Bernanke tells Warren ‘too big to fail’ banks ‘will voluntarily reduce their size’

By Stephen C. Webster - RAW StoryWednesday, February 27, 2013

The Chairman of the Federal Reserve looked mighty uncomfortable Tuesday being grilled by Sen. Elizabeth Warren (D-MA), a former Harvard professor and economics expert who posed one very blunt question to him that many Americans have been asking for years: “When are we going to get rid of too big to fail?”

His response: “Banks will voluntarily reduce their size” over an undetermined amount of time.

At the Senate banking committee hearing on monetary policy, Warren stressed that small banks are being crushed by interest rates while big banks have made billions from secret, low-interest Federal Reserve loans since the crash of 2008.

“So I understand that we’re all trying to get to the end of too big to fail, but my question, Mr. chairman, is until we do, should those biggest financial institutions be repaying the American taxpayer that $83 billion [yearly] subsidy they’re getting?” she asked

Bernanke said the aid to big banks through cheaper loans came about because of “market expectations” in 2008 that are no longer correct. “We have an orderly liquidation authority,” he said. “Even in the crisis, in the case of AIG, we wiped out the shareholders.”

Warren stopped him there. “Excuse me though, Mr. chairman, you did not wipe out the shareholders of the largest financial institutions, did you? The big banks?”

“We didn’t have the tools, now we could,” Bernanke insisted.

Moments later, Warren doubled back again. “We’ve now understood this problem for five years,” she said. “When are we going to get rid of too big to fail?”

“Well, as we’ve been discussing, some of these rules take time to develop,” Bernanke said. “The orderly liquidation authority, I think we’ve made progress on that. We’ve got the living wills. I think we’re moving in the right direction. Um, if additional steps are needed then Congress obviously can discuss those, but we do have a plan and I think it’s moving in the right direction.”

“Any idea about when we’re going to arrive in the right direction?” Warren asked.

“It’s, it’s, it’s gonna take…” Bernanke stammered. “It’s not a zero-one thing, it’s over time you’ll see increasing, uh, increasing market expectations that these institutions can fail. I would make another prediction, and predictions is always dangerous, that the benefits of being large are gonna be sm– are gonna decline over time, which means that banks will voluntarily reduce their size because they’re not seeing the benefits they used to get.”

“I read you on this,” Warren said. “I read your predictions on this in your earlier testimony, but so far it looks like they’re getting $83 billion for staying big.”

“Well, that’s one study,” Bernanke said. “You don’t know whether that’s an accurate number.”

The Dallas Federal Reserve reported last March that just five “too big to fail” banks control more than 50 percent of the banking industry’s assets. The top 10 institutions controlled over $7 trillion in 2010, or roughly half the U.S. gross domestic product that year.

Congress Debates the Federal Reserve: Reform or Abolish?

Wednesday, 09 May 2012
Written by  Alex Newman - New American

In a rare moment of bipartisan unity, lawmakers and economists on both sides of the aisle largely agreed on two points: The Federal Reserve System as it stands is hurting America and something must be done to stop it. Just what exactly needs to happen, however, was the subject of considerable debate during a Subcommittee on Domestic Monetary Policy hearing Tuesday chaired by sound-money advocate and GOP presidential contender Rep. Ron Paul (R-Texas). 

Dr. Paul, of course, has become famous around the world for his tireless efforts to audit, expose, and abolish the central bank. He even published a best-selling book in 2009 entitled End the Fed, a title that has become a rallying cry for millions of Americans angry about the institution’s multi-trillion-dollar bailouts, market manipulations, corruption, and debasement of the currency.

The subcommittee hearing, entitled “The Federal Reserve System: Mend It or End It?”, examined a range of different proposals to reform the nation’s monetary system — it was supposed to look at six different options emanating from both parties. One of the measures on the agenda was Congressman Paul’s own “Federal Reserve Board Abolition Act,” legislation to dismantle the central bank and restore sound money based on market principles.

“More and more people are beginning to understand just how destructive the Federal Reserve's monetary policy has been. I hope that this hearing will kick start a serious discussion on the need to rein in the Fed,” Chairman Paul said in a statement about the event. “A hundred years is far too long for Congress to have taken a hands-off approach. The Fed continues to reward Wall Street banks while destroying the dollar’s purchasing power and driving up the cost of living for average Americans. This reckless behavior must come to an end.”

Several experts who testified before the subcommittee agreed with Paul’s proposals. And while efforts to reform the central bank have persisted for a century, in the wake of the economic crisis — which saw the Fed shower trillions of dollars on domestic and foreign banks — popular outrage has forced the controversy back into the spotlight. 

“The Fed simply does not know the ‘optimal’ supply of money or the ‘optimal’ intervention in the banking system; no one does,” explained Dr. Peter Klein from the University of Missouri during the hearing, noting that central banks do not fight inflation — they create it. “Add the standard problems of bureaucracy — waste, corruption, slack, and other forms of inefficiency well known to students of public administration — and it becomes increasingly difficult to justify control of the monetary system by a single bureaucracy.”

Dr. Jeffrey Herbner of Grove City College, an economist, echoed those concerns, citing a vast body of available data on the effects of central banking. “Economic theory and historical evidence demonstrate that a central bank confers no benefit on society at large,” Prof. Herbner testified, knocking down pro-central bank arguments one by one using facts and logic. “The Fed should be abolished and a market monetary system of commodity money and money certificates should be established.”

Another proposal that was examined during the hearing was the Sound Dollar Act. The legislation, introduced by Republican Rep. Kevin Brady of Texas, seeks to reform the central bank’s mandate to focus only on keeping the value of the currency stable — as opposed to its current mission, which also includes maximizing employment.

Critics argue that the Fed has failed miserably on both counts — unemployment is out of control and the dollar has lost more than 95 percent of its value since the central bank took over. But under Brady’s bill, the Fed would face broad new restrictions in terms of what it could do. Its primary purpose, then, would be to ensure the stability of the currency’s value.

