I watched Ben Bernanke testify for a while yesterday morning before a Senate Banking Committee. This itself, of course, is kind of a weird thing to do. I noticed that even the Senators were getting a little better at handling the nuances, the strange little ins and outs and what-have-yous (as Dude Lebowski would say) of the relationship among the Federal Reserve, the Treasury and the U.S. money supply. Not that they actually understand all of this: these are American politicians, after all.
The Chairman was taking some heat from Senator Robert Corker of Tennessee on these very topics yesterday. Bob seems to be a Tea Party type, with that sense of omni-directional, poorly-focused rage against, well, everything, that seems to typify this "movement." One curious aspect of this Politics of Resentment is that it's always been the Tea Party, and not the Democrats, who have led the fight against Too Big to Fail, against TARP and the sequential bailouts, and the financial oligopolies who hold the national government as another asset on their books. The Democrats are fine with all that. Bernanke is the nominal leader of the financial cartel, the head honcho of the "public-private" combine known as the Federal Reserve System, and Bernanke is the Democrats' guy.
Although, nominally, Bernanke is a Republican appointed by George W. Bush. As I said, this is all suffused with the aura of the quantum physical world. Anyway, the hot topic du jour is the "unwind" of the Fed's balance sheet, that bloated financial document showing just north of $3 trillion in assets, consisting mostly of Treauries ($1.7 trillion) and mortgage-backed securities (MBS - just over $1 trillion), and a smattering of other things. This is an arcane subject, certainly, and it is premised on the idea that interest rates, at some future, undetermined date, will go up, and then the Fed is going to be presented with some difficult problems vis-a-vis its balance sheet. To wit, the balance sheet assets of the Fed are "interest rate sensitive." The Treasuries on the balance sheet in particular have a face value that is inverse to the interest rates generally prevailing in the economy; since the Fed has labored mightily to force interest rates down across the board, the Treasuries on its balance sheet (all $1.7 trillion of them) have a low yield, historically speaking. Who would buy these bonds from the Federal Reserve on the open market if Treasury rates available in regular auctions are significantly higher? Wouldn't the Fed have to discount its Treasuries heavily in order to sell them to the public? This is the heavy question. Thus, the Fed, having made up the money to buy these $1.7 trillion in bonds out of thin air, would "lose" money when it sells the bonds to the public measured as the difference between the (positive) amount it receives on their discounted value and zero, the amount the Fed actually paid. We should all be lucky enough to sustain such losses. This is the big problem that Corker was presenting to Bernanke.
The contraption the Fed is running goes sort of like this: in 2007, before the Great Recession hit (or, you might say, before the fundamental weakness in the American economy was revealed), the Fed's balance sheet stood at $869 billion, and almost all of it was Treasuries. The is was the "monetary base" of the U.S. money supply. The banks in the Federal Reserve system held only nominal "reserves" on the balance sheet. Everything was hunky-dory.
Then all Hell broke loose. The housing bubble burst, the stock market tanked, unemployment skyrocketed. Riding to the rescue was the Fed and U.S. Marshal Wyatt Earp, disguised as a mild-mannered, bald, bearded academic from the Princeton Economics Department. A student of the Great Depression and the Japanese "Lost Decades," Gentle Ben was presented with a chance to try out his somewhat unconventional monetary ideas: to wit, he would hallucinate money, buy up everything in sight, and singlehandedly prevent the overvalued assets of the American market place from deflating in value. The Fed's efforts are reflected in its current H.4.1 statement (I told you I'd gone off the deep end). http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab9.
You see, down deep Ben Bernanke is identical to his colleague at Princeton, Paul Krugman. The U.S. monetary system, in some deep, fundamental way, isn't "real." It's just like quantum physics - it's what we "observe" it to be. It is money seen through the lens of the Copenhagen Paradigm. The economy is not a "morality play" (Krugman's favorite phrase) and there is no need to suffer. House prices can be reinflated, if you are ingenious enough and (this is huge) if you happen to be the issuer of the world's reserve currency. Other countries tied to our system through globalization have to sit still for our shenanigans because everybody needs bucks in order to buy oil. The stock market can be revived. A "wealth effect" can be generated that will get everybody back to work, planning parties, tanning at the local salon. Planning & tanning: just like the good ol' Consumer Economy!
And c'mon, admit it: it's kinda worked, hasn't it? Housing prices in California have gone up about 8% in the last year, and they're predicted to do the same in 2013. That's more or less what was happening in the years leading up to 2006. The stock market? Need you ask? To the moon, Alice!
This befuddles the moralistic tut-tutters. There should be a steep price to pay for such unearned wealth -- shouldn't there? You can't really sustain an economy just by tapping in long strings of zeroes on Bernanke's computer in the corner of his office. Can you?
Corker and the other Mad Hatters in the Tea Party are seething with rage as this genial, somewhat defensive, 1600-on-his-SATs Jewish guy (I was kidding when I said Kevin Phillips was smarter - no one is smarter than Bernanke) bats away their impotent questions with answers he's already thought through with more penetrating clarity than they have.
Although, there might be one little teensy-weensy weakness in this whole situation. One tiny point of metal fatigue in the Money Machine Contraption. Which I will take up next time.
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