Guest Post: Can Bernanke Brake Without Derailing?

Tyler Durden's picture

Submitted by Frank Shostak via The Ludwig von Mises Institute,

According to most commentators, reducing monetary stimulus and winding down the balance sheet of the Fed without major economic disruptions is going to be a major challenge for US central bank policy makers. On Wednesday, June 19 Fed Chairman Ben Bernanke, said that given an improved outlook on the economy, the US central bank may moderate the pace of monetary pumping. According to Bernanke, by mid-2014 the Fed may even end the purchasing of assets.

Is it possible to slow down the pace of monetary pumping without major side effects?

According to the popular way of thinking, on account of major shocks prior to 2008 emanating from disruptions in the credit markets, the US economy was severely dislocated from a path of self-sustaining economic growth.

As a result, since 2008 the Fed has had to step in with massive monetary pumping to bring the economy onto the path of economic growth.

Now in this way of thinking, the spending of one individual becomes the income of another individual whose spending in turn gives rise to the income of other individuals, etc. In the absence of shocks, this process tends to become self-sustaining. The role of the central bank here is to make sure that the process does not get disrupted and to prevent bad dynamics. (Thus if, on account of a shock, consumers curtail their spending, this could lead to an implosion in economic activity.)

Note that the central bank is expected to intervene not only in response to negative shocks but also on account of positive shocks that tend to move the economy strongly above the path of self-sustaining economic growth.

Now, the manifestation of negative shocks is considered to be a decline in the growth momentum of prices and a fall in economic activity. In contrast the manifestation of a positive shock is overheated economic activity and a rising growth momentum of prices of goods and services.

With this way of thinking if the central bank is not careful enough in its response to negative shocks, this could push the economy into a so-called “overheated” zone.

It seems that although not an easy task, experienced and wise policy makers should be able to navigate the economy away from various disruptions and keep the economy on a healthy growth path.

Hence policy makers must carefully monitor key economic data in order to make sure that the economy, once it is brought onto a self-sustaining economic growth path, stays there.

Policy makers are probably watching a few key indices. For example, the Builders Expectations Index jumped to 52 in June from 44 in May. The growth momentum of housing starts shot up in May from the month before. Year-on-year the rate of growth of starts climbed to 28.6 percent from 13.5 percent in April.

Also economic activity in general appears to be gaining strength. The Philadelphia Fed Business Index had a big increase in June from May rising to 12.5 from minus 5.2. The New York Federal Reserve economic activity index had a visible strengthening rising to 7.84 in June from minus 1.43 in May.

It is against this background that one can understand the logic of Ben Bernanke and his colleagues when they say that given the strengthening in economic activity and the likely strengthening in the labor market, US central bank policy makers are likely to trim the pace of monetary pumping in the months ahead.

Note again that what is required here for the successful accomplishment of the Fed’s monetary policy is the correct assessment of the future course of the US economy.

Even if one were to accept this way of thinking, the dynamics of events are never possible to predict with great accuracy. The Fed’s policy makers are likely to be in the dark as to whether the economy is approaching the self-sustaining growth path or has already surpassed this path and has entered a rising inflationary path.

Note that policy errors are likely to add to various shocks that these policy measures are meant to counter. (The key policy measures of the Fed are monetary pumping and interest rate manipulations.)

On this score, whenever the Fed changes the pace of pumping, the effect on various markets is not instantaneous. The newly injected money moves from one market to another market and there is a time lag.

For some markets, the time lag is short; for other markets it can be very long. Whenever the new money enters a market, it means that now more money is chasing a given amount of goods in that market. The monetary expenditure, or the monetary turnover, in the particular market is now higher.

Now, various economic indicators depict changes in monetary turnover in various markets. For instance, changes in money supply after a time lag of nine months will manifest in changes in the so-called gross domestic product (GDP). Note that the alleged economic growth in this indicator has nothing to do with true economic growth but comes in response to past increases in the money supply rate of growth.

Given that the time lags are variable, various indicators such as price indices might be responding to changes in monetary policy that took place several years earlier.

Hence a situation could emerge that on account of the variability in the time lags, there could be a variety of responses in various indicators at a given point in time. (For instance a strengthening in the yearly rate of growth of the CPI whilst economic activity is declining.)

We know that Fed policy makers tend to be—most of the time—reactive to changes in economic indicators, which means that most of the time policy makers are responding to past policies. (It is like a dog chasing its own tail.) Needless to say that such types of policies tend to amplify rather than mitigate shocks.