“Except in the very short term, monetary policy cannot boost real output and job creation,” Brady told the subcommittee. “The last four decades of U.S. monetary policy demonstrate the advantages of a rules-based regime over a discretionary one. During the 1970s, the Federal Reserve had ‘go-stop’ policies, in which monetary policy quickly swung from ease to tightness and back again. This incoherence produced a highly volatile real economy and a rising inflation rate.”

Brady later told reporters that he hoped fellow lawmakers would take action on the bill this year, but he acknowledged that his efforts may simply be building the foundation for legislative action on the issue next year. “While the dual mandate may be politically appealing, it makes no sense for Congress to charge the Fed with controlling what it cannot,” he noted.

Stanford economics Prof. John Taylor largely agreed with Brady’s proposal, saying nearly 100 years of experience had shown that giving central banks broad discretion in centrally planning the monetary supply does not work. "Multiple goals enable politicians to lean on the central bank to do their bidding and thereby deviate from a sound money strategy," he explained, calling for a rules-based system.

Democrat Rep. Barney Frank, on the other hand, saw different problems with the Fed — most notably, its domination by powerful financial interests. “The problem you have now is this: the regional Fed bank presidents are picked by bankers,” he told the subcommittee, blasting what he called “private sector government.” Other critics have seized on that point to describe the Fed as a banking cartel with a state-issued monopoly over the nation’s currency.

Frank’s proposal, H.R. 3428, would strip much of the policy-setting power from the 12 regional Fed chiefs by removing their votes on the Federal Open Market Committee (FOMC). The legislation would also give lawmakers and the federal government more oversight authority over the privately owned central banking system, an idea the Fed itself has fiercely resisted under the guise of protecting its “independence.”

“I cannot think of another element of American government where there is formal binding legal power given to the representatives of the industry that’s in question,” Frank complained during his testimony. “I don’t think the American people are aware of the undemocratic nature of this.” Indeed, the Fed banks themselves have acknowledged on numerous occasions that they are owned and run by private banks. 

Other Fed reform bills that were on the agenda Tuesday included the “Democratizing the Federal Reserve System Act” introduced by Rep. Marcy Kaptur and Rep. Dennis Kucinich’s bill known as the “National Emergency Employment Defense Act.” Another piece of related legislation that was considered, H.R. 245, was introduced by Rep. Mike Pence. The bill is similar in some ways to Rep. Brady’s proposal in that it would end the so-called “dual mandate” of the Fed by forcing it to focus only on inflation.

While activists and lawmakers tear into the secrecy shrouding the controversial central bank, however, the Fed has gone to unprecedented lengths in recent years to protect its interests. It has accelerated its distribution of pro-Fed propaganda, for example, going so far as to design “education” lesson plans and comic books for the youth. The central bank also hired a lobbyist, and more recently, announced that it was developing a program to monitor critics online.

Still, despite the institution’s unconventional tactics to drum up support, pressure for change and outrage at the Fed continue to grow across the political spectrum. States are already taking action. Last year, Congress was finally able to obtain an audit — albeit a severely limited one — after the public outcry became deafening. According to polls, about 80 percent of Americans said they supported opening up the Fed’s books. And that, activists say, was just the beginning.   

The Book of Jobs

Forget monetary policy. Re-examining the cause of the Great Depression—the revolution in agriculture that threw millions out of work—the author argues that the U.S. is now facing and must manage a similar shift in the “real” economy, from industry to service, or risk a tragic replay of 80 years ago.
By Joseph E. Stiglitz- Vanity Fair

It has now been almost five years since the bursting of the housing bubble, and four years since the onset of the recession. There are 6.6 million fewer jobs in the United States than there were four years ago. Some 45 million Americans who would like to work full-time cannot get a job. Almost half of those who are unemployed have been unemployed long-term. Wages are falling—the real income of a typical American household is now below the level it was in 1997.

We knew the crisis was serious back in 2008. And we thought we knew who the “bad guys” were—the nation’s big banks, which through cynical lending and reckless gambling had brought the U.S. to the brink of ruin. The Bush and Obama administrations justified a bailout on the grounds that only if the banks were handed money without limit—and without conditions—could the economy recover. We did this not because we loved the banks but because (we were told) we couldn’t do without the lending that they made possible. Many, especially in the financial sector, argued that strong, resolute, and generous action to save not just the banks but the bankers, their shareholders, and their creditors would return the economy to where it had been before the crisis. In the meantime, a short-term stimulus, moderate in size, would suffice to tide the economy over until the banks could be restored to health.

The banks got their bailout. Some of the money went to bonuses. Little of it went to lending. And the economy didn’t really recover—output is barely greater than it was before the crisis, and the job situation is bleak. The diagnosis of our condition and the prescription that followed from it were incorrect. First, it was wrong to think that the bankers would mend their ways—that they would start to lend, if only they were treated nicely enough. We were told, in effect: “Don’t put conditions on the banks to require them to restructure the mortgages or to behave more honestly in their foreclosures. Don’t force them to use the money to lend. Such conditions will upset our delicate markets.” In the end, bank managers looked out for themselves and did what they are accustomed to doing.

Even when we fully repair the banking system, we’ll still be in deep trouble—because we were already in deep trouble. That seeming golden age of 2007 was far from a paradise. Yes, America had many things about which it could be proud. Companies in the information-technology field were at the leading edge of a revolution. But incomes for most working Americans still hadn’t returned to their levels prior to the previous recession. The American standard of living was sustained only by rising debt—debt so large that the U.S. savings rate had dropped to near zero. And “zero” doesn’t really tell the story. Because the rich have always been able to save a significant percentage of their income, putting them in the positive column, an average rate of close to zero means that everyone else must be in negative numbers. (Here’s the reality: in the years leading up to the recession, according to research done by my Columbia University colleague Bruce Greenwald, the bottom 80 percent of the American population had been spending around 110 percent of its income.) What made this level of indebtedness possible was the housing bubble, which Alan Greenspan and then Ben Bernanke, chairmen of the Federal Reserve Board, helped to engineer through low interest rates and nonregulation—not even using the regulatory tools they had. As we now know, this enabled banks to lend and households to borrow on the basis of assets whose value was determined in part by mass delusion.

