Martin Hutchinson: At last Thursday’s Fed meeting, Ben Bernanke finally played his last card. With an open-ended promise to buy $40 billion a month in agency-guaranteed mortgage bonds, the Fed Chief turned QE3 into a much larger gift called “QE Infinity.”
But the truth is he would have been better off if he had tried the helicopter.
For those who forget the reference, Ben’s first foray into national fame came in November 2002, when he delivered his famous “helicopter speech” at the National Economists Club in a Washington, DC Chinese restaurant.
Little did I know that day that I was about to witness history as Bernanke said the risk of deflation was so great that the Fed should drop interest rates to zero and consider using further measures — such as dropping $100 bills from helicopters — to “stimulate” the economy.
Of course, I blotted my Fed copybook for the next decade by asking a snotty question since I objected to his central premise that the risk of deflation was either imminent or would be disastrous when it happened.
The idea that deflation was imminent at the time was simply ridiculous. Consumer price inflation, on official BLS statistics which consistently understate it by about 1%, was 2.5% in 2002, 2.0% in 2003 and 3.3% in 2004.
Even then, Bernanke’s economics weren’t that well connected with reality.
The Problem with QE1…QE2…QE3 and QE Forever
The reality today is that it just doesn’t work.
Bernanke’s various “quantitative easing” policies have benefited primarily Wall Street; the mechanism by which they have fed through to the real economy is at best very indirect.
Currently for example, the Fed is now set to buy a total of $85 billion a month in long-term bonds, through the new mortgage bond purchases as well as the remains of his “Operation Twist” strategy.
This is supposed to lower interest rates, which in turn is supposed to support the housing market and produce jobs.
However the principal effect of all this Fed activity is to support stock prices, commodity prices and other asset prices. That’s why gold prices went on a tear after QE3 was announced, while interest rates have actually risen.
Traders have seen the limit of what the Fed can do to support the bond market and have begun to wonder whether the Fed’s activities will bring inflation. The question is what will happen to the bond market once Fed purchases slow. If the Fed’s efforts burst the bond bubble, $85 billion a month is nowhere near enough to begin to reflate it.
Meanwhile, in the real economy-the one where you and I live– not much changes.
Even if Fed purchases pushed down mortgage interest rates, we learned yesterday that mortgage originating banks, which must check all the documentation much more carefully than usual, cannot originate significantly more mortgages.
Indeed, borrowers are unlikely to see much benefit from a decline in mortgage bond yields; instead additional profits will go to – guess who? – the banks!
Even if lower mortgage rates increased housing sales, there would not be much effect on jobs. Maybe the new homeowners would buy some new furniture – mostly made in China, probably.
But housing construction would not suddenly surge – why should it? Not when there is still a vast inventory of unsold homes, homes held on banks’ books after foreclosures, and homes in mortgage arrears that are awaiting foreclosure.
The halcyon days of 2005, when laborers with neither skills nor large English vocabularies got high-paying jobs on construction sites, are not about to return.
And it will cost the Fed $40 billion per month!
Some of that will lead to inflation, but the real cost will appear when interest rates finally rise again and the Fed’s $2.6 trillion (and rising) of long-term bonds decline sharply in price, probably by around 20% if rates rise to their traditional levels in the 5-6% range.
That will cost someone 20% of $2.6 trillion. Want to make a guess who? Us! – as in, the Fed requires a massive humiliating bailout from the taxpayers.
Just Bill Printing and Helicopter Fuel
If only Bernanke had stuck to his original plan, it would have been so simple.
With a U.S. population of 310 million, $31 billion per month, dropped from helicopters, would have given every American man, woman and child an extra crisp new $100 bill per month.
Yes, it would produce an extra $31 billion per month on the nominal Federal budget deficit, but the Fed would have printed the new bills, so there would have been no additional strain on the nation’s finances.
It would be much better than a new social program, because there would have been no bureaucracy involved, just bill printing and helicopter fuel.
The money would nearly all have been spent, increasing consumption by perhaps $300 billion annually, creating perhaps 3 million jobs, and reducing unemployment by almost 2%.
And unlike with a government stimulus program, the money would have been spent on things people actually wanted. None of it would have been wasted on public sector boondoggles, “crony capitalism,” and administration.
Of course, it’s still as dumb an idea as it was in 2002, since it would cause an upsurge in inflation. But so do Ben’s current schemes, only they cause even more inflation because they’re quite a bit larger.
At least it would lead to some measure of fairness, though.
With real helicopters dropping money all over America instead of just one theoretical helicopter, hovering incessantly over Wall Street, real people might have actually gotten some of the benefit.
Thanks to Bernanke, all they got was you-know-what.
Related: SPDR Gold Trust (NYSEARCA:GLD), iShares Silver ETF (NYSEARCA:SLV).
Martin is a Contributing Editor to both the Money Map Report and Money Morning. An investment banker with more than 25 years’ experience, Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial markets. At Creditanstalt-Bankverein, Hutchinson was a Senior Vice President in charge of the institution’s derivative operations, one of the most challenging units to run. He also served as a director of Gestion Integral de Negocios, a Spanish private-equity firm, and as an advisor to the Korean conglomerate, Sunkyong Corp. In February 2000, as part of the Financial Services Volunteer Corps, Hutchinson became an advisor to the Republic of Macedonia, working directly with Minister of Finance Nikola Gruevski (now that country’s Prime Minister). The nation had been staggered by the breakup of Yugoslavia – in which 800,000 Macedonians lost their life savings – and then the Kosovo War. Under Hutchinson’s guidance, the country issued 12-year bonds, and created a market for the bonds to trade. The bottom line: Macedonians were able to sell their bonds for cash, and many recouped more than three-quarters of what they’d lost – to the tune of about $1 billion. Hutchinson earned his undergraduate degree in mathematics from Cambridge University, and an MBA from Harvard University. He lives near Washington, D.C.
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