PrintFebruary 27, 2010
Tough guy Bernanke blows smoke
Fed Chairman Ben Bernanke appeared before Congress this week wearing his "bad guy" face. I did not watch his testimony either day. Apparently, based on news reports and blogs, nothing of significance happened on the second day.
The Washington Times reported on Bernanke's Wednesday testimony:
With uncharacteristic bluntness, Federal Reserve Chairman Ben S. Bernanke warned Congress on Wednesday that the United States could soon face a debt crisis like the one in Greece, and declared that the central bank will not help legislators by printing money to pay for the ballooning federal debt.
"We're not going to monetize the debt," Mr. Bernanke declared flatly ...
These statements are unequivocal. It will be interesting to see how Bernanke rationalizes his way out of this testimony. I don't believe he can stop and pointed the reasons out in an AT post, Obama's Ides-of-March Moment is Near on 2/24.
My guess is that Bernanke's wiggle room will turn on something akin to what the definition of "is" is. It is likely to turn on a narrow definition of Quantitative Easing (QE) or "monetizing the debt." The Fed considers monetizing the debt a direct purchase of newly-issued Treasuries. But QE, as monetizing the debt is known, can be performed indirectly and, I suppose, claimed to be not QE
Here is a simple example illustrating both direct and indirect methods that show their equivalence. First the direct example: Suppose the Treasury was to issue another $50 billion of debt and the Fed bought it directly. That would clearly be considered QE. The nation's money supply would increase by $50 billion. The Fed's balance sheet would increase by $50 billion of new Treasuries.
Here is one way that indirect QE occurs and has occurred. A bank has toxic assets of $50 billion that it wants to get rid of. The Fed agrees to buy them at face value so long as the bank uses the proceeds to buy Treasuries from a primary dealer. The Fed's balance sheet has increased by $50 billion of toxic assets (presumably worth less) while $50 billion of new money has been created to buy them. The $50 billion goes into new Treasuries, recently bought by the primary dealer.
Economically there is absolutely no difference between the first and second example. They are both QE, regardless of whether the Fed says they are or not. To understand whether QE is taking place, all one has to do is look at the total assets of the Federal Reserve Balance Sheet. If they are increasing, QE is occurring.
You will know when QE stops one other way. Social Security or Medicare payments will stop.
Monty Pelerin www.economicnoise.com