The fact is the economy in the years before the current crisis was fundamentally weak, with the bubble, and the unsustainable consumption to which it gave rise, acting as life support. Without these, unemployment would have been high. It was absurd to think that fixing the banking system could by itself restore the economy to health. Bringing the economy back to “where it was” does nothing to address the underlying problems.

The trauma we’re experiencing right now resembles the trauma we experienced 80 years ago, during the Great Depression, and it has been brought on by an analogous set of circumstances. Then, as now, we faced a breakdown of the banking system. But then, as now, the breakdown of the banking system was in part a consequence of deeper problems. Even if we correctly respond to the trauma—the failures of the financial sector—it will take a decade or more to achieve full recovery. Under the best of conditions, we will endure a Long Slump. If we respond incorrectly, as we have been, the Long Slump will last even longer, and the parallel with the Depression will take on a tragic new dimension.

Until now, the Depression was the last time in American history that unemployment exceeded 8 percent four years after the onset of recession. And never in the last 60 years has economic output been barely greater, four years after a recession, than it was before the recession started. The percentage of the civilian population at work has fallen by twice as much as in any post-World War II downturn. Not surprisingly, economists have begun to reflect on the similarities and differences between our Long Slump and the Great Depression. Extracting the right lessons is not easy.

Many have argued that the Depression was caused primarily by excessive tightening of the money supply on the part of the Federal Reserve Board. Ben Bernanke, a scholar of the Depression, has stated publicly that this was the lesson he took away, and the reason he opened the monetary spigots. He opened them very wide. Beginning in 2008, the balance sheet of the Fed doubled and then rose to three times its earlier level. Today it is $2.8 trillion. While the Fed, by doing this, may have succeeded in saving the banks, it didn’t succeed in saving the economy.

Reality has not only discredited the Fed but also raised questions about one of the conventional interpretations of the origins of the Depression. The argument has been made that the Fed caused the Depression by tightening money, and if only the Fed back then had increased the money supply—in other words, had done what the Fed has done today—a full-blown Depression would likely have been averted. In economics, it’s difficult to test hypotheses with controlled experiments of the kind the hard sciences can conduct. But the inability of the monetary expansion to counteract this current recession should forever lay to rest the idea that monetary policy was the prime culprit in the 1930s. The problem today, as it was then, is something else. The problem today is the so-called real economy. It’s a problem rooted in the kinds of jobs we have, the kind we need, and the kind we’re losing, and rooted as well in the kind of workers we want and the kind we don’t know what to do with. The real economy has been in a state of wrenching transition for decades, and its dislocations have never been squarely faced. A crisis of the real economy lies behind the Long Slump, just as it lay behind the Great Depression.

For the past several years, Bruce Greenwald and I have been engaged in research on an alternative theory of the Depression—and an alternative analysis of what is ailing the economy today. This explanation sees the financial crisis of the 1930s as a consequence not so much of a financial implosion but of the economy’s underlying weakness. The breakdown of the banking system didn’t culminate until 1933, long after the Depression began and long after unemployment had started to soar. By 1931 unemployment was already around 16 percent, and it reached 23 percent in 1932. Shantytown “Hoovervilles” were springing up everywhere. The underlying cause was a structural change in the real economy: the widespread decline in agricultural prices and incomes, caused by what is ordinarily a “good thing”—greater productivity.

At the beginning of the Depression, more than a fifth of all Americans worked on farms. Between 1929 and 1932, these people saw their incomes cut by somewhere between one-third and two-thirds, compounding problems that farmers had faced for years. Agriculture had been a victim of its own success. In 1900, it took a large portion of the U.S. population to produce enough food for the country as a whole. Then came a revolution in agriculture that would gain pace throughout the century—better seeds, better fertilizer, better farming practices, along with widespread mechanization. Today, 2 percent of Americans produce more food than we can consume.

What this transition meant, however, is that jobs and livelihoods on the farm were being destroyed. Because of accelerating productivity, output was increasing faster than demand, and prices fell sharply. It was this, more than anything else, that led to rapidly declining incomes. Farmers then (like workers now) borrowed heavily to sustain living standards and production. Because neither the farmers nor their bankers anticipated the steepness of the price declines, a credit crunch quickly ensued. Farmers simply couldn’t pay back what they owed. The financial sector was swept into the vortex of declining farm incomes.

The cities weren’t spared—far from it. As rural incomes fell, farmers had less and less money to buy goods produced in factories. Manufacturers had to lay off workers, which further diminished demand for agricultural produce, driving down prices even more. Before long, this vicious circle affected the entire national economy.

The value of assets (such as homes) often declines when incomes do. Farmers got trapped in their declining sector and in their depressed locales. Diminished income and wealth made migration to the cities more difficult; high urban unemployment made migration less attractive. Throughout the 1930s, in spite of the massive drop in farm income, there was little overall out-migration. Meanwhile, the farmers continued to produce, sometimes working even harder to make up for lower prices. Individually, that made sense; collectively, it didn’t, as any increased output kept forcing prices down.

Given the magnitude of the decline in farm income, it’s no wonder that the New Deal itself could not bring the country out of crisis. The programs were too small, and many were soon abandoned. By 1937, F.D.R., giving way to the deficit hawks, had cut back on stimulus efforts—a disastrous error. Meanwhile, hard-pressed states and localities were being forced to let employees go, just as they are now. The banking crisis undoubtedly compounded all these problems, and extended and deepened the downturn. But any analysis of financial disruption has to begin with what started off the chain reaction.

The Agriculture Adjustment Act, F.D.R.’s farm program, which was designed to raise prices by cutting back on production, may have eased the situation somewhat, at the margins. But it was not until government spending soared in preparation for global war that America started to emerge from the Depression. It is important to grasp this simple truth: it was government spending—a Keynesian stimulus, not any correction of monetary policy or any revival of the banking system—that brought about recovery. The long-run prospects for the economy would, of course, have been even better if more of the money had been spent on investments in education, technology, and infrastructure rather than munitions, but even so, the strong public spending more than offset the weaknesses in private spending.

