Ben Bernanke was at Jacksonville University this past Friday discussing the Federal Reserve with college students. It’s actually a very good discussion. He goes through the banking crisis step by step and provides a very clear explanation of the Fed’s role during the crisis. He confirms most of what I have been repeating for weeks now.
Most importantly, however, he explains what the Fed is doing going forward. He makes several critical points:
- He explains that the Fed “is not printing money”. They are merely swapping treasuries for deposits (sound familiar?). As he mentioned in his op-ed the other day there is no reason to believe this operation is inflationary. It alters the duration of debt outstanding and nothing more. QE IS NOT INFLATIONARY.
- He says the price increases in commodities (caused entirely by speculators and not fundamental changes) are not a concern because the slack in the economy will make it difficult to pass these costs along to consumers (sound familiar?). Unfortunately, I think the Chairman is overlooking the fact that corporations will be less likely to hire as they see their margins squeezed. This is a significant issue the Chairman appears to be glaring over. It should not surprise any of us that he is viewing this environment as an academic and not as a business owner. Just one more piece of evidence showing he is unqualified for this position.
- The Chairman proves that he absolutely does not understand how the US monetary system functions when he says that the US is analogous to Japan in that we have high government debts. He claims that Japan funds their debt internally clearly implying a solvency constraint. He goes on to explain that the US budget deficit creates risks for the country despite previously explaining that high inflation is not a problem. Clearly, the Chairman believes the government balance sheet is no different than a household balance sheet. No wonder he has had this crisis wrong since before it started.
Updated: For those who don’t have the time to listen to the interview here is the important directly from the Fed Chief himself (courtesy of reader LVG):
“What the purchases do… is… if you think of the Fed’s balance sheet, when we buy securities, on the asset side of the balance sheet, we get the Treasury securities, or in the previous episode, mortgage-backed securities. On the liability side of the balance sheet, to balance that, we create reserves in the banking system. Now, what these reserves are is essentially deposits that commercial banks hold with the Fed, so sometimes you hear the Fed is printing money, that’s not really happening, the amount of cash in circulation is not changing. What’s happening is that banks are holding more and more reserves with the Fed. Now the question is what happens the economy starts to grow quickly and it’s time to pull back the monetary policy accommodation. There are several tools that we have”
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.