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. As I’ve described many times in the past, QE is just a simple asset swap.  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