Government spending unintentionally solved the economy’s underlying problem: it completed a necessary structural transformation, moving America, and especially the South, decisively from agriculture to manufacturing. Americans tend to be allergic to terms like “industrial policy,” but that’s what war spending was—a policy that permanently changed the nature of the economy. Massive job creation in the urban sector—in manufacturing—succeeded in moving people out of farming. The supply of food and the demand for it came into balance again: farm prices started to rise. The new migrants to the cities got training in urban life and factory skills, and after the war the G.I. Bill ensured that returning veterans would be equipped to thrive in a modern industrial society. Meanwhile, the vast pool of labor trapped on farms had all but disappeared. The process had been long and very painful, but the source of economic distress was gone.

The parallels between the story of the origin of the Great Depression and that of our Long Slump are strong. Back then we were moving from agriculture to manufacturing. Today we are moving from manufacturing to a service economy. The decline in manufacturing jobs has been dramatic—from about a third of the workforce 60 years ago to less than a tenth of it today. The pace has quickened markedly during the past decade. There are two reasons for the decline. One is greater productivity—the same dynamic that revolutionized agriculture and forced a majority of American farmers to look for work elsewhere. The other is globalization, which has sent millions of jobs overseas, to low-wage countries or those that have been investing more in infrastructure or technology. (As Greenwald has pointed out, most of the job loss in the 1990s was related to productivity increases, not to globalization.) Whatever the specific cause, the inevitable result is precisely the same as it was 80 years ago: a decline in income and jobs. The millions of jobless former factory workers once employed in cities such as Youngstown and Birmingham and Gary and Detroit are the modern-day equivalent of the Depression’s doomed farmers.

The consequences for consumer spending, and for the fundamental health of the economy—not to mention the appalling human cost—are obvious, though we were able to ignore them for a while. For a time, the bubbles in the housing and lending markets concealed the problem by creating artificial demand, which in turn created jobs in the financial sector and in construction and elsewhere. The bubble even made workers forget that their incomes were declining. They savored the possibility of wealth beyond their dreams, as the value of their houses soared and the value of their pensions, invested in the stock market, seemed to be doing likewise. But the jobs were temporary, fueled on vapor.

Mainstream macro-economists argue that the true bogeyman in a downturn is not falling wages but rigid wages—if only wages were more flexible (that is, lower), downturns would correct themselves! But this wasn’t true during the Depression, and it isn’t true now. On the contrary, lower wages and incomes would simply reduce demand, weakening the economy further.

Of four major service sectors—finance, real estate, health, and education—the first two were bloated before the current crisis set in. The other two, health and education, have traditionally received heavy government support. But government austerity at every level—that is, the slashing of budgets in the face of recession—has hit education especially hard, just as it has decimated the government sector as a whole. Nearly 700,000 state- and local-government jobs have disappeared during the past four years, mirroring what happened in the Depression. As in 1937, deficit hawks today call for balanced budgets and more and more cutbacks. Instead of pushing forward a structural transition that is inevitable—instead of investing in the right kinds of human capital, technology, and infrastructure, which will eventually pull us where we need to be—the government is holding back. Current strategies can have only one outcome: they will ensure that the Long Slump will be longer and deeper than it ever needed to be.

Two conclusions can be drawn from this brief history. The first is that the economy will not bounce back on its own, at least not in a time frame that matters to ordinary people. Yes, all those foreclosed homes will eventually find someone to live in them, or be torn down. Prices will at some point stabilize and even start to rise. Americans will also adjust to a lower standard of living—not just living within their means but living beneath their means as they struggle to pay off a mountain of debt. But the damage will be enormous. America’s conception of itself as a land of opportunity is already badly eroded. Unemployed young people are alienated. It will be harder and harder to get some large proportion of them onto a productive track. They will be scarred for life by what is happening today. Drive through the industrial river valleys of the Midwest or the small towns of the Plains or the factory hubs of the South, and you will see a picture of irreversible decay.

Monetary policy is not going to help us out of this mess. Ben Bernanke has, belatedly, admitted as much. The Fed played an important role in creating the current conditions—by encouraging the bubble that led to unsustainable consumption—but there is now little it can do to mitigate the consequences. I can understand that its members may feel some degree of guilt. But anyone who believes that monetary policy is going to resuscitate the economy will be sorely disappointed. That idea is a distraction, and a dangerous one.

What we need to do instead is embark on a massive investment program—as we did, virtually by accident, 80 years ago—that will increase our productivity for years to come, and will also increase employment now. This public investment, and the resultant restoration in G.D.P., increases the returns to private investment. Public investments could be directed at improving the quality of life and real productivity—unlike the private-sector investments in financial innovations, which turned out to be more akin to financial weapons of mass destruction.

Can we actually bring ourselves to do this, in the absence of mobilization for global war? Maybe not. The good news (in a sense) is that the United States has under-invested in infrastructure, technology, and education for decades, so the return on additional investment is high, while the cost of capital is at an unprecedented low. If we borrow today to finance high-return investments, our debt-to-G.D.P. ratio—the usual measure of debt sustainability—will be markedly improved. If we simultaneously increased taxes—for instance, on the top 1 percent of all households, measured by income—our debt sustainability would be improved even more.

The private sector by itself won’t, and can’t, undertake structural transformation of the magnitude needed—even if the Fed were to keep interest rates at zero for years to come. The only way it will happen is through a government stimulus designed not to preserve the old economy but to focus instead on creating a new one. We have to transition out of manufacturing and into services that people want—into productive activities that increase living standards, not those that increase risk and inequality. To that end, there are many high-return investments we can make. Education is a crucial one—a highly educated population is a fundamental driver of economic growth. Support is needed for basic research. Government investment in earlier decades—for instance, to develop the Internet and biotechnology—helped fuel economic growth. Without investment in basic research, what will fuel the next spurt of innovation? Meanwhile, the states could certainly use federal help in closing budget shortfalls. Long-term economic growth at our current rates of resource consumption is impossible, so funding research, skilled technicians, and initiatives for cleaner and more efficient energy production will not only help us out of the recession but also build a robust economy for decades. Finally, our decaying infrastructure, from roads and railroads to levees and power plants, is a prime target for profitable investment.

