Will Bernanke Become 'Hurricane Ben'?
by Gary North: Uncle
Gary's Bedtime Story: 'Why Congress Invented Tax-Deferred IRA Accounts'
will deal with quantitative easing (QE). To prepare you for this
report, I ask you to watch a short video. It is under 3 minutes.
is the best thing I have seen on quantitative easing. I wish Bernanke
would be this forthright, but I suppose this will never happen.
I will assume
from this point on that you have seen the video. If you deal with
colleagues who have been confused about what QE really means,
forward it to them.
with the video is this: the economics profession, the financial
services industry, the financial media, and Paul Krugman have
not been able intellectually to make the connection that the interviewer
did. He did it effortlessly, but the professionals who are paid
to explain things to the public are on the payrolls of special-interest
groups that have a direct financial stake in the continuation
of the present system. When men are paid very well to see things
in a particular way, they become impervious to alternative explanations
of causes and effects.
HELICOPTER TO HURRICANE
famous in 2002 because of a line in a
speech that he delivered in late 2002. It was on combating price
deflation. He described policies that in fact were being implemented
as he spoke: Bush's huge (in those days) Keynesian deficit and Greenspan's
practice, the effectiveness of anti-deflation policy could be significantly
enhanced by cooperation between the monetary and fiscal authorities.
A broad-based tax cut, for example, accommodated by a program of
open-market purchases to alleviate any tendency for interest rates
to increase, would almost certainly be an effective stimulant to
consumption and hence to prices. Even if households decided not
to increase consumption but instead re-balanced their portfolios
by using their extra cash to acquire real and financial assets,
the resulting increase in asset values would lower the cost of capital
and improve the balance sheet positions of potential borrowers.
A money-financed tax cut is essentially equivalent to Milton Friedman's
famous "helicopter drop" of money.
The line led
to his description as Helicopter Ben. There are cartoons
and Photoshopped images all over the Web that use this as their
theme.. He will always be known by these images. No other Federal
Reserve Board chairman has achieved such poster-child status.
with the helicopter image is that it does not convey the serious
nature of the threat. Picturing a bearded man tossing bills out
of a helicopter is amusing.
the image itself is incorrect. The commercial banks are the source
of the money, not the Bureau of Engraving and Printing. Dollars
are mostly digital. The mental image of German wives in 1923 with
wheelbarrows full of paper bills applies to hyperinflations, but
it does not apply well to monetary creation in a digital world.
difficulty with digital money is that it is lent into circulation
at specific points. It can be lent as credit card money or as
bank credit. Credit card money is used by card-holders to buy
things. Bank commercial credit money is used by entrepreneurs
to purchase goods and services used in production.
banks buy government IOUs, governments send out welfare checks
and pay other special-interest groups. The recipients spend money.
This sends a signal to entrepreneurs: demand is increasing. They
begin to respond by expanding their facilities to increase output.
They go to banks to borrow the money.
been no increase in saving. There has merely been a central bank
purchase of government-issued IOUs. But businessmen begin to bid
up the prices of factors of production. If they are willing to
borrow, and if bankers are willing to lend, this creates competition
for resources. Customers want finished goods and services immediately.
Businessmen want factors of production, in order to produce goods
for sale later. Businessmen initially win this competition. They
can outbid customers.
if businessmen are not persuaded that the flow of new digital
money will continue, or if they are already deep in debt, commercial
banks will lend to governments, or to consumers, or just hand
over the money to the central bank as excess reserves. The banks
have been building excess reserves ever since 2008. This has kept
prices from climbing to match the increase in central bank purchases
of government IOUs.
If the American
economy begins to recover to the degree that businessmen are willing
to borrow and bankers are willing to lend to them, the monetary
base that the FED holds will at long last push up consumer spending
by the employees of businesses. The M1 money multiplier statistic
will increase as people spend this money on customer goods.
point, the FED will have to decide how to offset this in order
to head off major price inflation. If it does not sell assets,
mainly Treasury bonds and Fannie Mae and Freddie Mac mortgage
bonds, it will face mass inflation (15% to 25%). If commercial
banks still lend, the near tripling of the monetary base in 2008-10
will produce a near tripling of consumer prices. That will be
MOMENT OF DECISION
point, all central bankers will face this decision. They can continue
to buy assets, thereby increasing the monetary base. But this
increase will produce hyperinflation. This has happened after
major wars among the losers. The German and Austrian inflations
after World War I are legendary. Even worse was the hyperinflation
of Hungary after World War II. In our day, Zimbabwe's hyperinflation
early in this century became the worst since Hungary's.
West European government has experienced this. The German economy
from 1945 until June of 1948 was a ration-based economy. It had
repressed inflation. The Allies printed paper money. Then they
imposed price and wage controls to hold down inflation. Production
then shifted to the black markets. This ended the day after Ludwig
Erhard unilaterally abolished the price controls and shrank bank
money by 90%. General Clay, who was in charge, backed him. The
German economy revived. That was the basis of the "economic miracle"
a miracle only in the eyes of the price controllers.
decides to stop buying U.S. government debt and all other forms
of debt, and the FED ceases to create new reserves, there will
be a recession. If the FED sticks to its guns, the fractionally
reserved banks very large banks will fail. That
will shrink the money supply. That is what happened in the United
States from 1930 to March 1933. About 9,000 banks failed. The
FED bailed out the biggest ones.
next time will be this: the biggest banks are leveraged 33 to
one. This meets the "stress test" which the FED conducted earlier
this year. This is twice as high as the former head of the FDIC
says it should be. She thinks big banks will be under great stress
in the next financial crisis. She wants a more bare-bones banking
Financial institutions fail when they cannot meet their debt obligations.
