The Federal Reserve’s decision to continue its policy of extraordinary monetary easing through at least mid-2013 is indicative of the Fed’s support of the government’s decision to raise the debt ceiling over this same period. This will help keep long-term interest rates moderate through Fed purchases of government bonds and could help dampen bond market fluctuations because of the recent downgrade of US Treasuries by S&P.
The financial markets have reacted to the decision favorably as can be expected. The Federal Reserve administered a positive monetary shock (surprise) to the falling markets. When the monetary surprise will be built into expectations, ceteris paribus, markets will eventually settle down to focus on real variables and price/earnings (P/E). Risk to personal consumption, however, should prevent markets from overreacting to Mr. Bernanke’s money supply if domestic real investment does not show a trend increase.
The rise in domestic investment appears to be because of the cheap dollar and the associated rise in exports and favorable conditions for import substitution, though its full effects on the employment situation are yet to be known.
The reliance on exports for raising domestic investment to create employment for the purpose of assuaging the downward pressures on consumption and alleviating employment uncertainty poses significant downside risks to economic growth and especially when government investment and consumption could be stagnant through mid-2013 together with the rising uncertainties in the global economy.
Relenting to the desire of the Congress and the White House, the Federal Reserve could also serve as the investment bank of the United States, provided it divests itself of its responsibility to regulate commercial and non-commercial banking entities and consumer affairs from within the Federal Reserve.
The Federal Reserve’s reluctance to engage in industrial policy under the provisions of the Federal Reserve Act (FRA) during these uncertain economic times for the US economy is, therefore, disappointing.
To note is the dissent of the known inflation hawks, presidents of Federal Reserve Banks of Dallas, Minneapolis and Philadelphia, not to commit in advance to this extended period of monetary easing, perhaps due to the rising inflationary pressures (pending FOMC meeting minutes and forecast data).
To avoid the 2006-2008 run up in commodity and agricultural prices after the housing decline, foreign portfolios, in response to monetary easing, could consist of unsterilized dollar reserves from their government sale of US financial assets; export of sterilized and unsterilized dollar reserves and emerging market currencies abroad, mostly to Africa, to acquire natural resources, including land; and returning the dollars to US capital markets to export inflation into the United States. Foreign non-European central banks could steadily increase reserve requirements to tighten their monetary policies.
Our reading of the politics of the Fed’s decision before the general election of November 2012 is that during the next recession, when US inflation dips because of negative growth rates and higher unemployment, Mr. Bernanke could implement industrial policy through the Federal Reserve for economic recovery, unlike the FDR-Marriner Eccles Fed since 1934, to avert another panic of depression and be reappointed to a third term in 2013 by a Republican president, to return to his Bush 43 roots of 2003 and 2006.
Then he is likely to support the new president to undo the Obama reforms he had supported from 2009-2013, including the Dodd-Frank financial regulatory law, on the pretext of budget constraints and the long run economic consequences of the Obama reforms.
Mr. Bernanke could also then make the Fed more transparent by instituting an explicit numerical inflation targeting range and release the Fed’s Greenbook and Bluebook staff analyses of economic conditions and policy options to the public and Congress, having displaced all internal opposition at the Federal Reserve to these Federal Reserve reforms.
We believe that the Fed Chairman had every opportunity to make these decisions since he took office in 2006 after a stint as a Fed Governor from 2003-2006, which included a brief appointment as Chairman of the President’s Council of Economic Advisers (CEA) in 2005, to avoid or substantially mitigate the current economic predicament of the United States because Mr. Bernanke’s possible future actions date back to sensible advice in real time, during the period 2006-2010 as the economic crisis was unfolding and when the principal threats were disinflation and deflation, from the author causing controversy at the Fed when this author was a non-economist Research Systems Analyst (RSA) at the Federal Reserve.
Mr. Bernanke has seriously compromised monetary policy independence at great risk to the prospects for American prosperity. He is responsible for the divergence of financial market performance and real economic growth because of gross errors of judgment at critical times since he was confirmed as the Chairman of the Federal Reserve first in 2006 and again, contentiously (unprecedented in Federal Reserve history), in 2010 but supported all along by the White House and personally by the president.
The political risks are, therefore, Barack Obama and Ben Bernanke. There is no reason why foreigners should continue to want to buy new US debt to support ever higher debt ceilings at low yields, forcing the Fed to keep buying bonds to keep yields low.
The United States is caught in a liquidity trap risking Japan’s and other nations’ investments in US debt.