The second conclusion is this: If we expect to maintain any semblance of “normality,” we must fix the financial system. As noted, the implosion of the financial sector may not have been the underlying cause of our current crisis—but it has made it worse, and it’s an obstacle to long-term recovery. Small and medium-size companies, especially new ones, are disproportionately the source of job creation in any economy, and they have been especially hard-hit. What’s needed is to get banks out of the dangerous business of speculating and back into the boring business of lending. But we have not fixed the financial system. Rather, we have poured money into the banks, without restrictions, without conditions, and without a vision of the kind of banking system we want and need. We have, in a phrase, confused ends with means. A banking system is supposed to serve society, not the other way around.

That we should tolerate such a confusion of ends and means says something deeply disturbing about where our economy and our society have been heading. Americans in general are coming to understand what has happened. Protesters around the country, galvanized by the Occupy Wall Street movement, already know.

American Dream "American nightmare"

QE2 and Last Rites for the World's Reserve Currency

Dollar in the Dustbin
By MIKE WHITNEY

Millions of Americans have no idea what Quantitative Easing is or how it will effect them personally. That's why Wednesday's announcement that the Fed will purchase another $600 billion in US Treasuries merely reinforced feelings of helplessness and a sense that government spending is out-of-control. Unfortunately, Ben Bernanke's rambling explanation of QE2 in a Washington Post op-ed on Thursday only added to the confusion. The article is loaded with half-truths and omissions that are meant to mislead the public about how the program works and what the Fed's real objectives are. It's another missed opportunity by Bernanke to come clean with the people and let them know what policies are being enacted in their name. Here's an excerpt from the article:

"The Federal Reserve's objectives ---- are to promote a high level of employment and low, stable inflation. Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 percent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer. The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills.....Low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating. The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed.....the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability. Steps taken this week should help us fulfill that obligation."

Bernanke mentions employment/unemployment 5 times in the first 3 paragraphs to give the impression that QE is about creating new jobs. But everyone knows that's baloney. If Bernanke was really worried about jobs, he would have appealed to Congress for a second round of fiscal stimulus in his speech, which he didn't, because he remains hawkish on deficits like his colleagues in the GOP-led congress. 

Also, if QE2 is mainly about jobs, than why not settle on benchmarks to determine whether the program is successful or not? In other words, if unemployment is still hovering at 8 or 9% in June 2011, when the program ends, then we can assume that Bernanke was either wrong in his calculations or deliberately misled the public about what the program really does. 

The truth is, Quantitative Easing will not reduce unemployment, narrow the output gap, or increase aggregate demand. At best, it will lower long-term interest rates (slightly) and buoy asset prices. That may be good for the stock market, but it won't lay the groundwork for a strong recovery. In fact, it might not even be enough to keep the economy from slipping back into recession. As last Friday's report from the Bureau of Economic Analysis indicates, most of 3rd Quarter GDP was from rebuilding inventories. Remove inventory restocking, and final demand was a sickly 0.6%. So, how will Bernanke's bond purchasing program increase final demand?

It won't. If the Fed buys Treasuries, Treasury yields go down which pushes investors into riskier assets (like stocks). That pushes stocks higher, investors feel richer, spending takes off, businesses hire more workers, and the economy grows. It's a great theory, but it doesn't work. Yields are already at record lows and businesses are still not hiring because there's no demand for their products. The problem cannot be fixed from the supply side, which is to say, that it doesn't matter how cheap money is, if no one is borrowing. And no one is borrowing because they are either broke or out-of-work. Bernanke's grand plan doesn't get money to the people who need it, so the economy will continue to sputter. 

Also, Yields on the 10-year and 30-year Treasuries have already dipped in anticipation of QE2, but is there any sign that businesses are planning to start hiring again? Of course not, because low interest rates don't matter in this environment. Case in point; record-low interest rates haven't increased home sales at all. Cheap money doesn't generate demand when personal balance sheets are underwater. Bernanke knows this because he's studied Japan's Lost Decade and understands what happened. They initiated two massive QE programs and got zippo---bank loans and credit continued to go sideways. So, Bernanke is being disingenuous. But why?

The reason is that the Fed is locked in a violent exchange-rate war to push down the value of the dollar. Bernanke wants to trim the current account deficit to boost exports. But he'd rather not tell the American people that he's using their currency as a bludgeon to beat trading partners into submission. It's easier just to scribble some gibberish about "generating jobs" and send it off to the Washington Post. 

The Fed is at war; that's the truth of the matter. Economist Michael Hudson calls Quantitative Easing (QE) "a form of financial aggression." But Hudson probably understates the case; "monetary terrorism" (moneterrorism?) is probably closer to the truth. QE is flooding emerging markets with cheap capital that's forcing their leaders to take defensive action to protect their economies. EM's have already seen the first wave of liquidity surge into their markets raising havoc with prices and forcing central banks to raise rates. But emerging markets aren't taking it laying down. They're throwing up protectionist barriers and monitoring capital flows. If Bernanke's going to print more money, they'll print, too. Mass competitive devaluation will ignite a full-blown currency war that leaves the present trade regime in tatters and the dollar in the dustbin. 

