What's Ben Gonna Do?
Every day the deflation story gets stronger. Almost all of the numbers
in the US are pointing in that direction. A slowdown in the EU is a sure
thing. Japan is going nowhere. China is a question mark, but even if
they do continue growing it will not result in enough Eco. Juice
to offset the global deflationary forces.
I was anticipating a slowdown in the 4th Q. It is now looking more
likely that we will fall of a cliff starting July 1st. Extended benefits
will be ending. Most states start a new fiscal year and they are all
dead dead dead on revenue. Any benefit we got from the census will be in
reverse gear. By August 1st approximately 1mm temporary workers will
again be out of a job. Housing is falling off a cliff.
The market sees this. The ten-year is at an incredible 3.1%. The last
few days of trading in gold has a smell of deflation as well.
Bernanke must be beside himself. He bet the farm to save the economy in
2009. He has done things that no other Fed head as ever contemplated. As
betting goes, he is “all in” on this one. He bet the economy, our
future solvency and his reputation. In my opinion there is no way he is
going to throw in the towel and accept that deflation is inevitable.
Ben spelled out what he would do in the “unlikely” event that deflation
became a real threat in his famous 2002 “Helicopter” speech. The full
speech is here.
This speech has been hashed many times before. Given the news of late
it is worth relooking at what Ben had to say. Some excerpts:
fiat money system, a government should always be able to generate
increased nominal spending and inflation, even when the short-term
nominal interest rate is at zero.
Well Ben, we have had ZIRP for two years now. It has made a difference.
But zero interest rates have just bought time, not a recovery.
The U.S. government has a technology, called a
printing press that allows it to produce as many U.S. dollars as it
wishes at essentially no cost. We conclude that, under a paper-money
system, a determined government can always generate higher spending and
hence positive inflation.
Ben has been running that printing press. QE created $1.75t. It has not
had a lasting benefit.
Fed could stimulate spending by lowering rates further out along the
Treasury term structure. There are at least two ways of bringing down
longer-term rates:(I) Fed
could commit to holding the overnight rate at zero for some specified
A more direct method, which I personally prefer, would be for the Fed
to begin announcing explicit ceilings for yields on longer-maturity
Treasury debt. The Fed could enforce these interest-rate ceilings by
committing to make unlimited purchases of securities.
Ben has done (I). As of yet we have not seen (II). For me it is scary
that this is his “favorite” approach. That makes this one a sure thing
if evidence mounts that we are rolling over. But this does not
accomplish much in today’s markets. The 2-year is at 75bp. What is
Bernanke going to do? Push that to zero also? He might.
Fed could also attempt to cap yields of Treasury securities at still
longer maturities, say three to six years.
Why stop at 6 years Ben? To make a dent he would have to have the
10-year at 1%. Is that what he has in mind? I think it is a real
An option would be for the Fed to use its existing
authority to operate in the markets for agency debt.
We have done that already in a biblical manner. $1.25 trillion. Three
months after the program ended the housing market is falling off a
cliff. I would not be surprised if Ben re-established this program.
Buying another $1 trillion would not accomplish anything but make the
primary dealers rich. But a desperate Ben would do this again in a NY
The Fed might next consider attempting to influence
directly the yields on privately issued securities.
Oh boy, this is the beginning of the end. Ben would buy corporate debt.
GE would be high on the list; the rest of corporate America would
follow. Ben could buy BP bonds. That would solve our problems, wouldn’t
Fed might make 90-day or 180-day zero-interest loans to banks.
Lights out when this happens. Ben will stop at nothing. This option is
not far from reality. That said, if this happens the public backlash is
going to be vicious.
The Fed has the authority to buy foreign government
debt. Potentially, this class of assets offers huge scope for Fed
operations, as the quantity of foreign assets eligible for purchase by
the Fed is several times the stock of U.S. government debt.
The “nuclear option” is to buy up the sovereign debts of other
countries. This would extend QE globally. In a way we just did this with
the opening of $100b in swaps lines to the European central banks. This
gives them the wherewithal to buy their debt. The ultimate is when the
Fed starts doing it for their own account. I doubt this option is
realistic. It would require the approval of the other CB’s. That said,
should you see this headline buy lots of canned food and rice. If this
step is implemented bread lines will follow.
worth noting that there have been times when exchange rate policy has
been an effective weapon against deflation.
In this case the Fed would attempt to devalue the dollar in order
achieve its goals. This of course would just destabilize everything else
in the world and would insure a downward spiral in economic activity.
Most of the things Ben spoke of back in 2002 have already been tried (or
are now in place) and have not worked. The remaining options do not
appear to have much chance of working either. But that does not mean
that we will not see these steps.
Ben has already destroyed savers. This is the consequence of his steps.
It was not his goal, but he understood fully that savings would have to
be penalized. He is in so deep at this point that I believe he will
consider anything to protect his reputation in history. The one thing
that he did not bring up in the 2002 speech was negative interest rates.
While this option sounds ridiculous it can’t be excluded as a
possibility. The SF Fed had a paper
on this recently. A graph of the “proper” Fed funds rate:
John Hilsenrath at the WSJ
also put the idea of negative interest rates on the table in a
recent piece. I think the article was from Ben’s lips, into John’s ear
and then onto the front page of the Journal. If Ben has something to
say on this matter he should address us all. He should not use a beard
to influence public/market thinking.
How could something as crazy as negative interest rates work? Consider
this from none other that Harvard
economist Greg Mankiw. He had this to say on the subject back
in March of 2009:
I can now state
the proposed solution: Reduce the return to holding money below zero.
Imagine that the Fed were to announce that it would pick a digit from 0
to 9 out of a hat. All currency with a serial number ending in that
digit would no longer be legal tender. Suddenly, the expected return to
holding currency would become negative 10 percent.
This bit of lunacy comes from one of our best and brightest economists.
Should this (or any other negative % plan) be implemented it would mean
that a depression is just a few months away. The last desperate acts
would insure that we would fall into a very big hole. We will hear more
on these “emergency” measures in the coming months. Should any of them
come to pass, be guided accordingly. These steps will only agonize what
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