THOUGHTS ON “AN OPEN LETTER TO BEN BERNANKE”

The Wall Street Journal ran this open letter to Ben Bernanke from many noted economists, professors and fund managers.  The list is a who’s who of Wall Street and the general message is not dissimilar to what Sarah Palin and Glenn Beck (not exactly the people you want to be next to when making economic prognostications) have been saying – in essence, cease and desist Chairman Bernanke.  While I agree with the general message of the letter (that QE should not be allowed to go forward) it also shows the great level of sheer misunderstanding when it comes to QE.  This one policy has generated more misunderstanding than any policy measure I can remember.

Many of the people on this list have been warning about bond vigilantes while also comparing the USA to Greece for several years now.  Of course, they’ve been terribly wrong and it is entirely due to the fact that they do not understand how the US monetary system works.  Their general fears of inflation and a crashing dollar have been far off the mark for reasons I have discussed in great detail. What’s unfortunate is that these are many of our best minds.  These are the people driving the economic bus.  It’s no wonder this country is in such an economic hole.

The full letter is attached with some commentary:

“We believe the Federal Reserve’s large-scale asset purchase plan (so-called “quantitative easing”) should be reconsidered and discontinued.  We do not believe such a plan is necessary or advisable under current circumstances.  The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment.”

The LSAP should be discontinued, but not because it causes inflation or currency debasement.  In fact, it will cause no such thing as QE involves no printing of new money (Chairman Bernanke explicitly stated as much) and has a marginal deflationary bias.  In addition, its impact on interest rate is questionable at best as we’ve seen in Japan, the UK and the USA during QE1.  As I have shown, the early evidence shows that the program is counterproductive.  This program should be ended so as to maintain the credibility of the Federal Reserve and stop all market distortions that are occurring due to the sheer misconception surrounding the policy.

“We subscribe to your statement in the Washington Post on November 4 that “the Federal Reserve cannot solve all the economy’s problems on its own.”  In this case, we think improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.”

Yes, in a balance sheet recession monetary policy becomes quite ineffective.  If the government is going to provide aid to Main Street (not Wall Street!) it should do so via fiscal policy.  A tax cut (such as a payroll tax holiday) is not only politically feasible, but would do a great deal in combating the debt problems that American households currently confront.

“We disagree with the view that inflation needs to be pushed higher, and worry that another round of asset purchases, with interest rates still near zero over a year into the recovery, will distort financial markets and greatly complicate future Fed efforts to normalize monetary policy.”

Inflation does need to be pushed higher, but it needs to be pushed higher by an increase in aggregate demand.  This will not occur because the Federal Reserve decides to provide the banks with more reserves.  Since QE does not increase the money supply this policy will not cause inflation. Just as it did not cause inflation in QE1 and in Japan earlier in the decade.  IT IS NOT MONEY PRINTING!

The Fed’s purchase program has also met broad opposition from other central banks and we share their concerns that quantitative easing by the Fed is neither warranted nor helpful in addressing either U.S. or global economic problems.

Cliff Asness
AQR Capital

Michael J. Boskin
Stanford University
Former Chairman, President’s Council of Economic Advisors (George H.W. Bush Administration)

Richard X. Bove
Rochdale Securities

Charles W. Calomiris
Columbia University Graduate School of Business

Jim Chanos
Kynikos Associates

John F. Cogan
Stanford University
Former Associate Director, U.S. Office of Management and Budget (Reagan Administration)

Niall Ferguson
Harvard University
Author, The Ascent of Money: A Financial History of the World

Nicole Gelinas
Manhattan Institute & e21
Author, After the Fall: Saving Capitalism from Wall Street—and Washington

James Grant
Grant’s Interest Rate Observer

Kevin A. Hassett
American Enterprise Institute
Former Senior Economist, Board of Governors of the Federal Reserve

Roger Hertog
The Hertog Foundation

Gregory Hess
Claremont McKenna College

Douglas Holtz-Eakin
Former Director, Congressional Budget Office

Seth Klarman
Baupost Group

William Kristol
Editor, The Weekly Standard

David Malpass
GroPac
Former Deputy Assistant Treasury Secretary (Reagan Administration)

Ronald I. McKinnon
Stanford University

Dan Senor
Council on Foreign Relations
Co-Author, Start-Up Nation: The Story of Israel’s Economic Miracle

Amity Shales
Council on Foreign Relations
Author, The Forgotten Man: A New History of the Great Depression

Paul E. Singer
Elliott Associates

John B. Taylor
Stanford University
Former Undersecretary of Treasury for International Affairs (George W. Bush Administration)

Peter J. Wallison
American Enterprise Institute
Former Treasury and White House Counsel (Reagan Administration)

Geoffrey Wood
Cass Business School at City University London

A spokeswoman for the Fed responded:

“As the Chairman has said, the Federal Reserve has Congressionally-mandated objectives to help promote both increased employment and price stability. In light of persistently weak job creation and declining inflation, the Federal Open Market Committee’s recent actions reflect those mandates.  The Federal Reserve will regularly review its program in light of incoming information and is prepared to make adjustments as necessary.  The Federal Reserve is committed to both parts of its dual mandate and will take all measures to keep inflation low and stable as well as promote growth in employment.  In particular, the Fed has made all necessary preparations and is confident that it has the tools to unwind these policies at the appropriate time. The Chairman has also noted that the Federal Reserve does not believe it can solve the economy’s problems on its own.  That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators, and the private sector.”