This is from Richard Portes in an article titled "Currency wars and the emerging-market countries":

"If the large developed market countries do more QE, however, then the flow of liquidity to the emerging markets may force the latter to respond. They may try to resist exchange-rate appreciation by intervening in the foreign exchange markets. Here we do have competitive devaluation – the “currency wars”....
This is why we see statements like “The US will win this war: it will either inflate the rest of the world or force their exchange rates up against the dollar” (Wolf 2010). But there is a potential downside for the US. Substantial dollar depreciation will weaken the global position of the dollar, as it did in the late 1970s. (Chinn and Frankel 2007)

The Fed will proceed with QE. It will not accept foreign constraints on its monetary policy, nor will it run an internationally “coordinated” or “cooperative” monetary policy." ("Currency wars and the emerging-market countries", Richard Portes, VOX)

See? This isn't about jobs at all. It's about power. It's about who is going to dictate policy to the rest of the world. Bernanke wants emerging markets to bear the costs of a financial crisis that originated on Wall Street and was nurtured every step of the way by the easy money policies of the Federal Reserve. Rather than accept responsibility for his actions--by restructuring the banking system and forcing them to write down their debts-- Bernanke has decided to create inflation by opening the sluice-gates and releasing a wall of liquidity that will (inevitably) produce asset bubbles and turmoil in foreign markets. The plan will put the dollar under severe pressure and could trigger a flight from dollar-backed assets, particularly US Treasuries. That would spark the Doomsday Scenario; a disorderly unwinding of the dollar and a swift plunge into crisis. That possibility is not as remote as many think. Here's a clip from the UK Telegraph's Ambrose-Evans Pritchard:

"The Fed's "QE2" risks accelerating the demise of the dollar-based currency system... a chorus of Chinese officials and advisers is demanding that China switch reserves into gold or forms of oil. As this anti-dollar revolt gathers momentum worldwide, the US risks losing its "exorbitant privilege" of currency hegemony." (QE risks currency wars and the end of dollar hegemony, Ambrose-Evans Pritchard, Telegraph)

Or, this from Nobel prize winner, Joseph Stiglitz:

"The world is on the verge of moving to another regime of managed exchange rates and fragmented capital markets....A new global reserve system or an expansion of IMF "money" (called special drawing rights, or SDRs) will be central to this co-operative approach. With such a system, poor countries would no longer need to put aside hundreds of billions of dollars to protect themselves from global volatility, and these would add to global aggregate demand.... with such a system, the US would no longer enjoy the extraordinarily cheap borrowing that comes with being the minter of the most important global reserve currency. But the current arrangement is an anomaly. The world is at a critical juncture." (A currency war has no winners, Joseph Stiglitz, The Guardian)

Or this from economist Michael Hudson who believes that the rising powers Brazil, Russia, India and China (BRIC) will challenge the current dollar-dominated regime leading the way to a new multi-polar world order. Here's what he says:

"The most decisive counter-strategy to U.S. QE II policy is to create a full-fledged BRIC-centered currency bloc that would minimize use of the dollar....A BRIC-centered system would reverse the policy of open and unprotected capital markets put in place after World War II. ... In September, China supported a Russian proposal to start direct trading using the yuan and the ruble rather than pricing their trade or taking payment in U.S. dollars or other foreign currencies. China then negotiated a similar deal with Brazil. And on the eve of the IMF meetings in Washington on Friday, Premier Wen stopped off in Istanbul to reach agreement with Turkish Prime Minister Erdogan to use their own currencies in a planned tripling Turkish-Chinese trade to $50 billion over the next five years, effectively excluding the dollar."

It won't happen overnight, but the transition away from the dollar has already begun. The financial crisis has greatly eroded US moral authority and the trust that's needed to preserve America's role as the steward of the world's reserve currency. Bernanke's misguided hyper-monetarism is merely hastening the dollar's decline. QE2 could very well be the straw that breaks the camel's back.

The ties that bind at the Federal Reserve

By Kristina Cooke, Pedro da Costa and Emily Flitter

NEW YORK/WASHINGTON (Reuters) - To the outside world, the Federal Reserve is an impenetrable fortress. But former employees and big investors are privy to some of its secrets -- and that access can be lucrative.

On August 19, just nine days after the U.S. central bank surprised financial markets by deciding to buy more bonds to support a flagging economy, former Fed governor Larry Meyer sent a note to clients of his consulting firm with a breakdown of the policy-setting meeting.

The minutes from that same gathering of the powerful Federal Open Market Committee, or FOMC, are made available to the public -- but only after a three-week lag. So Meyer's clients were provided with a glimpse into what the Fed was thinking well ahead of other investors.

His note cited the views of "most members" and "many members" as he detailed increasingly sharp divisions among the officials who determine the nation's monetary policy.

The inside scoop, which explained how rising mortgage prepayments had prompted renewed central bank action, was simply too detailed to have come from anywhere but the Fed.

A respected economist, Meyer charges clients around $75,000 for his product, which includes a popular forecasting service. He frequently shares his research with reporters, though he kept this note out of the public eye. Reuters obtained a copy from a market source. Meyer declined to comment for this story, as did the Federal Reserve.

By necessity, the Fed spends a considerable amount of time talking to investment managers, bank economists and market strategists. Doing so helps it gather intelligence about the market and the economy that is invaluable in informing the bank's decisions on borrowing costs and lending programs.

But a Reuters investigation has found that the information flow sometimes goes both ways as Fed officials let their guard down with former colleagues and other close private sector contacts.

This selective dissemination of information gives big investors a competitive edge in the market. In the past, Fed officials themselves have privately expressed discomfort about the cozy ties between the central bank and consultants to big investors, though their concerns have largely fallen on deaf ears.

No one is accusing Meyer and his firm, Macroeconomic Advisers -- or any other purveyors of Fed insights for that matter -- of wrongdoing. They are not prohibited from sharing such information with their hedge fund and money manager clients.

But critics question whether it is proper for Fed officials to parcel out details that have the potential to move markets around the world, especially with the government's involvement in the economy being so pronounced.

"It's certainly not what Fed officials should be doing," said Alice Rivlin, a former Fed governor and now a fellow at the Brookings Institute think tank. "The rules when I was there were you don't talk to anybody about anything that could be used for commercial purposes."

In an effort to counter concerns about close ties between business and government, U.S. President Barack Obama issued an "ethics pledge" that forbids appointees of his administration from contacting the agencies they worked under for at least two years after leaving.

But such measures are tough to enforce. And in the case of the Fed's Washington-based board, governors are allowed to transition directly into a banking sector job immediately after they leave the central bank, though they must first serve out a rather lengthy 14-year term, which many do not.

"COLOR" IN GRAY AREA

Against the backdrop of today's shaky recovery and the Fed's efforts to provide ongoing support to growth, information about what central bank officials agree or disagree on can be even more valuable than usual.