We are of the view that the entire framework of thinking regarding the existence of some kind of a growth path that the Fed supposedly could navigate the economy onto is erroneous. There is no such thing as an economy as such, apart from individuals that are engaged in various activities to maintain their lives and well-being.

Whenever the central bank raises the pace of monetary pumping in order to bring the economy onto a self-sustaining growth path, it in fact sets the stage for various non-productive bubble activities. The increase in these activities, which is hailed as economic prosperity, sets in motion the diversion of real wealth from wealth generators toward bubble activities. It weakens the process of wealth generation.

Whenever the Fed curbs its monetary pumping this weakens the diversion of real wealth towards bubble activities and threatens their existence. Note that bubble activities cannot support themselves without the monetary pumping that diverts real wealth from wealth generators. This leads to an economic bust.

Obviously then there is no way that the Fed could somehow curb the monetary pumping without setting in motion an economic bust. It would contradict the law of cause and effect. The severity of the bust is in accordance with the percentage of bubble activities out of overall activities. The larger this percentage is the greater the bust is going to be.

This percentage in turn is dictated by the magnitude and the length of the loose monetary stance of the Fed. Once this percentage gets out of hand the pool of real wealth comes under pressure. Consequently, banks’ willingness to engage in the expansion of lending despite the central bank’s loose stance is reduced. This leads to a decline in the growth momentum of the supply of credit out of “thin air,” which in turn leads to the decline in the growth momentum of money supply. After a time lag this works toward a decline in economic activity, i.e., sets in motion an economic bust.

Meanwhile after closing at minus 1.4 percent in September 2012 the yearly rate of growth of the Fed’s balance sheet jumped to almost 20 percent in June. On account of banks reluctance to lend (surplus cash stood at $1.963 trillion in June) the downtrend in the growth momentum of US AMS remains intact. (After closing at 14.8 percent in November 2011 the yearly rate of growth stood so far in June at 7.7 percent). We suggest this has already set in motion an economic bust.

Summary and conclusion

According to most commentators, although not an easy task, experienced and wise policy makers should be able to navigate the US economy away from various bad side effects that come in response to a tighter Fed stance. We suggest that whenever the Fed raises the pace of monetary pumping in order to “revive” the economy it in fact creates a supportive platform for various non-productive bubble activities that divert real wealth from wealth generators. Whenever the US central bank curbs the monetary pumping this weakens the diversion of real wealth and undermines the existence of bubble activities - it generates an economic bust. We suggest that there is no way that the Fed can tighten its stance without setting in motion an economic bust. This would defy the law of cause and effect.

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THX 1178's picture

I came here to say that.

fonzannoon's picture

the first post should be the only post with 500 up arrows.

jon dough's picture

In the shuffling madness
Of the locomotive breath,
Runs the all-time loser,
Headlong to his death.
He feels the piston scraping
Steam breaking on his brow
Old Ben Bukkake stole the handle and
The train won't stop going
No way to slow down.

old naughty's picture

b,b...but wait, the 'copter's on the ground (so you use the brake)?

Hope they have shut down the rotor...

wee-weed up's picture

The bastard has already left multiple turds in our economic punchbowl...

He'll do whatever it takes to make it to the end of his term...

Then it's - fuck you all! Suckers!

Tao 4 the Show's picture

The more important question is...

Can Beranke derail without breaking? I.e. Will he make it to his own finish line before another 2008 comes around.

andrewp111's picture

He only got 6 months. Surely he can make it across that finish line.

peter4805's picture

1, 2, 3 and all together now... FUCK YOU BERNANKE !!

DavidPierre's picture


Jim Willie lays it all out.

He sez ZH is the best blog on the web.

When is ZH going to give him some recognition and post his diatribes?

Midasking's picture

It needs to derail otherwise we will never have a true recovery just more QE nonsense.  Bernanke is what is standing in the way of the recovery.  If he stops you will see one heck of a "derail" but we must go through the pain to fix things.

franzpick's picture

(TD: Are we going to have to look at Hillaryious' picture for the next 3 years?)

knukles's picture

She's gonna be your next predident for 8 years, not Head-o-de-Fed


as if it's gonna matter....

XitSam's picture

Neither position requires any knowledge of economics.

Seasmoke's picture

yes of course.......he will hit the brakes but they will have no pads or fluids and off the cliff we go.......but NO derailment !

Atomizer's picture

The 7, the 6½—these are guide posts that tell you how we’re going to be shifting the mix of our tools as we try to [crash] land this [air]ship on a, you know, on a—in a smooth way onto the aircraft carrier.

surf0766's picture

Yo , did you watch what happened when he hit the "We might tapper" button?



