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Warren Mosler sent me some comments by Ben Bernanke in early February at his Congressional hearing.  Dr. Bernanke said:

“Even the prospect of unsustainable deficits has costs, including an increased possibility of a sudden fiscal crisis. As we have seen in a number of countries recently, interest rates can soar quickly if investors lose confidence in the ability of a government to manage its fiscal policy. Although historical experience and economic theory do not indicate the exact threshold at which the perceived risks associated with the U.S. public debt would increase markedly, we can be sure that, without corrective action, our fiscal trajectory will move the nation ever closer to that point.”

There’s little doubt in my mind that Dr. Bernanke is a genius.  But it confounds me how he has not connected the dots on a few things.  As the man in control at the Fed he should know that the Fed is the supplier of reserves to the banking system.  This is not a small power to harness.  It is a colossal power.   But Dr. Bernanke does not understand the depth of his own powers.

You see, as the supplier of reserves the Fed can control the yield curve.  That’s right.  There are no bond vigilantes in the USA.  There is no time when the Fed has to buckle to the demands of the bond markets.  If the Fed wants to set rates across the entire curve they will simply say so.  They could buy back every outstanding bond there is at a specific rate of 0%.  This would essentially flatten the curve.  You could bet against the Fed’s actions, but as the supplier of reserves the Fed will never lose this fight to a bunch of arrogant Wall Streeters.  After all, the bankers are currency users.  The Fed is part of the currency issuer.

Now, some will say that the Fed will have to raise rates when we become insolvent or when inflation surges.  This is true, but only to a certain degree.  An autonomous currency issuer like the USA cannot “run out” of money.  The USA has a printing press.  As long as our debts are denominated in the currency we can print at will it is silly to worry about us defaulting on our debts (assuming our politicians don’t choose to default!).  Dr. Bernanke alludes to Europe in this case, but the European nations are all currency users.  They do not create the currency their debts are denominated in.  So his analogy displays a clear misunderstanding).

But what about inflation?  Yes, it will rise one day.  But the most likely cause of rising inflation will be surging oil prices via a supply shock (which will likely cause recession when the price shock hits consumer wallets) or will arise from the fact that consumers have spending power and the economy is booming again (a problem Dr. Bernanke would love to have right now).  So yes, inflation is always our concern.  And if inflation surges due to a strong economy the Fed will be right in raising rates.

So yes, be very afraid.   But not because of bond vigilantes.  But because the wizard doesn’t fully understand the machine he’s in control of.


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