Haag Sherman, chief investment officer of Salient Partners, a Houston-based money management firm that oversees around $8 billion in assets, says even the slightest hint of the possible direction of policy can give investors a huge leg up.

"The fact is that government today is driving the markets more than any time in recent history and having insight into near-term and long-term plans provides a money manager with a significant competitive advantage," Sherman said.

Markets have been particularly sensitive to Fed policy in recent months as renewed weakness in the economy sparked widespread speculation that the central bank would try to ease borrowing conditions further, probably by ramping up its purchases of U.S. government bonds.

By adding to the over $1.7 trillion in such purchases undertaken in response to the financial crisis so far, the Federal Reserve would be providing further incentives for banks to lend and consumers to borrow -- despite the fact that official interest rates are already effectively at zero.

In his note, Meyer said many Fed officials hadn't found out about the pace of mortgage prepayments -- which meant the central bank's support for the economy was ebbing -- until just before the August 10 meeting.

"For a few members, it was too late to affect their decisions; for others it was a very important factor, even the most influential factor," wrote Meyer. "Shouldn't the FOMC at least have a neutral balance sheet policy given the weaker outlook? This was obvious to the doves, persuasive to the center, but not the hawks."

Fed-watching, of course, has long been a cottage industry, albeit a fairly wealthy one. Investors are constantly looking for clues about what officials may or may not be thinking, parsing their language much like Kremlinologists of yore. And markets can jump at the first whiff of a change in tone.

For example, five days after Meyer's note, the Wall Street Journal published a more detailed account of the divisions on the Fed's policy-setting committee. The newspaper report was credited with moving bond yields 0.20 percentage point, a relatively steep decrease.

Small wonder that large funds are willing to shell out tens of thousands of dollars a year to receive "color" -- as investors refer to the useful tidbits that plugged-in consultants supply.

The precise number of former Federal Reserve employees tapping their network of old colleagues can't be determined, but by most accounts they are a sizable group.

"The revolving door between the Fed and the private financial sector is quite significant," said Timothy Canova, professor of international economic law at Chapman University School of Law in Orange, California.

There is no required registration process for economic and monetary policy consultants, former Fed lawyers say.

Some especially high-profile former Fed officials now have their own shops, too: Former Fed Chairman Alan Greenspan's Greenspan Associates offers policy consulting to Pimco, the world's biggest bond fund.

"THREE BIG FEDDIES"

Though rarer, access is sometimes also bestowed upon outsiders. Paul Markowski, a China expert who counts hedge funds and foreign central banks among his consulting clients, has never worked at the Fed but says his relationships with officials there date back to the 1960s. For him, he says, it's a question of knowing the individuals on the committee well enough to understand their sometimes cryptic signals.

"You have to establish a relationship over time. If you go and see someone once or twice you are not going to be able to read what they are saying to you properly," he said. "They look at me, for one, as someone who has deep relations with the financial markets. It's a two-way street."

On the same day as the Fed's eventful August meeting, Markowski wrote to his clients: 

"While I thought they could hold off doing what they did, a senior Fed official told me that after measuring the risk of doing nothing they had little to lose and more to gain."

On Friday, September 24, three days after the September 21 meeting, he described a string of conversations with "three big Feddies."

Earlier in the year, just a day after the April 27-28 gathering, Markowski offered clients the type of material that, if true, went beyond anything even the minutes from the meeting would offer three weeks later:

"I had two interesting phone conversations with senior Fed officials -- one last night and another this morning. What I heard was that going into the meeting the staff were split 50:50 as to the recommendation on rates; there were 6 members who favored some change in the asset sales issue and 3-4 who favored changing (the Fed's commitment to keep rates low for an extended period), with another 1-3 suggesting putting the change off to the next meeting."

QUID PRO QUO

Of course, speaking to one or two officials at the central bank does not necessarily provide the full story, especially at a time when policymakers diverge on key issues such as the outlook for the economy and appropriate policy actions.

Niche analysts may also have a vested interest in exaggerating the extent of their access -- it makes their offering all the more enticing.

Some investors point out that markets are inherently volatile, and inklings into the broad contours of policy do not necessarily translate into an obvious short-term trading strategy.

"Having this information from the Fed would be beneficial only if you understood what the effects of what the Fed is doing might be," said Joseph Calhoun, strategist at Alhambra Investments in Miami.

Even those who seem to be in the know are not always right: both Meyer and Markowski called the August 10 meeting wrong, thinking the Fed would hold pat when it in fact chose to provide additional stimulus.

But Canova, the Chapman law professor, says the immediate investment value of the information is not the main issue. For him, the backroom exchanges are part of a bigger problem of financial industry influence over economic decision-making.

"This is one of many quid pro quos in a system of opaque subsidies," Canova said. "It seems to me naive to think private investors would routinely share proprietary information without any legal obligation or subpoena unless they were getting some tangible benefits in return."

A DIFFERENT COMMUNICATIONS CHALLENGE

Over the past two decades, the Fed has become much more transparent than it once was. In the 1990s, it began releasing the results of its interest rate decisions and minutes of its policy meetings, as well as transcripts of those gatherings with a five-year lag.

Yet as institutions go, the Fed is hardly a paragon of openness. Chairman Ben Bernanke seldom speaks to the press on the record. When he does, it is often during well-orchestrated, pre-vetted events. During the financial crisis, Fed lending to troubled financial institutions, including the infamous rescues of AIG and Bear Stearns, was done hurriedly and behind closed doors, fostering public suspicion and political ire.

The Fed's opaque communications structure makes it easy for markets to misinterpret the rather terse policy statements released after each meeting, adding to the demand for kernels of wisdom about their decisions.

The pitfalls of the Fed's communication strategy were highlighted by the August 10 meeting. Just a few weeks earlier, Bernanke had spent the bulk of his testimony to Congress discussing the central bank's eventual exit from its ultra-accomodative policies. And the Fed had done little to explain to markets the link between the economic outlook and the size of its balance sheet.

For many investors, therefore, the policy pivot on August 10 -- the decision to buy more bonds -- came out of the blue. Markets broadly took the Fed's move as a significant shift toward more support for the economy. Some market participants also interpreted it as a sign the Fed was more worried about the economy than it was letting on.