The Chairman should cease and desist, but not for reasons expressed in the above letter.  The Federal Reserve has placed its credibility at risk while also creating market distortions due to misconceptions surrounding a policy that very few people actually understand.  This is not only unhelpful in solving the actual cause of the current crisis, but creates extreme disequilibrium in markets that only makes matters worse.

Source: WSJ

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.

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Comments

  1. while discussions about what should be done are interesting, i am more interested in positioning myself best for what will be done.

    and in the course of human events,irrationality rules and what should be done rarely is done. this is obvious from history, especially economic history.

    extend and pretend or paper over n hide is the rule of the day….the coming Eur debacle insures a precious metals bubble

    signed, bubble rider…….because that is what is available

    • Buying EUO and all comodities, but looking to get out early, things seem to be geting kind of hostle.

    • that road is getting shorter……i feel like i’m watching 2 trains headed wide open towards each other on the same track….from a spot on the great plains looking westward—where u can sometimes see things vividly so far away…..

      its like—don’t they know?….then there’s ben……geeeeez

  2. The Fed pays more for the assets than it should. Its the quality of the money, not the quantity.The goverment distorted the price of asstets by propping up the mother of all assets-RE. This distortion from mark to market by bailing out the banks creates the delusion of asset inflation and the Fed rides with it.
    The tertiary affect on other assets allows the Fed to pay more than it should for treasuriesbecause the illusion/delusion has been sold. The quality of the dollar is really a lot worse than the market realizes yet. Therefore, the Fed is able to pay higher prices than it should to try and fight off coming deflation.
    Paying more than they should has the appearence of creating money, because everyone knows that the mother of all assets-RE is toast.

  3. “Quantitative easing merely involves the central bank buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system – that is, crediting their reserve accounts. The aim is to create excess reserves which will then be loaned to chase a positive rate of return. So the central bank exchanges non- or low interest-bearing assets (which we might simply think of as reserve balances in the commercial banks) for higher yielding and longer term assets (securities).

    So quantitative easing is really just an accounting adjustment in the various accounts to reflect the asset exchange. The commercial banks get a new deposit (central bank funds) and they reduce their holdings of the asset they sell.”

    This quote is from Professor Mitchel’s blog and can be found under quantitative easing 101. Anyone can also listen to the video that TPC had the other day about Ben Bernanke’s talk at a Florida university where he too explained that QE is just an asset swap. Maybe the people on the list are responsible people, but as TPC has indicated that does not mean they understand QE.
    My point is that if the reserves are going no where, then most of the price increases in commodities, emerging markers, and the stock market is just speculation and maybe even front running by hedge funds. Correct?

  4. The great myth -

    ” Bank lending is never constrained by lack of reserves .”

    The disambiguated reality -

    “If [banks] are short of reserves then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost).”

    [ ie. reluctant/ CONSTRAINED against using the latter facility because of penalty ]

    according to billy blog at http://bilbo.economicoutlook.net/blog/?p=661

    Thank you Diffused .

  5. If there was no QE, will deflation/recession happened already?
    If no deflaton because of QE, can we say from relative point view that QE generate inflation(compare with deflation happened if no QE)?
    (sorry English is not my native language)

    TPC – No. The fears of deflation and double dip were overdone near the August lows. The ISM print of 56 on August 31st made that clear. I think it’s very far fetched to say that QE (or expectations of it) has done anything for the real economy thus far.

  6. Is QE1 nothing to do with TARP in 2008? If bank did not receive money from government/fed will they bankrucpt already(include Goldmen Sachs)? If a lot of banks went bankrucpt, will there recession/deflation happened?

  7. I don’t mind being in the minority when a deep thinker like Sarah Palin is in the majority. I think I’m even a minority member of the minority because I don’t see QE2 as a bad thing either. I wouldn’t ask Bernanke to cease and desist, just to modify the program a little.

    I don’t believe that the people demanding a stop to QE2 truly appreciate the black holes that exist out there in the economy. I see QE2 as a stealth bailout for the states, people need to consider what happens if California goes down when they demand a stop to QE2.

