Is the “Fed Rage” Unwarranted?

I see a lot of people talking about how great Ben Bernanke is these days and how all the “Fed Rage” (the constant degradation of Bernanke and his policies) is unwarranted.  Yes, people are probably too hard on one guy.  And a lot of people are probably mad for all the wrong reasons (like silly predictions about hyperinflation, bond bubbles, etc).  But I find it interesting that Keynesians like Paul Krugman dismiss this concept so quickly.  After all, the Minskyan idea of the Financial Instability Hypothesis (FIH) is “an interpretation of Keynes’s ‘General Theory'”, as Minksy himself once said.

I have a feeling though that there’s a good reason why so many academics and those not familiar with Minksy are quick to shrug off the idea that the Fed might be hurting the economy in some ways.  First, Minksy’s FIH is based on two important concepts which are largely ignored by the layperson as well as the academic economist:

1)  The monetary system is credit based.

2)  The idea of equilibrium within the economy is a farce.

The first one is rather obvious to anyone who’s read my paper on Monetary Realism.  Misunderstanding the role of credit in the monetary system is like ignoring the role of the circulatory system in the human body.  Most economists don’t even include banks in their models and the few who do still don’t seem to actually understand how banks work.  But it’s also equally important to understand that the monetary system is a non-linear dynamical system.  It’s constantly in a state of flux.  In other words, you could argue that it’s always in a state of disequilibrium to some degree.  The economy is not like a pen resting still on a table in a nice state of equilibrium.  It’s more like a pen that got thrown through the air in a thunderstorm.

Minksy said that “stability creates instability”.  But I don’t even know if I agree with that.  In my opinion it’s more like “disequilibrium is susceptible to increased disequilibrium”.  For instance, trying to catch the pen in mid air to contain its vulnerability during flight might actually increase systemic fragility as your body is a conduit for attracting a lightning bolt.  Not that the lightning bolt always hits, but it certainly can and does at times.

When you understand these important points you become increasingly concerned about policy that pushes this unstable system into an increasingly unstable environment.  Especially when it’s central bank related because central banks operate primarily through the financial markets by influencing credit.  So they can often times contribute to the instability by encouraging actions that become inherently more unstable as they progress (like sub-prime lending and securitization).

So, is that happening right now?   I don’t know.  I certainly don’t think there’s a bubble in t-bonds or that hyperinflation is coming.  But I do get concerned about the concept of “keeping asset prices higher than they otherwise would be” because I believe the economy is in a constant state of flux that just needs to be nudged in the wrong direction which creates a positive feedback loop leading to negative outcomes.  That doesn’t mean that everything a central bank does is bad.  I am not anti-monetary policy all the time.  But I do think there are lines that can be crossed at times which push us into an increasingly unstable environment.


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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • Raskolnikov

    Cullen, you sound a lot like Mohamed El-Erian who is certainly not “anti-Fed” but is increasingly worried about the effects of QE long term. He points to the distortions in financial asset prices, junk bond yields etc. and, of course, volatility which suggests more stability then is (perhaps) warranted given that these emergency operations are somewhat untested.

  • Conventional Wisdumb

    Nassim Taleb’s “AntiFragile” is all about this concept of how forcing stability on inherently unstable systems makes them far more prone to crashing. It generally has negative unintended consequences.

    Stability is an ephemeral off shoot of all the central banks of the world’s intervention and it will be interesting to see if it works.

    If you want to read some interesting money-geek, history stuff I highly recommend “Lords of Finance” which covers the lead up to the Great Depression. Different monetary system but the spate of actors involved and the issues they faced have an eerie symmetry to today’s environment.

  • EconFan

    stability creates instability is a solipsism i.e. doesnt increase udnerstanding. In physics of non linear systems one tries to come up with models, test it with some inputs, identify size of inputs whre it becomesnon linear etc. I view Bernanke’s actions in this light. I dont see any alternative to such study since the experiments are happening in the market anyway.

