Why America should mind the Bernanke gap

MIND THE GAP! American tourists no doubt grow weary of the constant refrain on London’s Underground. But Federal Reserve chairman Ben Bernanke must have wanted to holler it this week as the central bank embarked on its latest attempt to save the world. Bernanke’s gap – chasm may be a better word – is potentially just as dangerous as any on London’s subway system. It’s the distance between the size of the economic ills the Fed remains tasked with healing and what the central bank has left in the medicine cabinet.

September has provided Americans with a stark illustration of it. Firstly, a couple of the symptoms. Three weeks ago, Wal-Mart said it would be reintroducing layaway plans in the countdown to the Thanksgiving holiday and Christmas, the busiest time of the year for retailers. If you’re not familiar with them, layaway plans allow people to pay a fee and in return pay for goods over a period of time without being charged interest. Wal-Mart, America’s biggest retailer, ditched the plan in 2006 when more and more of its customers were using credit cards.

Then last week, the US Census Bureau published its survey of incomes and poverty for 2010. Amid the reams of statistics, it emerged that the number of households that are “doubling up” has risen sharply since the financial crisis began. These households are defined as those with at least one extra person who is over 18, not at school and neither the spouse or partner of the homeowner. Their number has increased 11pc to 21.8m since 2007 and now account for almost 20pc of all households in the US.

These are just two of the ways in which this crisis has changed daily life for millions of Americans as unemployment rises and incomes are squeezed. And there are plenty more. So it’s little wonder that this week stock markets finally woke up to the Bernanke gap when the Fed chairman gave everyone a peek inside the bank’s arsenal.

Operation Twist, launched on Wednesday, will see dealers at the Fed buy $400bn of longer-dated US government bonds and then sell the same amount in debt maturing in one to three years. The aim is simple: drive yields to such miserably low levels that investors are forced to take more risk to ensure a return that outpaces inflation. Shares, property, private equity – almost anything will do. As Jim Vogel of FTN Financial says “the Fed is turning the screws to make it that much more painful to just leave your money in the Treasury market.”

It’s certainly helped drive down bond yields. Those on the 30-year have tumbled 45 basis points this week, while 10-year yields are close to their lowest since the 1950s. But it’s hard to believe that Bernanke & co believe it will make much difference in an economy where interest rates have been at a record low since December 2008 and are set to stay there until at least 2013.

Operation Twist may make a difference at the margin, which is the space in which any future policy from the Fed is likely to play out in. The Fed will no doubt empty its arsenal further should the economy deteriorate from here. But Bernanke should spell out to Americans even more clearly that these are not magical healers for a country emerging from its worst recession since the 1930s. Failure to do so risks a crisis of confidence in the central bank at a moment when the country can ill-afford it.

It may also provoke some more imaginative thinking in The White House and in Congress about the sorts of policies that might make a difference.

The Bernanke Rally?

Bravo Bernanke for telling the screaming markets to go to bed without their supper.

There can be no justification for QE3 at a time when core inflation is creeping up to 2pc.

Nor when the M2 money supply is growing at 10pc, or M1 growing at 20pc, or credit is at last returning from the dead and turning positive again. Credit has accelerated to an 8pc annual compound growth rate over the last three months. And remember, Bernanke is a “creditist”. Lending is his lodestar.

Quite why markets seemed so assured that he would intervene to prop up Wall Street is beyond me. It shows how deranged this game has become.

Bernanke looks at fundamentals, which include the wealth effects of Wall Street as just one variable. His real enemy is deflation and the Japan syndrome, though he has been remarkably bad at articulating this.

As he said in Jackson Hole, the economy is very slowing healing itself in spite of fiscal tightening (some might even say because of it). Indeed it is. US corporations are sitting on $2 trillion. Households are chipping away at their debts (admittedly by defaulting on mortgages in many cases, but that too is debt clearance).

I have a hunch that Bernanke’s first hints of cautious optimism may prove better rocket fuel for a durable rally than the Fed’s body-language of despair, whatever the markets say over coming days.

Nobel laureate Edmund Phelps advised the Fed should keep its “finger on the trigger” just in case the deflation threat returns, or Euroland blows up, or the world takes another nasty turn.

Europe may indeed blow up. The German constitutional court will rule on Sept 7 on the legality of the EU bail-outs, and that might be a moment to fasten your seatbelts.

What is ever clearer to me after spending a few days in Germany again is that the Bundestag is in no mood to increase the EFSF rescue fund by one pfennig beyond €440bn, let alone contemplate the €2 trillion figure deemed necessary by City banks. Which means Italy and Spain will be left to their fate once the ECB’s bond buying hits the limit (October?).

But the Fed cannot set policy on the basis of EMU contingencies. It sets policy for America, and America is not as sick as it looks.

The Fed is a Rogue Elephant (wonkish rant)

Ben Bernanke thinks the money data is a `Black Box’

Ben Bernanke has moved the goal posts yet again.

