Federal Reserve Chairman Ben Bernanke likes to tout his expertise in studying the Great Depression. To show off the knowledge, he's taken a Fed balance sheet with $800 billion in Treasury securities a year ago and nearly tripled it to $2.26 trillion by acting as the toxic waste absorber for a financial industry run amok. Now Bernanke is planning to take that campaign to the next level.
How so? As I posted, Bernanke has run out of interest rate cutting ammunition -- dropping the Fed Funds rate from 5.25% down possibly to as low as 0.5% today -- so he'll start to use the Fed balance sheet to perform "quantitative easing." Bernanke has set short term interest rates to zero or below and now he'll try to do the same for longer-term ones, say, two year interest rates as well. One way to do this would be to purchase those longer-term Treasuries to inject more cash into the economy.
What affect is all this liquidity having on the economy? Things seem to be quite bad -- a 3.9% GDP decline is anticipated for the fourth quarter of 2008 and job cuts are rampant -- 1.9 million so far this year. The stock market has lost $30 trillion in value in the last year and home equity values have declined $6 trillion. Not only that, but consumer borrowing is down. That is probably because banks don't trust consumers to pay back the loans that the U.S. wants banks to make with our taxpayer money.
While the Fed would argue that things would be much worse without all the liquidity, I have not seen a compelling case for that position. Meanwhile, the Fed's once pristine balance sheet is now polluted with trillions of dollars of the worst financial toxic waste that Wall Street could dream up. I need help understanding how that does not put the Fed at greater financial risk.
Is it possible that what Bernanke thinks might have worked to cure the Great Depression in the 1930s does not apply to the current situation? That does not matter -- because if the only tool you have is a hammer, then every problem looks like a nail.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter
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Reader Comments (Page 1 of 1)
12-16-2008 @ 10:47AM
william lindblad said...
Ample comment, however it does not say much. Why waste the words to imply a critical position when you offer no alternative?
While I agree with Bernanke and many others, all of which are trying to compare the present with the 1930's or the the 1970's, what confronts all is an elusive situation that has some similarities, but is really unique - to itself. If ones goes back further, comparisons can be made to 1893 and 1857. If you really want to dig - back to 1816. Problem is that out of all of these only one is worldwide and that is 1816 and that was caused by a volcanic eruption, not humans. In short, the present is UNIQUE and nothing from the past will provide a solution.
If a solution is to be found it will be in the leadership of the major economies getting together and making an agreement to attacking one problem at a time - together. It will take the combined economic might of all, working unilaterally, to prevent a depression.
Considering that this has never happened, but depressions have, it does not take much to determine the immediate future.