  • Michael C

    As I understand Minsky’s law “stability breeds instability” can best be described by the housing bubble. You flip one house to make money, terrific. You do it again and make money. (You don’t see the market being distorted) Now you flip three houses and the bubble has burst and you lose your ass. In my opinion, what makes the economy work properly is when there is minimal manipulation by the government. This allows for undistorted prices discovery. Of course the markets will go to extremes but that’s human nature. Some make monies many lose money in those situations, but that’s life. But when the powers that be such as the Federal Reserve get involved they totally distort price discovery and therefore you get massive extremes, not normal distortions. Result of government intervention is terribly destructive to those who are not” among the inside elite”. It’s pure theft.

  • Alberto

    it’s seems to me that you are acknowledging that the economy is a thermodynamical system and so it follows the laws of any dynamical system. Uncommon for an economist, most of them are still believing in endless growth in an finite resources environment. Knowledge can grow forever, but not material economy (and so stocks)

  • Indignado

    Cullen, your critique sounds pretty similar to what Jack Lew just said regarding Japan´s monetary policy. I guess they are just different degrees of distortion. :-)

  • dctodd27

    Read “Ubiquity” by Mark Buchanan. I heard about it from John Mauldin. His thesis is that all catastrophes start out the same way – as small, seemingly insignificant events. But whether it’s avalanches, stock markets or forest fires, when those small occurences happen in unstable environments then bad things can and do happen…Stability may not breed instability but maybe its that the appearance of stability can HIDE the instability that is ubiquitous in our world. Maybe what Bernanke is doing is simply providing the illusion of stability…

  • chase

    yeah…but your disequilibrium hypothesis is present in all entropic, societal/economic situations at all instantaneous moments, whether a central bank exists or doesn’t. Minsky’s disequilibrium revolves around ponzi finance (such as houses unsupported by incomes with increasing debt levels which require higher asset prices for the debtor to make the creditor whole)

    where would interest rates naturally be in today’s environment without fed assistance to the financial system? possible still negative in as in the aftermath of Lehman? look at swiss rates at the height of the euro crisis. the fed has supported negative rates with positive inflation. without the fed making people believe their actions are inflationary (they aren’t) at a time corresponding with increased government deficits we’d see rates more akin to Japan and deflation would set in

    if we are now…and I would argue that we are…in a permanent low interest rate world in which savings accumulated grows quicker than financial assets then in a slow growth world it would make much sense for equity risk premiums to be constantly discounted. if so…equities could have a long long way to run over time (3 to 5 years). we will have to deal with ponzi elements at sometime in the future…but with financial excesses reigned in and regulated tightly and governments unnecessarily reducing deficits, low interest rates and slow growth will be with us for a long time without threat of a surprise financial calamity…imho…this isn’t anything like 2008. 33:1 leverage and AAA MBS Basel approved securities aren’t going to crash the financial system…

    To me…the greatest risk is governments not providing enough net financial assets…

  • Boston Larry

    +1 Very well said. “providing the illusion of stability”

  • Kristian Blom

    Yes and no: never trust a man with perfect hair or beard. Mostly it is a waste of effort to ‘rage’ at the Fed, although it is astonishing that ‘The Market’ listens to what Ben and the Fed has to say. Absolutely astonishing. There is not a shred of evidence that they have any ability to forecast much of anything or that QE “works”.

    Nevertheless; making money is the objective so we need to look at where the ‘current belief system’ resides. ‘The Market’ is aggregate human psychology in action, which in turn consists of humans whom we know are willing to lie to themselves in order to ‘see’ their particular desired outcome.

    The current belief system revolves around Central Banks as demi-gods. That does annoy me, but just look at today’s action for a small example of opportunities created by Ben’s nonsense and take advantage of it: don’t fight it.


  • fin


  • LVG

    The credit markets are inherently unstable and have an embedded ponzi effect in them because good times always lead to looser credit standards which leads to defaults. All these economists rambling on about how great the Fed is never understood this as the cause of the housing bust so I’d say they “forgot”, but I don’t think they ever knew.

    Look at NYSE margin debt or the ramp up in high yield bond issuance. There’s your building credit bubble.

