Friday, March 20, 2009

Making Money. Literally.

I read an email by one of blogger Hugh Hewitt's readers, whose nom de plume is Banker Guy, who implied that Ben Bernanke is the one adult in government who has a clue. Banker Guy likens Treasury man Geithner to a hapless team quarterback who is stuck for a gameplan. When the quarterback asks for the next play, Coach Obama is unavailable by virtue of being interviewed by Jay Leno. "Then," says BG, "all of a sudden, a walk-on player runs onto the field, grabs the ball, and starts running through the opposition toward the goal line … its Ben Bernanke!"

Banker Guy is particularly taken with Wednesday's stunning announcement that the Fed will expand its balance sheet another $1.2 trillion through the purchase of $300 billion in long-dated Treasuries, $750 billion in mortgage-backed securities (Fan/Fred), and another $100 billion in
U.S. agency debt. Called "monetizing the debt" or "quantitative easing," the debt buy-back program essentially requires the Treasury to print money. Lots and lots of it. BG says this has spurred "some real optimism in the markets."

With all deference to Banker Guy, I am wondering why, if the Fed's debt monetization policy is
such a brilliant play, the Dow is down now over 200 points since it was announced. And if Bernanke is providing such "sound leadership," why did the Dow drop 122 points today in a slide that began just as the Fed chairman was speaking to community bankers at noon? I think Bernanke's policy is rightfully seen as a monetary "Hail Mary" pass, only riskier.

Perhaps investors have had time to think about the implications of the debt purchase program. Having run out the clock on its ability to manipulate rates at the short end, the Fed is trying to bring down mortgage rates by buying back billions of medium-term Treasuries,
agency debt, etc. To my knowledge this is without precedent.

The Fed's stated purpose is to free up private credit markets, something that trillions of dollars in bailouts, guarantees and credit facilities established since last summer have not accomplished (apparently). But the real story seems to be that the Fed is not convinced that recovery is imminent notwithstanding the bits and pieces of positive news that sparked the bear
market rally of the past weeks. Rather the policymakers appear to be still concerned, perhaps even panicked, that we are danger of falling into a deflationary spiral.

Even if it succeeds, the massive debt purchases will weaken the dollar, increase tensions with our trading partners, and perhaps ultimately lead to a catastrophic bursting of
the bubble in Treasuries. Why would the Fed embark on a policy which is designed to create massive asset inflation when the risk of success is bad and the risk of failure could be catastrophic?

According to Larry Kudlow, the four killers of prosperity are high taxes, high inflation, protectionism (currency devaluation) and increased regulation. It seems to me that Bernanke's prescription will result in all four.

I hope that Banker Guy is right, and I am wrong.

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