Headline CPI inflation in the US is 3.4pc. There is no deflationary threat at this stage that can justify holding rates near zero until the moon turns into blue cheese, let alone embarking on emergency money printing.

The Bernanke Fed has more or less ignored headline inflation until now, arguing that what matters is “core” inflation. This strips out energy, fuel and food, which none of us consume of course.

Unfortunately, core inflation has been catching up lately. The Dallas Fed’s “trimmed mean” measure known as core PCE has risen (on a six-month annualized basis) from 0.9pc in January to 2.1pc in June.

So what the does the Fed do? It switches tack and says that headline inflation is not such a bad gauge after all. They do this knowing that the oil and food shock has subsided and that the headline rate will fall back for a while. This will create the impression that inflation is abating. “Cheeky,” said ING’s global economist Rob Carnell.

Indeed.

As you can see from the two charts below, the broad M2 money supply is growing robustly at 8pc and narrow M1 is growing at over 15pc.

Yes, I know, Ben Bernanke thinks the money data is a “Black Box” that cannot be understood, and ultimately a form of medieval witchcraft. Well, perhaps he should rethink. This is not picture of an economy facing imminent deflation.

Note how weak M2 was fifteen months ago (and broader M3 – which Bernanke has abolished, but others track – was actually contracting at 1930s rates). That was a very good lead indicator of the economic relapse we saw in the first half of 2011.

I am wary of Bernanke’s sudden change of heart on headline inflation. It confirms my suspicion (shared by many readers) that the Fed is deliberately bringing about inflation and currency debasement to cushion the effects of debt-deleveraging. This amounts to a soft default on America’s debts.

QE1 was an entirely appropriate response to the threat of spiralling collapse and an implosion of the money supply. I backed it whole-heartedly, and make no apologies for doing so.

QE2 was a different animal. The threat of imminent deflation was bogus. The effect was to juice stock prices and increase the asset wealth of the rich, hoping for a trickle down. In reality it punished poor people through rising food and fuel costs long before any trickle came through.

Needless to say, it also punishes prudent savers in order to rescue improvident and promiscuous borrowers. This has immense social and moral consequences over time, and risks undermining the virtues that made America the world’s paramount power.

Dallas Fed chief Richard Fisher said in a speech last March, further QE would “only prolong the injustice that we have inflicted on savers.”

He warned of the risk that the Fed will be viewed as “a pliant accomplice to Congress’ and the executive branch’s fiscal misfeasance,” if it carries on down this road. “Barring some frightful development, I will vote against any program that might seek to extend or enlarge the substantial monetary accommodation we already have provided. The liquidity tanks are full, if not brimming over. The Fed has done its job. What is needed now is for business to be incentivized to commit that liquidity to creating American jobs. This is the task of the fiscal authorities, not the Federal Reserve.”

Mr Fisher stuck to his word. He voted against the Fed’s promise yesterday to keep rates near zero until mid-2013.

The Fed is engaged in dangerous forms of social engineering. Central banks should never enter this territory.

Yes, I have been critical of the ECB for other reasons. It allowed the Club Med bubble to build up from 2004-2007, misread both the oil spikes of 2008 and 2011, has allowed M3 to gyrate wildly, but the ECB is not — or not yet — a rogue elephant trampling social norms under foot.

An intellectual case can be made that inflation should be raised to 4pc to 6pc in the western world to lift us out of our debt trap. EX-IMF chief economist Ken Rogoff and others have made exactly that argument. Fine. Let debate be joined.

But if so, the Fed needs to state this openly and not carry out a social revolution by subterfuge. Any such decision should be subject to democratic endorsement by elected parliaments.

How can we bring these the central bankers to heel?

Fed mixes it up and comes up with the worst of all worlds

Ben Bernanke, chairman of the US Federal Reserve, was able to deliver something to turmoil wracked markets; he promised to keep the fed funds rate close to zero until mid-2013, the first time, as far as I am aware, that the Fed has ever pledged to hold rates for such a long, and specific, length of time.

To commit to hold rates at virtually zero for nearly two years is unprecedented, and a mark of just how concerned policymakers have become at the economy’s inability to lift itself out of its funk. It provides markets and business with a degree of certainty on rates that they’ve never had before, and may therefore lift confidence.

But was it enough? The fact that three members of the open markets committee (FOMC) dissented from this promise maintains a strong, hawkish voice on the FOMC that undoubtedly remains fiercely opposed to any further quantitative easing. QE3 was the only thing that would comprehensively have reversed the current market rout, but Mr Bernanke cannot, for the moment at least, deliver it. Undue caution from the Fed combined with continued political paralysis on Capitol Hill does not make for a happy economy.

What committing to two years of zero interest rate policy will certainly do, on the other hand, is further weaken the dollar. Does the Fed know something the rest of us don’t to have taken such an aggressive position on rates. And what does it do if inflation returns? The Chinese, with inflation already at 6.5pc, will be spitting tacks. The Fed has mixed it up and come to a messy compromise which is neither one thing or the other. This was not what we hoped for.