  • Andrea Malagoli

    Given my background in science, I know where Minsky’s assertion of “stability breeds instability” comes from. It is related to models called “Self-Organized Criticality”. These are particular types of complex systems that exhibit was are known as “punctuated equilibriums”, i.e. states that “look” stable, but where hidden mechanisms are breeding the roots of the upcoming instability. There are many examples of such systems in nature. The most famous one is the “sand pile”, but there are examples also in animal evolution, where species seem to remain unchanged for very long periods until suddenly a critical point is reached and a dramatic change occurs.

    In economics, it is the “appearance” or “perception” of stability which breeds instability. It is just hard to know when. However, one can be aware of this and at least remain vigilant.

    The Fed’s extreme monetary policy (and the rest of the world’s) will breed instability if this time is not used to introduce structural changes in the real economy, rather than trying to perpetrate the status quo as is happening instead.

    The idea that we can re-start business as usual by re-leveraging, thanks to cheap rates, and resuming the irresponsible spending habits that caused the problems (i.e. MacMansions) can only end in one way.

  • jldasch

    Cullen, as I have often pointed out, the idea of equilibrium in the economy is not a farce, it just only exists at the level of subsistence. However, our economy is far from equilibrium, as you recognize, so you can’t go back to basing an argument on equilibrium dynamics.

    “ But I do get concerned about the concept of “keeping asset prices higher than they otherwise would be” because I believe the economy is in a constant state of flux that just needs to be nudged in the wrong direction which creates a positive feedback loop leading to negative outcomes.”.

    Once you have accepted, as you have, that equilibrium dynamics is invalid in discussing our economy at larger scales then the concept of keeping prices higher than they otherwise would be is invalid (even if it’s a quote and not your words). The Fed isn’t buying stocks so the effect, if there is one, is indirect. But more importantly, we have no idea what asset (stock) prices would be without QE. It well could be that the system has moved further from a critical point where feedbacks in the system would had led massive asset price declines. We don’t know.

  • Cullen Roche

    You’re saying that equilibrium dynamics is invalid and then you’re concluding by saying that the Fed might have moved us from a disequilibrium towards something more closely resembling an equilibrium. That doesn’t make any sense….

  • Kristian Blom

    I see the markets as an eco-system that does move from equilibrium to equilibrium. But; the word itself is not very satisfying in this context, it only vaguely hints at the situation which is one of constant change and we humans suck at detecting small and constant change.

    The Fed, in my humble opinion, has ‘pinned’ a form of equilibrium on the economy and capital markets via various forms of ‘stimulus': I think it’s pretty damn unstable…it is something like a plate balanced on top of some edge, slightly off center, but a stream of water (perceived effects of QE), keeping it in place. Once the ‘water’ stops the ‘equilibrium’ shifts and likely tips into an area of value.

  • jldasch

    It’s clear that you are not a scientist because a scientist would not make comments like “The Fed’s extreme monetary policy (and the rest of the world’s) will breed instability if this time is not used to introduce structural changes in the real economy, rather than trying to perpetrate the status quo as is happening instead.”

    Given the available range of potential Fed actions a rational person could not conclude that the Fed actions are “extreme.

    Similarly “resuming the irresponsible spending habits that caused the problems” can only be made by someone who substitutes belief for rational thought and is clearly not exhibiting scientific thought. Since consumption and production are two sides of the same coin if you argue for less spending then you are arguing for less employment. One can make cogent arguments to favor one type of spending over another but ultimately spending drives production. Less spending, less production, fewer jobs.

  • Andrea Malagoli

    First of all, it is clear that you do not understand what I am talking about and you just try to offend people. Second, when I say “irresponsible spending” I mean spending fueled by excessive credit creation and devoted to unproductive investments.

    Yes, more spending drives more production, especially in an economy dominated by consumer spending and not by investments in things like infrastructure. However, when spending is supported by excessive credit creation, that becomes a problem. By “excessive” I mean that it is credit for which there is little chance that it will be paid back at some point in the future. This is the essence of Minsky.

    What I add to Minsky is that capital must be deployed in productive investments to be useful. This is where the structural changes in the economy are needed. If you provide a lot of credit to people who produce nothing you will get economic growth but with excessive inflation.