Iam_Silverman's picture

""We might tapper" button?"

OK, I'm confused again.  Tapper?

Last week it was all about the possibility of Taper.

Maybe someone can write a short article to explain the terms that get all jumbled up here.

As the Tepper Curve tapered, the tapir was revealed as the real tapper. Endlessly tapping his pencil against the table while he tried to find a way to slow down asset purchases.

Meanwhile, at home, the painter was at a stop as he waited for the taper to finish his work.

andrewp111's picture

Bernanke looks more like a Groundhog than a Tapir.

nmewn's picture

Stupid is as stupid does.

Print Forrest print!!!

Dr Benway's picture

The discounting and pricing mechanism of the market has been purposefully destroyed by intervention, yet we implicitly assume the market efficiency we have selfadmittedly destroyed, when basing economic policy on 'market' prices and using it as foundation for our pension system.

We had a golden goose but greedy old criminals forcefed it to death, and now they're trying to shill the rotting corpse to the next generation.

q99x2's picture

That dufess can't do anything unless he is told what to do

Aurora Ex Machina's picture

There's a Law to Media questions that ask a question, and the answer is always: NO.

Even Hollywood breaks the plane when you force a crash.

P.S. Hollywood is all over this stuff.

Oh, and most amusingly: ask around, and see just how bankrupt Hollywood is at this point. DVD loss crippled them, and the entire industry is fucked. The Old Ones are all about to crash and burn; the greatest propaganda matrix on the planet, and it couldn't even survive Capitalism. And that's even after a century of Hollywood Accounting. Little tip: if you're selling mental crack cocaine, and can't make it work, you're probably running a Ponzi scheme without merit and without skill.


Good Night, and Good Luck..Bonus Round.

kchrisc's picture

The fascists will probably just ramp up the lawsuit machine against downloaders so they can squeeze more "juice" from grannies across the US.

Mean while they can make more of those agitprop goverment and "military are good and gun and badge thugs (GBT) are your friends" movies. Case in point: the new Superman (Man of Steel) movie. Government and military all throughout.

Seems many movies now days have the same gov, military and GBT plot with everything else then filled in around it. Like the Transformers, the Last two Die Hard films, the Avengers, the Ironman films, etc.

Disclaimer: I am not reviewing any of these films, but just pointing out the fascist agitprop in them.

trader1's picture

what denzel movie is that?!  that scene was intense!


are you sure it was dvd loss that dealt holloywood the crippling blow?  they love to argue piracy...

andrewp111's picture

Hollywood Accounting is all about making sure the insiders get theirs even if the movie is loss-making overall.

toadold's picture

Can Bernanke break without impaling?

Is there a hot stake waiting for him? 

If they use a short blunt stake will it be possible to charge for admission and sell high priced popcorn? 

pragmatic hobo's picture

"experienced and wise policy makers should be able to navigate the US economy away from various bad side effects that come in response to a tighter Fed stance"

this is probably true ... except we have federal reserve run by naive academics who doesn't know how much a gallon of milk costs. These are neither experienced nor wise men running the printing press of the nation. There will be hell to pay.

involuntarilybirthed's picture

This article says nothing except the routing glorifying and pumping of the fed as if it were our god that must be worshiped as it holds our lives in it's printing press.   

Outside of the hype crap what difference does it make that the Fed buys 40 or 60 or 85B of MBS? If it wasn't published I doubt anyone could tell the difference (except Manhattan and it's usual  suspects)? 

world_debt_slave's picture

It will go as good as Michael Hasting's being "Boston Braked" by the same criminals in D.C.

kchrisc's picture

Petition: A petition for a law that will make mandatory biannual engine motor-mount safety checks for all motorized vehicles. With the program to be administered by Haliburton and Booz Allen. Hint: Go long their stocks.

Also petitioning for: "Intentionally left blank to accomodate Pelosi read-after-passing pork and treason boiler-plate."

TrustWho's picture

Same concept that a country, community or family should save in the good times and use the savings to pass thru the bad times. This is NOT a PhD problem. Good execution requires wise men. The mistake is always made in NOT recognizing the good times in the moment, so saving is difficult. Anyone can recognize the decline, anyone can reduce interest rates, and anyone can print money. Paul Volcker had strong character, but Greenspan and Bernanke are cowardly PhDs. 

Dr Benway's picture

You seem to be saying that the strategy of central bank intervention is sound, but currenly let down by execution.