Equity can absorb losses. In contrast, debt is a fixed legal obligation.
When you have unexpected losses, as is the case in a financial
crisis, you need a significant cushion of equity to absorb the
losses. The more debt an institution has in comparison to its
equity, the more likely it is that the institution will fail.
Short-term investors will pull their loans quickly from a highly
leveraged institution, even when it is still solvent. Insured
deposits and long-term debt are more stable. That is why it is
important to stress liquidity as well as capital to make sure
financial institutions can survive a highly stressed environment.
through the 2008-9 crisis as FDIC chairman. She watched hundreds
of banks fail. She watched Wachovia go under. So, she is alert
to the risk.
So is Bernanke.
If the FED puts on the brakes at any point and keeps them on,
the contracting leverage will topple some very large banks. If
the FED doesn't put on the brakes, there will be hyperinflation,
which will lead the commercial banks to use their leverage for
even more pyramiding of credit. Then what? Breakdown. Hyperinflation
destroys traditional capital markets.
is stuck with the helicopter image. The only way that he can escape
this image is through a switch to Hurricane Ben. He does not want
If it comes
down to making digital money available to big banks to bail them
out vs. buying the government's debt, the Federal Reserve will
side with the banks. That will tempt Congress to nationalize the
FED. It legally can do this. Then monetary inflation will continue
under the new, improved FED. At that point, Ben will bow out if
he is still chairman at the time. He can live with Helicopter
Ben. He can't live with Hurricane Ben.
No one at
the FED will want to preside over the destruction of the dollar.
The effects would be disastrous. The person in charge of a legally
independent central bank will be on the hook. So will the members
of the Federal Open Market Committee (FOMC), which sets policy.
If Congress mandates the purchase of T-debt, someone will be hired
to do the government's will. His excuse will be this: "I was just
of the boom-bust cycle. The good times are followed by the bad
times. But we can as accurately call it the bust-boom cycle. The
boom in America has never become what Mises called the crack-up
boom: the destruction of the dollar. It also has never become
the market-clearing bust, when all insolvent banks are allowed
to fail, and the money supply is allowed to contract accordingly.
That would end the leverage once and for all.
get to once and for all. The government never releases the monetary
of the federal deficits is concealed by purchases of T-debt by
the central banks of China and Japan. But the main cause of low
interest rates and rapid purchases of the debts is not Asia. It
is the investing public in the United States. Foreign central
banks purchase less than half of the $1.3 trillion a year that
the government is forced to sell by the deficit.
bought no Treasury debt since July 2011. It has allowed $140 billion
to lapse. It did not roll over these debts. Japan did keep buying.
The Bank of Japan bought almost $200 billion. The increase from
all foreign sources has been from $4.66 trillion to about $5.1 trillion.
(http://bit.ly/TICreport) This is close to $400 billion. That is
about half the deficit that is owned by the public. About $6.5t
is held by the Federal Reserve and various U.S. government retirement
trust funds. Check "Ownership
of Federal Securities".
In the meantime,
total on-budget debt grew from about $14.3t in June 2011 to
Treasury would be paying far above one-tenth of one percent on
90-day T-bills if the foreign purchasers were to decide to stop
buying. If central banks just allowed their T-debt holdings to
mature and then refused to roll them over, there would be a funding
crisis at the Treasury. Rates would rise as the Treasury scrambled
for lenders. But that would create a recession. Americans would
stop buying as many foreign goods. Foreign governments don't want
that. So, they keep inflating to buy dollars to buy T-bills to
hold down Treasury debt rates.
If the FED
ever stops buying U.S. government assets, there will be price
deflation and a depression. If it never buys again, there will
be a Great Default: federal bankruptcy. Bernanke will not preside
over that, either.
But at some
point, it will have to be one scenario or the other. The endless
can-kicking will end. There will be too much federal debt to service.
Rates will rise. The depression will hit.
dares not default on its short-term debt. It must roll it over
to stay in business. So, it will have to find ways to cut off
other outlays. It will have to abandon Keynesianism. It will have
to balance the budget.
mean deciding whose oxen will get gored by default. The military
budget is a sure loser. But that will not be enough. Means-testing
for oldsters will be imposed: Medicare and Social Security. "Stiff
the rich!" Politically, that will play in Peoria.
will cut payments to physicians and hospitals. Physicians will
begin to stop treating Medicare patients. They will not be allowed
to refuse. So, older physicians will retire. We can see where
this is headed: real socialized medicine, not mere Obamacare.
But that will not cut costs, either. Costs will rise.
In a full-scale
depression, these measures will not be enough. The government
will have to cut back on Medicare. That will be the day of generational
reckoning. Who will pay granny's medical bills?
is that a hurricane will never come not a deflationary
hurricane or a hyperinflation hurricane. So far, this has proven
to be the case. But the deficit rises relentlessly. The can-kicking
continues. The bills will come due. The numbers do not lie. The
bills will come due almost overnight, when central banks refuse
to buy more Treasury debt at low rates, followed by the Federal
Reserve, followed by the pension funds.
teaches that the day of reckoning need not come. Chicago School
economists say it need not come. We will figure something out. Supply-siders
say the same. Only Austrian School economists say that the can cannot
be kicked forever, and that the day of reckoning will come.
It is getting
close in Greece. Greece is the early warning signal to the whole
It is wise
to begin to prepare for a hurricane. The problem is, which kind?
Hyperinflation? Deflationary depression and default? Mass inflation
followed by depression followed by another round of inflation?
media do not discuss this. They all think we can muddle through.
I don't think we can.
of the hurricane's arrival is a matter of conjecture. But be prepared
to batten down the hatches before it comes.
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.
2012 Gary North
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