When its policymakers are on the same page, the Fed often has no trouble making its position known following its FOMC meetings. But when policymakers disagree, as has been the case recently, the cacophony of voices can merely confuse markets.

That may be one reason Fed officials feel the need to help investors better understand the public statements they make.

Other central banks around the world try to avoid such risks by taking a different approach. Some strip away some of the mystery around policy by stipulating a specific inflation target. The European Central Bank holds a press conference after its key meetings that gives its president, Jean-Claude Trichet, a chance to explain the reasoning behind its actions in a public forum.

"If Bernanke can't stop the leaks he ought to have a full press conference after the meeting. It's inappropriate for certain people to gain an advantage on information from the Fed," said Ernest Patrikis, a former No. 2 official at the Federal Reserve Bank of New York and now a partner at law firm White & Case.

CLUB FED

For the U.S. Federal Reserve, the willingness to share market-sensitive information may reflect the institution's history and culture. Critics have long argued that the central bank has been too close to the financial industry.

The Fed was established in 1913, in part as a response to the panic of 1907, by bankers who wanted a lender of last resort to help prevent frequent runs on the nation's financial institutions.

Bankers still serve on boards of directors of regional Fed banks and former Fed staffers are hotly sought after on Wall Street and in the investment community.

Meyer founded his consulting firm, then called Laurence H. Meyer and Associates Ltd, before joining the Fed in 1996. When he left the Fed in 2002, he returned to his firm, now called Macroeconomic Advisers.

Another example is Susan Bies, who retired from the Fed's board in 2007, and took a job on the board of Bank of America in 2009. A number of chief economists at top U.S. banks at some point have also held staff positions at the Fed.

Going the other way, William Dudley, head of the powerful New York Federal Reserve Bank, was the chief economist at Goldman Sachs and a partner at the firm.

Critics say this revolving door structure makes it difficult for Fed staffers to be disciplined in not inadvertently revealing too much in conversations with old colleagues and friends.

Fed board staffers who retire even get to keep their pass for the central bank's building, which boasts fitness facilities, a barber and a dining room.

Though their identification badges designate their "retired" status, they are not restricted to where they can go once inside the building -- even if they now work in the private sector.

Nowhere is the sense of cliquish old-world camaraderie more evident than at the Fed's annual gathering for world central bankers in Jackson Hole, Wyoming. Receiving an invitation to the exclusive event is no small feat, and economists take pains to get themselves on the short list. Being there means face time with Fed officials in an informal setting -- and more importantly, a stamp of legitimacy that is difficult to put a price tag on.

This year's conference, held in late August, featured not only panels on monetary policy and a string of speeches from leading central bankers and academics, but also an unusual evening excursion to watch a horse-whisperer tame a wild stallion.

"Too often, the Federal Reserve believes that rules do not apply to them," said Sherman at Salient Partners. "If we allow some to have access, then how are we different than those that follow 'crony capitalism' in the Third World?"

The Secret of Oz

vidlink

Interesting documentary about monetary reform.

The Federal Reserve: No exit

I disagree with this article's rosey outcome but it's opinion on the Fed is interesting.

Despite internal dissent, the Fed plans to maintain ultra-easy monetary policy
Apr 22nd 2010 | WASHINGTON, DC | From The Economist

AMERICA’S GDP is growing, the stockmarket is buoyant. Yet one thing has not changed: the Federal Reserve’s monetary pedal remains firmly pressed to the floor. For more than a year it has kept its short-term interest-rate target near zero while pledging to keep it there for an “extended period”. It has also bought $1.7 trillion of long-term bonds, primarily mortgage-backed securities (MBS), to keep long-term interest rates down.

That is unsettling some inside the Fed, fuelling speculation it will soon signal an exit from that ultra-easy monetary policy, perhaps even by altering its “extended period” commitment when its next two-day policy meeting wraps up on April 28th.

The most vocal dissident is Thomas Hoenig, president of the Federal Reserve Bank of Kansas City and the Fed’s longest-serving policymaker, who has twice formally objected to the Fed’s “extended period” language. That commitment plus zero rates, he explained on April 7th, lead “banks and investors to search for yield… take on additional risk [and] increase leverage”. He argued the Fed should soon raise rates to 1% to “end the borrowing subsidy”.

The next day Narayana Kocherlakota, president of the Minneapolis Fed, voiced a different concern: that the excess bank reserves created by the Fed’s MBS purchases create the potential for high inflation. He advocated selling $15 billion-25 billion of MBS a month, which would clear the Fed’s inventory in five years instead of the 30 it would take for the bonds to mature.

The rest of the Fed and its chairman, Ben Bernanke, have listened politely but are not ready to drop or even water down the “extended period” language, much less raise rates. Dropping the commitment would be tantamount to a tightening of monetary policy as bond yields rise in anticipation of short-term rate hikes. Mr Bernanke has already said the Fed would eventually sell some MBS, but not now. By pushing up long-term rates that too would be a tightening of monetary policy.

Bank credit is contracting and getting more expensive. Excess bank reserves will not lead to inflation so long as the Fed can still raise interest rates, which it can. Indeed, the Fed has an embarrassment of ways to tamp down inflationary pressure when the time comes, from raising interest rates on excess reserves to selling bonds to telling banks to tighten lending standards. It has far fewer tools at its disposal for battling deflation, not a remote risk.

Still, as long as the recovery proceeds, the debate cannot be put off forever. The Fed will spend a lot of its policy meeting talking about how to talk about its exit. The Bank of Canada has helpfully provided a tutorial. On April 20th it dropped its own commitment to keeping its short-term rate at 0.25% until the second half of this year, citing stronger growth and firmer inflation than expected. “The need for such extraordinary policy is now passing, and it is appropriate to begin to lessen the degree of monetary stimulus,” it said. Bond yields and the Canadian dollar rose in response.

The Fed also sees its “extended period” commitment as conditional. It does not mean six months, as many seem to think, but only as long as unemployment remains high and inflation (both actual and expected) stays low. If those things change, so will interest rates.