ARROGANCE and CONTROL

The two words of the day are ARROGANCE and CONTROL

Mr. Bernanke, you know, almighty commander of the high and supreme Federal Reserve made a speech today to which I hope everyone paid attention.  He said:

Some observers have expressed the concern that, by expanding its balance sheet, the Federal Reserve will ultimately stoke inflation.

Uh, yeah.  The balance sheet in now near $2Trillion dollars.

At this point, with global economic activity weak and commodity prices at low levels, we see little risk of unacceptably high inflation in the near term; indeed, we expect inflation to be quite low for some time.

Really?  You guys haven’t been able to predict the economy so far, why should I think that your prediction of low inflation will hold true?

However, at some point, when credit markets and the economy have begun to recover, the Federal Reserve will have to moderate growth in the money supply and begin to raise the federal funds rate. To reduce policy accommodation, the Fed will have to unwind some of its credit-easing programs and allow its balance sheet to shrink.

OK, now we’re starting to get the truth.  When the economy begins to recover you plan to take over and moderate growth in the money supply to avoid rampant inflation.  That is, you’re admitting that inflation is a risk, but you’re so ARROGANT that you think you’ll be able to stop it.  Guess what?  I don’t believe you!  Government reacts too slowly.  By the time you realize that inflation is growing it will be too late.  You won’t be able to undo it at the flip of a switch, and it will increase out of control.

A significant shrinking of the balance sheet can be accomplished relatively quickly, as a substantial portion of the assets that the Federal Reserve holds--including loans to financial institutions, temporary central bank liquidity swaps, and purchases of commercial paper--are short-term in nature and can simply be allowed to run off as the various programs and facilities are scaled back or shut down.

Simply allowed to run off?  Government programs and facilities shut down?  My experience with government is that once programs are started they are like parasites and are incredibly hard to kill.  They don’t just go away.

Importantly, the management of the Federal Reserve's balance sheet and the conduct of monetary policy in the future will be made easier by the recent congressional action to give the Fed the authority to pay interest on bank reserves. Because banks should be unwilling to lend reserves at a rate lower than they can receive from the Fed, the interest rate the Fed pays on bank reserves should help to set a floor on the overnight interest rate. Moreover, other tools are available or can be developed to improve control of the federal funds rate during the exit stage. For example, the Treasury could resume its recent practice of issuing supplementary financing bills and placing the funds with the Federal Reserve; the issuance of these bills effectively drains reserves from the banking system, thereby improving monetary control.

This whole paragraph assumes is saying that the Fed wants CONTROL of all the money.  They are going to start paying the banks interest for heaven’s sake!  They are doing everything in their power to give incentives to banks to keep their money with the Fed.  One of the biggest problems with the bank bailouts to this point is that the banks are not using the money to get credit flowing again.  They are just holding onto it until things are a little less risky and interest rates go up so that they can make more money off your tax dollars.  The Fed is actually encouraging this behavior.

This is how it’s going to play out.  The government will keep trying to “stimulate” the economy by spending more and more money.  Please read this article by Frank Shostak to understand why this is such a bad idea.  Eventually, the economy will start to improve despite the ludicrous spending.  At that point interest rates will start to go up.  Remember, this is what Bernanke wants to happen because he thinks ~2% inflation is good for growth.  However, when rates start to rise, banks will start removing their funds from the Fed.  Also good, right?  This is also what Bernanke wants because it will shrink the balance sheet.  However, it will be like opening the floodgates and unleashing billions of dollars into the economy in a very short period of time in addition to the Stimulus Package(s).  Too much money in the system will make it worth less (i.e. inflation).  Bernanke won’t be able to stop it.  Nobody will be able to stop it.  Inflation wil increase out of control.  Bet on it.  Thousands of investors are betting on it… the price of gold has risen more than $100/oz in the last 30 days. 

Commentary on the Bernanke speech on MarketWatch.

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