. Alex Cowie

The Long, Drawn Out Retreat in Australian House Prices
10-12-2012 – Dr. Alex Cowie



Already a subscriber to Money Morning... or simply, just like what you're reading? Then show your support and spread the word...
Share this post on...
Share

MoneyMorning
At Money Morning our aim is simple: to give you intelligent and enjoyable commentary on the most important stock market news and financial information of the day - and tell you how to profit from it. We know the best investments are often the hardest to find. So that's why we sift through mountains of reporting, research and data on your behalf, to present you with only the worthwhile opportunities to invest in. Become a more informed, enlightened and profitable investor today - by taking out your free subscription to Money Morning now.

Leave a Comment

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.

If you would prefer to email the editor, you can do so by sending an email to moneymorning@moneymorning.com.au


Comments are closed.



GET THIS NEW REPORT : 5 Things You Can Do To Boost Your Retirement Pot


In this report we’ll give you strategies, tips and advice to help you kick-start, or revive your retirement savings right now.

PLUS you'll get Money Morning every weekday...absolutely free.

Enter your email address below and hit the 'Claim My Free Report' button now.

Privacy Statement
We will collect and handle your personal information in accordance with our Privacy Policy.
You can cancel your subscription at any time

Diggers and Drillers

A 3-Point Plan to Re-Engage with the Aussie Mining Boom


This new video reveals a way for Aussie share investors like you to RE-ENGAGE with the next phase of the mining boom…while valuations are still dirt-cheap…


The plan centres round three specific stocks.


To find out what they are, click here.

Australian Small-Cap Investigator

The Australian wildcatter
exploring oil's 'final frontier'


The US Geological Survey says this area contains up to 71 billion barrels of oil.

Only a few explorers have secured licences to drill.

One of them is a daring little Aussie firm that begins drilling 'in early 2014'.

According to small-cap analysts Tim Dohrmann it's impossible to speculate just how high this one could go. Find out why here.

World War D

Couldn’t make it to our
‘War Summit’?


Don’t sweat it. Click here for the next best thing…


World War D was the most important meeting of minds of the decade so far. What came out of it will almost certainly force you to reshape your investment plan for the rest of the decade. There's no way to go back in time and get inside the Savoy Ballroom of the Grand Hyatt.

But you can do the next best thing…
to find out what it is, click here.

  • ^NDX3534.532+1.446 - +0.04%
  • ^FTSE6625.25+41.08 - +0.62%
  • ^AORD5444.800+32.200 - +0.59%
  • ^AXJO5454.200+33.900 - +0.63%
  • AUDUSD=X0.933
  • USDJPY=X102.445

Graphic Ad 1 – Blue Chip Stocks Report


Revolutionary Tech Investor

This report is about TECH MOON-SHOTS


Four of them, to be precise.


It's an early-days project. But one biotech aiming for the cancer moon-shot is already up - get this - 497.14% since tipped.


For four more tech moon-shots, click here.

Gowdie Family Wealth

WARNING:
The worst mistake you can make when handing wealth on to your kids


This brand new investor briefing shows you what your family’s in for if you don’t take care to leave your wealth to them in exactly the right way.


And it shows you precisely how to prevent infighting, recklessness and misunderstanding over money.


Read it here.

The Money For Life Letter

Holden. Toyota. Qantas. BUST


Do you really expect the share market to boom in times like these? That's why Nick Hubble says the best thing you can do right now is invest for safety and income.


This brand new video shows you how you can get predictable, reliable and rock solid cash flow no matter what happens in the wider economy.


You could lock in up to $20,000 a year - and that's just the start. See how here.



Sound Money. Sound Investments. [bullish prediction]

Greg Canavan's first bullish prediction in four years


Greg Canavan
doesn't make forecasts like this often.


When he does, it's because he’s found something that could make you money for years to come.


Read more here.

Is the Australian Housing Boom Really Back?

The Denning Report

2014 Predicted


Dan Denning accurately forecast 2013's flight from
bonds to stocks, the commodities crash and the
Aussie dollar top…to the exact week


In this brand new forecast report, he shares his
three critical predictions for 2014…

More Recommended Reading Below...

The Pursuit of Happiness & The Daily Reckoning

  • The Pursuit of Happiness
  • The Daily Reckoning Australia

Done properly, a retirement business can not only help fill a retiree’s time and replace their work [Read More...]

Free speech is no longer really a right at all. Governments, vested interests, and lobby groups are [Read More...]

Australian house prices are going to remain high. Perhaps finally, when the last baby boomer retires [Read More...]

Make sure that the changes you make to your financial plan are from a credible source. Otherwise the [Read More...]

It was day two of the World War D conference, and the final session was starting. We were closing th [Read More...]

Since the US Federal Reserve’s relief efforts began, total world debt has gone up by $30 trillion, w [Read More...]

A one size fits all strategy or rollover to your own self managed super fund with the ability to tai [Read More...]

Services will boom according to the Reserve Bank of Australia. Sales assistants and tour guides are [Read More...]

In the many years since the creation of the US Federal Reserve System as America's central bank [Read More...]

In business, as in other things, we are being roughened up… and toughened up. We promised a grim acc [Read More...]

TESTIMONIALS

"I think you're fantastic! I love to read what you write...you're so interesting and amusing and I've learned so much" -
Money Morning reader, Chris Gadd

"You guys are brilliant. I feel more relaxed about the future than ever simply because I know what is going on rather than floundering around with smoke screens and mirrors from the government and mainstream" -
Money Morning reader, Helen Carter

"Wow what can I say? I was an economically confused moron until I read your newsletter and even though I've been a subscriber for a short period I can now see how easy it is to understand, if you use common sense and can have the spin translated into everyday language. Thanks for an entertaining read." -
Money Morning reader, John

"Keep up the good independent and well thought out articles offering a view that often debunks mainstream myths." -
Money Morning reader, Craig

"I do admire your straight talking and simple analysis of the situation, I think of you as the Jeremy Clarkson of finance." -
Money Morning reader, Jeffery