    Please refrain from making derogatory comments in the future.

  • Andrea Malagoli

    And if you want a “scientific” measure of why the Fed’s actions are “extreme”, just look at the Fed’s balance sheet size in relation to its historical size and relative to other measures. Of course … “everything is relative”.

  • cindy biscoe

    The Federal Reserve has orchestrated what amounts to massive theft of our country’s assets and has given the spoils to its cronies the big banks, big corporations and rich
    people. The FED has printed more than $4 Trillion since the 2008 crash and has used the money to buy most of the debt that our Treasury issues every month to run our government (the FED currently buys $85 Billion per month). The FED has taken over the U.S. government bond market so that there is nothing left for anyone else to buy. This has forced all the people who have money, to buy stocks, thus driving stock prices to higher levels than would normally exist if people could spread their money around to stocks and bonds. The problem is that all the world’s assets that the FED is not buying (corporate stocks and bonds) are being grabbed up by rich people and the poor people in the world are going to be left with even less than they had before because these assets now cost too much and rich people only want to sell these assets at higher and higher prices which poor people cannot afford. We all need a refresher course on the law of supply and demand and how that affects prices.

    Our Congress should be horrified and ashamed that they have allowed this to happen
    to our citizens. After all, they created the Federal Reserve and they have the power to
    either shut it down or take away its mandates. We should all call our Congressmen
    and ask them to stop this travesty of outright theft so that our markets can return to
    the fair and efficient markets that are supposed to exist in a free society. The FED has
    made sure that we no longer have a free society. In case we haven’t acknowledged
    it yet, we are no longer free, we do not have a republic as our Constitution says and
    we are definitely not helping poor people. It’s all a sham and a Ponzi scheme.
    Our country is in big trouble and the sooner we acknowledge this reality the sooner Americans will get on with what we are good at – fixing and building a great country.
    Just give us back our freedom and give us a Congress that represents all the people not just the rich ones!

  • Mercator

    Those benefiting from QE and equity prices for the most part are the elites. Low interest rates should favor the working class… is that happening? Welfare recipients at an all time high. Idle workers at an all time high. Is this why we need a lenient immigration bill? Since Jan., I have been dollar cost averaging out of equities because I believe that almost no one is fearful anymore. Very hard to do in the face of all this optimism, but haven’t heard the case for it’s different this time.

  • jldasch

    No, I’m simply saying that we don’t know what combination of parameters for the flows in the system (including psychology) move us to a critical point where some combination of positive feedbacks in the system move us far from the current position of relative local stability. I offered a hypothetical condition and concluded that we don’t know. The point was that it’s possible that the system was closer to a critical point without Fed intervention than it is now, but it’s also possible it is closer to one now (possibly a different one).

    The problem with QE, as I see it, is the prevalent view that the Fed is “printing money” to support the economy (which it’s not) and the general misunderstanding of the monetary system by a majority of the population so that when it is eased off, removed, or reversed, the effect may well be very large.

  • Anonymous1

    Bernanke, Fisher, Evans et all should read this post.
    Congratulations on a nicely articulated post, your a great American!

  • Malmo

    Well stated. This is merely trickle down economics Obama style. The working class be damned.

  • bahar

    There are rumours about Fed ‘tapering off’. If that turns out to be true we’ll soon see what the effect is on the economy. Hyperinflation? Inflation? Deflation? In the meanwhile Futures are all supposedly tumbling…

  • jldasch

    I agree that those benefitting the most are those with higher education, income, and assets. But the Fed is between a rock and a hard place. Only fiscal policy can partially compensate for the inherent flow imbalances resulting from an economy that is far from the equilibrium sustenance level. The only option available to the Fed is bootstrapping the system. This has the potential (high I would argue) to further the income/wealth disparity but with the wacko Right Wing controlling the house fiscal policy to address the situation is going in the wrong direction. Basic food, shelter, and clothing, the true equilibrium condition, can probably be satisfied with no more than 10% of the population. Include transportation for workers, and minimal health care, and it might be 20% to 30% and that’s not even true equilibrium.

