In this excellent piece, Warren Mosler elaborates on the Fed Chief’s comments and provides a great deal of clarity to the current economic environment. This is a must read in my opinion (Warren’s comments in bold):
“DUFFY: We had talked about the QE2 with Dr. Paul. When — when you buy assets, where does that money come from?
BERNANKE: We create reserves in the banking system which are just held with the Fed. It does not go out into the public.
DUFFY: Does it come from tax dollars, though, to buy those assets?
BERNANKE: It does not.
DUFFY: Are you basically printing money to buy those assets?
BERNANKE: We’re not printing money. We’re creating reserves in the banking system.
DUFFY: In your testimony — I only have 20 seconds left — you talked about a potential additional stimulus. Can you assure us today that there is going to be no QE3? Or is that something that you’re considering?
BERNANKE: I think we have to keep all the options on the table. We don’t know where the economy is going to go. And if we get to a point where we’re like, you know, the economy — recovery is faltering and — and we’re looking at inflation dropping down toward zero or something, you know, where inflation issues are not relevant, then, you know, we have to look at all the options.
DUFFY: And QE3 is one of those?
“PAUL: I hate to interrupt, but my time is about up. I would like to suggest that you say it’s not spending money. Well, it’s money out of thin air. You put it into the market. You hold assets and assets aren’t — you know, they are diminishing in value when you buy up bad assets.
But very quickly, if you could answer another question because I’m curious about this. You know, the price of gold today is $1,580. The dollar during these last three years was devalued almost 50 percent. When you wake up in the morning, do you care about the price of gold?
BERNANKE: Well, I pay attention to the price of gold, but I think it reflects a lot of things. It reflects global uncertainties. I think people are — the reason people hold gold is as a protection against what we call “tail risk” — really, really bad outcomes. And to the extent that the last few years have made people more worried about the
potential of a major crisis, then they have gold as a protection.
PAUL: Do you think gold is money?
BERNANKE: No. It’s not money.
PAUL: Even if it has been money for 6,000 years, somebody reversed that and eliminated that economic law?
BERNANKE: Well, you know, it’s an asset. I mean, it’s the same — would you say Treasury bills are money? I don’t think they’re money either, but they’re a financial asset.
PAUL: Well, why do — why do central banks hold it?
BERNANKE: Well, it’s a form of reserves.
PAUL: Why don’t they hold diamonds?
BERNANKE: Well, it’s tradition, long-term tradition.
PAUL: Well, some people still think it’s money.”
“CLAY: Has the Federal Reserve examined what may happen on another level on August 3rd if we do not lift the debt ceiling?
BERNANKE: Yes, we’ve — of course, we’ve looked at it and thought about making preparations and so on. The arithmetic is very simple. The revenue that we get in from taxes is both irregular and much less than the current rate of spending. That’s what it means to have a deficit.
So immediately, there would have to be something on the order of a 40 percent cut in outgo. The assumption is that as long as possible the Treasury would want to try to make payments on the principal and interest of the government debt because failure to do that would certainly throw the financial system into enormous disarray and have major impacts on the global economy.
So this is a matter of arithmetic. Fairly soon after that date, there would have to be significant cuts in Social Security, Medicare, military pay or some combination of those in order to avoid borrowing more money.
If in fact we ended up defaulting on the debt, or even if we didn’t, I think, you know, it’s possible that simply defaulting on our obligations to our citizens might be enough to create a downgrade in credit ratings and higher interest rates for us, which would be counterproductive, of course, since it makes the deficit worse.
But clearly, if we went so far as to default on the debt, it would be a major crisis because the Treasury security is viewed as the safest and most liquid security in the world. It’s the foundation for most of our financial — for much of our financial system. And the notion that it would become suddenly unreliable and illiquid would throw shock waves through the entire global financial system.
And higher interest rates would also impact the individual American consumer. Is that correct?
BERNANKE: Absolutely. The Treasury rates are the benchmark for mortgage rates, car loan rates and all other types of consumer rates.”
BERNANKE: A second problem is the housing market. Clearly, that’s an area that should get some more attention because that’s been one of the major reasons why the economy has grown so slowly. And I think many of your colleagues would agree that the tax code needs a look to try to improve its efficiency and to promote economic growth as well.”
G. MILLER: Well, the problem I had with the Fannie-Freddie hybrid concept was the taxpayers were at risk and private sector made all the profits.
BERNANKE: That’s right.
G. MILLER: That — that’s unacceptable. What do you see the barriers to private capital entering mortgage lending (inaudible) market for home loans would be?
BERNANKE: Well, currently, there’s not much private capital because of concerns about the housing market, concerns about still high default rates. I suspect, though, that, you know, when the housing market begins to show signs of life, that there will be expanded interest.
I think another reason — and go back what Mr. Hensarling was saying — is that the regulatory structure under which securitization, et cetera, will be taking place has not been tied down yet. So there’s a lot of things that have to happen. But I don’t see any reason why the private sector can’t play a big role in the housing market securitization, et cetera, going forward.”
“CARSON: However, banks are still not lending to the public and vital small businesses. How, sir, do you plan on, firstly, encouraging banks to lend to our nation’s small businesses and the American public in
And, secondly, as you know, more banks have indeed tightened their lending standards than have eased them. Does the Fed plan to keep interest rates low for an extended period of time. Are the Fed’s actions meaningless unless banks are willing to lend?
CARSON: And, lastly, what are your thoughts on requiring a 20 percent down for a payment? And do you believe that this will impact homeowners significantly or — or not at all?
BERNANKE: Well, banks — first of all, they have stopped tightening their lending standards, according to our surveys, and have begun to ease them, particularly for commercial and industrial loans and some other types of loans.
Small-business lending is still constrained, both because of bank reluctance but also because of lack of demand because they don’t have customers or inventories to finance or because they’re in weakened financial condition, which means they’re harder to qualify for the loan.
“PETERS: Do you see some parallels between what happened in the late ’30s?
BERNANKE: Well, it’s true that most historians ascribe the ’37- ’38 recession to premature tightening of both fiscal and monetary policy, so that part is correct.
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.
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