Friday, July 8, 2011

Bending Ben Bernanke

The sainted Anna Jacobson Schwartz once told Ben Bernanke that he was out of his league ( She was right. Ben Bernanke has been the most malleable Fed chairman since G. William Miller and is in the discussion for the worse Fed chairman ever (although Paul Krugman would nominate Alan Greenspan). Bernanke has been the ultimate accommodator to the administration. If the Fed did not monetize the national debt by directly buying Treasurys, the fiscal policy initiatives of the administration would have collapsed under their own weight. Let me explain. The administrations' dramatic $2 trillion increase in spending could only occur if they got "revenues" from increasing taxes or by selling Treasurys. They did the latter. However, the market only wants a certain amount of Treasurys for portfolio reasons and will not buy more than that amount. In rides the Fed who then purchases them directly from the Treasury. In addition to buying commercial paper, mortgage backed securities and who knows what from the private sector, the Fed bought from the Treasury as well. Now I am perhaps the only one who is not overly critical of the Fed buying from the private sector. Those purchases are actually collateral for loans at the discount window and will be bought back by the borrower when the loans are repaid. If the loans default then the Fed can either sell the collateral or sit on it. Buying Treasurys directly is entirely a different matter. If the Fed did not buy them, then the ability of the government to expand its spending is curtailed. This is why I would like to see a law prohibiting the Fed from purchasing Treasurys directly except in the case of a national emergency declared by the president and confirmed by a super-majority vote in both houses of Congress. Why the Bernanke Fed has chosen to abdicate its independence is beyond my pay grade but there is hope. With Obama sliding in the polls and looking increasingly like a one term president, Bernanke has a chance to grow a set. If a new president is elected, Bernanke should know that he will not be re-nominated as Fed chair. His only hope would be to start asserting his independence and conducting monetary policy for the good of the country rather than for the good of the party in power. Let's hope that it is not too late.

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