    While in general, at the micro scale, we can describe flows in the system using linear differential equations, they are inherently stiff in the face of either exogenous shocks or coupled factors. In a non-uniform distribution (which the economy and the market are clear representations of, the concept of dollar cost averaging is no different statistically from throwing darts.

  • SMOB

    What is the root cause of the instability in our financial system? Bernard Lietaer attributes it to lack of diversity -one currency, curious to hear what you have to say on it?

  • rp1

    Instability creates volatility, which creates trading opportunities and Fed subsidies.

  • Anonymous

    Also buy gold so it does not drop to $400 an ounce again! Those libertarian gold hoarders need to make a living!

    And damn Bernanke for following this silly, statutory requirement of keeping employment high and inflation low. He should have let the banks collapse, hes should have allowed a Great Depression v2.0 with 40% unemployment and millions of Americans starving and dead! All those thousands of peppers were well prepared!

  • tyty

    money reflects our expectations…

  • Greg

    I think we have the Fed really at odds with the “financial system” in a way. The Fed as a mostly political entity does care about stability and wants to see the US system NOT thrown into crises. It believes in its mandate of affecting (lowering) unemployment. The Fed believes it is serving a public purpose. Ill bet Bernanke would answer “Damn straight” to a question about whether or not he and his board are serving public purpose. The banks and rest of the system they monitor and regulate do not care about public purpose. They are at odds with the Fed and actually profit immensely off real and perceived instability. Financial institutions want a degree of insability, stability is boring and not as potentially profitable.

  • jt26

    Monetary policy is a religion and I can’t help but think it is portrayed as a panacea like Communism in the 1910’s. Stabilized output; no GDP variability? NGDPLT and guaranteed debt forgiveness? Sounds like: “guaranteed job; workers collective …”. Communism vastly underestimated the human element; selfishness, corruption, status quo, and the path of least resistance are incredibly powerful forces. Russia and Cuba were hailed in the 50s and 60s for having great healthcare, education, literacy etc. before the collapse decades later. The Greenspan put had a great run, until the GFC. Pinning all our hopes on monetary policy will turn the US into a nation of homebuilders, Starbucks baristas, and bankers, oh wait …

  • jt26

    BTW the solution, and I’m in agreement with Cullen, is something like the Innovation Initiative. I often use the example: if Japan and Germany in 1940 knew what would follow in the 60’s and later do you think they would have started a war? That’s a warning that lack of imagination and thinking the world is zero-sum is incredibly dangerous and limiting. Thinking monetary policy will deliver us prosperity is zero-sum thinking.

  • Bruce

    Would these people, including you, prefer the FED act more like the ECB? BOJ? BOE? This is all still the consequences of 2007, in other words, all the distortions are the consequence of trying to get out of the hole we were in. It’s not realistic to think there was a clean path, a path that wouldn’t cause any adverse effects, from where we were (2007) back to “normal”. I agree that it is causing distortions all over the place. But the FED has only crude tools. Why not become outraged at those who control the Fiscal side? Why not be outraged at the FED for lax oversight prior to 2007 (I mean, Geithner was president of the NY FED with oversight of the major banks prior to 2007, and he got promoted to Treasury Sec.)? Why not be outraged at congress for doing almost nothing in terms of structural changes (e.g. reform, etc.).

    A bubble in junk bonds is better than 9% unemployment, right? What are the tradeoffs you would make if you were the FED, because everyone else who can contribute (congress) seems to be AWOL?

    I agree that what’s happening is crazy. But the FED seems to be doing better than everyone else.

  • jldasch

    I am simply pointing out that you are not a scientist and do not think as a scientist. This is a fact. Pointing out facts is rational and scientific. Claiming they are derogatory is not a scientific statement, it’s an emotional one.

    You go back to a belief based world view when you say “I mean spending fueled by excessive credit creation and devoted to unproductive investments.” As I will point out, the Minsky understanding of credit is not applicable to the structure of money in the world today.