    As for the inflation story, I believe TPC has it right (and is very much in the minority). What we are seeing is speculation based on *expectations* of inflation, with those expectations being rooted in misinformation (that QE is money printing). Speculation is driving prices higher, causing producers to chase those prices, leading to oversupply in an environment of declining demand. Bad news for those chasing the inflation play in the long term…

    TPC – I agree Mediocritas. And what’s worse is that many of these people demanding BB cease and desist are doing it purely for political gain and are using QE to gain political favor with a populace that believes money printing is bad…..They’re taking advantage of people plain and simple. It’s sick.

  8. After reading the comments on this post I am removing this group of Einstein’s from my book mark. You assumptions on what QE is doing and not doing is way off. All you have to look at is the effect on trade and commodities to see the “inflation”.

    Get out out your ivory towers and your BS “Political party red team blue team” thinking and look at the economic damage done to the markets, the economy, and our society.

    BB should be beaten with a tube sock full of wood screws for being a complete economic moron.

    TPC – That’s odd. I have explicitly argued that he is causing distortions in the commodity markets. Oh well. This site isn’t for everyone.

  9. hmmm, thanks GLC and Ron. I go to billyblog as well to try to make sense of this. would be interested in TPC’s comments on “no reserve constraint” and “creating excess reserves” since usually Mitchell and TPC seem to be on a similar page.

    • That is correct rhp. Banks do not lend their reserves. Several countries have no reserve requirements at all. This is also evident in QE1 when reserves exploded and bank lending fell 25%.

  10. oops, sorry GLH (as opposed to glc). I went back and looked at Prof. Mitchell’s “101″. Here is another quote later on:

    “The conceptualisation suggests that if it (th bank) doesn’t have adequate reserves then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending.

    But this is a completely incorrect depiction of how banks operate. Bank lending is not “reserve constrained”. ”

    I believe his first quote may be about how people or Bernanke view QE and not what actually happens (my interpretation) otherwise, it would seem to be a contradiction……..

  11. Well TPC if QE doesnt do anything on net net basis, why is FED doing it?What are they hoping to achieve.
    Are you telling me out of all the majority financial whiz kids, no body understand that QE is hog wash. Are you saying market is wrong or prices are wrong (commodities, stocks etc)?

    TPC – So prices are always right? The fed knows what they’re doing. They’re trying to lower rates and talk inflation into the market. I’ve said it won’t work. That doesn’t mean they won’t try…..

  12. Pardon me, just a dumb redneck here with a fancy name. But if the existing assets(tdebt) are exchanged for a previously non-existent asset(increased reserves) then does that not add to and subtract from balance sheets?

    The holder of tdebt gives the tdebt to the Fed, removing them from their balance sheet. The Fed then adds the tdebt to their balance sheet. The Fed in return increases the reserve account balance of the seller by a like amount. The reserve holder has in effect swapped one asset for another. The Fed has increase its balance sheet, but, and here is where I become confused, without having had an asset to trade in the first place. Either the Fed has created an asset to trade or there is an unknown source of asset of which I am unaware.

    The Fed has not ‘retired’ the tdebt because it has not returned to the issuer. The Fed is often quoted as saying that it is not a part of the Federal Government, and indeed it is not under the control of any agency of the Federal Government. Since the Fed is not the Government how has the tdebt retired? It has in fact not. It (the tdebt) is still outstanding on the books of the Treasury Department. When it issues interest payments they will travel to the owner of the tdebt, in this case the Fed.

    An open ended source of asset (the Fed) has swapped some of its asset for an asset that is still very much alive. So where do the assets of the Fed come from?

    Since the big bang, there has not been the creation of something from nothing. Not in science, not in bookkeeping. If the ledger shows an increase, it must also show a source, or you go to jail. But if you are the Fed the source turns out to be either paper currency or electrons. The end result is the same, the creation of money(asset) where there was none before.

    If currency is created (physical or electronic) is reduces by extension the
    value of all other currency in existence if there is no increase in productivity to account for the increase. Since the GDP in all likelihood will not expand at a rate needed to account for a nearly $1 trillion (QE2+POMO) infusion of funds, then inflation is the only possible result.

    You can line up the mirrors any way you like, the emperor is still naked.

  13. @Ben Franklin, Jr.

    Actually the gov’t has ALWAYS created “money from nothing”. Can you imagine if we were trying to run our economy using only the $200 million that the Continental congress printed up in the 1780′s?? We wouldn’t be able to carry out the transactions required in a complex economic system. One of gov’t's functions is to try to keep the money supply, credits, currencies, deposits balanced with the goods and services that need “money” to facilitate flow between people.

    This transaction between Fed and primary dealers does not NET anything new. The amount of cash the Fed dispenses to the banks is balanced by the trsys it acquired. The only way new gov’t assets w/o compensating liabilities enter the system is through fiscal spending by the gov’t, i.e payments of the gov’t to you and me via soc sec, medicare, armed forces, contracts between gov’t and private institutions.