I disagree with that. It's not that they're failing at implementing a basically sound plan, they are failing at executing a fundamentally idiotic strategy that was intrinsically doomed to eventual failure.

Steve in Greensboro's picture

The Doctor is right. Creation of fiat money and artificial credit expansion is too much power to be placed in any government's hands. These matters were certainly better handled before the Progressive era when we had the gold standard and the free market handled them. Individuals made their small, personal mistakes in a free market, but no one individual was able to disrupt the economy so massively (e.g. Greenspan and Bernanke) before this power was centralized.

TrustWho's picture

Yes, you correctly capture my thought on a narrow basis. The econony expands and contracts according to natural laws and the money supply needs to expand and contract to optimize the efficiency of the transactions that fuel the economy. During the 1800s, the boom and bust cycle are obvious for all to see. I do not know if wise men can execute a strategy that would outperform the natural process, but I do think the post WWII experience with the example of Paul Volcker suggests maybe wise men can. I believe the post WWII USA experience presents a special case that may totally explain the 1800 vs 1900 experience.

I believe you expand my thought to include the wall street financialization with CDOs, CDS and other derivatives that expanded the leverage beyond a sane man's imagination; and the GSEs and government sudsidies/intervention that reduced financial risks beyond a sane man's imagination. The fact that the Fed was responsible for managing this risk and did nothing is a travesty that suggest the Fed is incapable of managing anything. This leverage and risk was not considered in my original blog. 

Daddy Bernanke is acting like the Wizard in the Wizard of Oz and has pumped money as the only solution. He is a coward full of fear and has created great risk. If Bernanke was my only example, I agree he is executing a fundamentally idiotic strategy.

kchrisc's picture

"Good execution requires wise men."

Isn't that assuming that the whole thing isn't a criminal con in the first place?! Run not by "wise men," but by sociopathic thieves and murderers?!

TrustWho's picture

"sociopathic thieves" is a reasonable hypothesis based on the 1992 - 2013 period. Rubin, Summers, Weill and Greenspan are my top financial criminals. 

Iam_Silverman's picture

Maybe the trick is to NOT announce what you are up to?

The Momo day traders will assume they are fighting HFT bots or GS frontrunning them on some info they hadn't heard yet.  The Fed can just sit on their hands and not buy until the players figure out what is going on, and then just buy enough to string them along again.

involuntarilybirthed's picture

Imagine knowing what Ben would say later in testimony that was out of sink  to the fed statement released earlier.  that's where the money is made, if you were on the inside. 

Iam_Silverman's picture

Well, when all of the money runs out, they probably will throw in the kitchen sink too.

andrewp111's picture

Problem is, all POMO operations are announced far in advance on the NY Fed web site. If they stopped announcing in advance, that in itself would be a big change.

Bunga Bunga's picture

Nobody can hit the brakes, it will be like in "The Bullet Train".

Iam_Silverman's picture

"Nobody can hit the brakes, it will be like in "The Bullet Train"."

Or like the movie Speed.  Can't slow down or things will explode.  Everybody on board dies.  You know, just plain old bad stuff.

MyBrothersKeeper's picture

About a year and a half ago on another board, most people were convinced that a Greek default was imminent (including me) but there was one poster that insisted that there was no way that was going to happen and no way the EU was going to kick out or even allow Greece to leave.  The reason was it would cause a chain of events that would be out of control for the EU and banks around the world. Now I am starting to feel the same way this poster felt except about QE.  I see no way QE tapers or ends without causing a mass chain of events that ends up in economic chaos.  I think seeing what this little bout with interest rates did to equity and bond markets has scared the collective crap out of the central planners here and abroad.  Actual tapering runs the risk of capitulating markets and soaring interest rates...both of which could drown every ounce of positive GDP. Kicking the can to 2014 would be even more dangerous as elections loom and ACA goes fully into effect. Unless we magically start to get consistent real gdp reads at 4%+, I don't see how QE taper can ever happen over the next 1.5-2 years.  This article reinforces that belief...we'll see.

paint it red call it hell's picture

No, he can't.

Let me add that nothing about his situation is a miscalculation. Hitting the wall is part of the plan. IMO

dirtyfiles's picture

Its like sitting in a elegant restaurant and tray not to fart

ebworthen's picture
Q.  "Can Bernanke Brake Without Derailing?"



It is too late for the FED or .gov to do ANYTHING because they have completely lost control of the train.

Most citizens are in the caboose getting ready to jump off - or praying for a miracle.

In First Class they think they are making great time to San Francisco.