    If you work through the differential equations for this what you would realize is that productive investment must be balanced by more consumption. If all credit creation is only for productive gains then you have a system with only positive feedback which is completely unstable. A good view on this is the classic Kalecki paper on employment. His argument was based around Nazi Germany which was hugely productive in building weapons. Eventually the production has to be consumed. The same argument applies to all forms of production. Build more infrastructure in the form of roads and people respond by living further apart and using more roads. You can only employ people building McMansions if people buy them. The list is endless. What you refer to as unproductive investment is the negative feedback in the system. Since the equilibrium position is sustenance these unproductive investments serve to move us, slightly, closer to equilibrium. The Production vs. Consumption dilemma is very clearly illustrated in the Eurozone.

    If you understand MR then you will understand that in aggregate credit creation must be higher than credit destruction to avoid deflation. It’s worthwhile to work this through from basic principles, using a 3 or 4 agent model. You can do this on the back of a napkin. You are confusing credit creation for people who produce nothing with money creation for the same. Money creation is a function of the birth and death processes involved in credit creation. Over short periods of time if the birth rate exceeds the death rate (roughly times the interest rate) inflation may obtain, but these periods lead to, as Minsky noted, collapses. Integrated over longer periods of time, what we expect from the increasing gap between production and consumption of needs and wants, is deflation, and that is what the data clearly show. Minsky had no understanding of money as it exists today. In Minsky’s (distorted) view, money was something with tangible value. But it has zero value at the global macro level (you can’t eat money). Bubbles are probably an inherent property of any economy that exists far from the sustenance true equilibrium position.

  • jldasch

    As Cullen has pointed out, the Fed could set the entire yield curve to 0%. There is on the order of $34T in bond type debt in our system, but to buy all bonds at a PV that equates to 0% would take on the order of $45T. So the Fed is more than an order of magnitude from an easy definition of extreme. Scientifically, factors of two are often important, but orders of magnitude always are.

    Fed relative holdings of Treasuries are near the low end of the range they have been since the 1940’s. Is this extreme?

    Last year the Fed was more than twice at profitable ($88 B) as the most profitable NYSE company, Exon Mobil ($41 B) (granted the Fed has ca. $3T in assets, XOM $0.3T). But compare the Fed to BAC, assets of ca. $2.2 T and income of $0.7 B. So the Fed balance sheet is not extreme at all. The big banks all have net assets around $2T. The Fed income might be considered extreme (relative to the banks with similar assets). But almost all of that money is paid back to the Treasury.

    So, again, your views of extreme are based upon belief, not scientific thinking.

  • jldasch

    The fiscal side is clearly where impacts are greatest. As Cullen has pointed out, the fiscal stimulus in the US was probably largely responsible for the US avoiding the unemployment levels in the Eurozone.

    I am generally in favor of programmed fiscal policy as opposed to monetary policy but we don’t have a mechanism for that. Programmed fiscal policy would be some algorithmic prescription for addressing economic downturns. As the economy cycles down, the government would pick from the top of a prioritized list of spending projects (e.g. fixing roads, dams, bridges, hiring teachers, police, scientific research, ….) and fund them through an established algorithm (which like a PID algorithm would require subtle tuning to get correct) and when the economy cycled up (unemployment down, inflation up) these projects would be smoothly reduced in magnitude by the same algorithm.

    The Fed is doing better because there are a lot of very bright people involved in the Fed system and they don’t have direct political needs. Bernanke is not running for office (and likely never will). He can go to a chaired position at any of the top 10 Universities in the world. That is a great thing about this system. Bernanke is probably more motivated by the historical academic analysis of his tenure than anything else.

    The Fed has only crude tools, and Bernanke has pointed this out as diplomatically as he can in congressional testimony. He probably also knows that the crude tools are not good ones, in the sense that they likely will lead to increased wealth disparity. But when all you have is a hammer, you have to treat everything as a nail.

  • Alberto

    unemployment levels in the Eurozone differ wildly, so what country ? germany, france, spain, an average… what ?

    Furthermore unemployment statistics are computed differently in the US and the EU and differently in Germany or France or Italy or… be very careful when comparing numbers which can be… well not really comparable. We’re obfuscated by statistics.

  • InvestorX