Three is nice sounding number, isn’t it? That is the number of high ranking Fed officials who proved that they don’t understand our monetary system in the last 24 hours. In a fairly uneventful speech yesterday in Rhode Island Ben Bernanke described our sizable fiscal “challenges”. What’s so interesting in his comments is that he makes it abundantly clear that he really has no idea how our monetary system works. You probably would have called such comments blasphemous when he was first sworn in (after all, he has a PhD in economics and taught at Princeton!), but given the Chairman’s consistently wrong stance on just about everything over the last few years this should really come as no surprise. What baffles me is the market’s undying faith in this man.
There is a lot to criticize in this speech, but I’ll point out a few obvious errors that the Chairman makes:
He thinks the Federal government is revenue constrained like a state or household. He makes NO distinction between them. In discussing the deficit woes at the Federal level he says the following:
“The same underlying trends affecting federal finances will also put substantial pressures on state and local budgets.”
That’s not even remotely true. The Federal government is nothing like a state or household which is always revenue constrained. The Federal government can spend at will. States and households must finance their spending, however. At the household level you really have bond vigilantes as do the states. The US government, however, as a supplier of the currency has the ability to always find funding through its central bank or the banks it harnesses as agents. The Federal government is essentially its own banker. They set the interest rate and control the issuance of currency. No one else does this for them.
“Almost by definition, unsustainable trajectories of deficits and debts will never actually transpire, because creditors would never be willing to lend to a country in which the fiscal debt relative to the national income is rising without limit.”
This should really come as no surprise. Alan Greenspan has been screaming about bond vigilantes for several years now. The fact that his apprentice is awaiting their arrival is not even remotely surprising. After all, Mr. Bernanke has applied all of the same misguided responses that Mr. Greenspan would have applied – the same responses that Mr. Greenspan has admitted were based on a “flawed” model (his words, not mine).
He goes on to imply that the private sector has been crowded out and that the bond vigilantes are right around the corner:
“Failing to address our unsustainable fiscal situation exposes our country to serious economic costs and risks. In the short run, as I have noted, concerns and uncertainty about exploding future deficits could make households, businesses, and investors more cautious about spending, capital investment, and hiring. In the longer term, a rising level of government debt relative to national income is likely to put upward pressure on interest rates and thus inhibit capital formation, productivity, and economic growth. Larger government deficits increase our reliance on foreign lenders, all else being equal, implying that the share of U.S. national income devoted to paying interest to foreign investors will increase over time.”
He makes no mention of inflation in this entire speech. It’s fascinating because Mr. Bernanke has actually admitted that the Federal government can spend at will so long as Congress keeps signing the checks. He has literally said so, yet he doesn’t understand that the threat here is not one of solvency, but default via hyperinflation and spending in excess of productive capacity. Of course, hyperinflation is not even a remote risk at this juncture, but Mr. Bernanke is more worried that we’re the next Greece despite having an entirely different monetary system.
What does it all mean to Mr. Bernanke? It means we need austerity sooner rather than later:
“What we do know, however, is that the threat to our economy is real and growing, which should be sufficient reason for fiscal policymakers to put in place a credible plan for bringing deficits down to sustainable levels over the medium term. The sooner a plan is established, the longer affected individuals will have to prepare for the necessary changes.”
He really thinks he controls the entire economy by changing interest rates. He didn’t predict this crisis. He has done nothing to help Main Street get out of the crisis. And he proves on an almost daily basis that he still doesn’t understand the system which he believes he controls. Unfortunately, Congress is likely to listen to this nonsense and accept it as gospel. Lord help us.
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.