Money for Nothin’

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To pick up where we left off on Friday, the Fed’s Ben Bernanke announced at its annual Jackson Hole gig that more stimulus money was probably on the way.  His reasoning was that the economic cycle we’re in has not yet been impacted enough by the Fed’s policy…so he’s going to do more of the same.  Does that seem strange to you?

By “economic cycle” he means that over time—since World War II, to be precise--the economy has moved in boom-and-bust cycles.   That is, there are times of economic expansion and times of economic contraction, or recession.  Past history shows that post-recession employment levels usually return to close to where they were before the recession began.

What structural changes?

As Bloomberg reported today:

“I see little evidence of substantial structural change in recent years,” Bernanke told fellow central bankers and economists at the annual monetary-policy symposium in Jackson Hole, Wyoming. “Following every previous U.S. recession since World War II, the unemployment rate has returned close to its pre-recession level.”

But are the problems that we face today really “cyclical”?  Or, despite what Bernanke says, are they truly structural in nature?

That’s a big question, because everything is affected by what the Fed does.  If we are just in a down cycle, as Bernanke says we are, then more stimulus spending, apparently, is the answer.

As noted in Bloomberg report, “Bernanke and his supporters argue that the sluggish recovery and lingering unemployment are more the result of temporary headwinds, such as tight credit conditions and housing-market weakness, and can be cured with monetary aid.”

But so far, only the banks and the stock market have benefitted from the stimulus money.  In fact, the latest figures show that US manufacturing is not growing, but unemployment is.

And, given that the financial crisis in which that the world finds itself is the most severe since the Great Depression—which happens to predate World War II—what makes Bernanke think that the problems are cyclical and not structural?

Who does Bernanke think he’s kidding?

Certainly not chaps like Richmond Fed President Jeffrey Lacker, Northwestern University’s Robert Gordon and Mohamed El-Erian and Bill Gross of Pacific Investment Management Co., who think that our problems are more structural than cyclical in nature.

Stimulus is the problem

The latter two believe that where we are today is the “new normal.”  They think that the economy has fundamentally changed, and therefore, that more stimulus by the Fed is not the answer that Bernanke thinks it is.

I tend to agree.  I have talked about this before in The Gorrie Details, how the stimulus strategy actually tightens credit availability while providing banks with more liquidity at the same time.  Bernanke himself wrote about that very effect in a research paper.   Banks are not lending so the “liquidity” never really enters the economy at large, but rather, stays within banks and large corporate balance sheets.  The small business community—which provides 70% of the jobs in the country—is largely shut out of the stimulus.

So that means that the “headwinds of tight credit and the housing market” are in fact, not really helped by the medicine Bernanke wants us to swallow.  It may, in fact, be making things worse.  How?  By making it easy for banks to get revenues.  They don’t have to lend money to make money, but just the opposite.  The less they lend, the more money they are paid by the Fed.

I called that the “Dire Straits effect”:  the banks are paid “Money for nothing.”  I would assume their checking is free also.

This doesn’t sound very “cyclical” to me; does it to you?

Truth is, one could persuasively argue that the very act of the Fed spending $2 trillion to buy Treasury bonds, mortgage-backed securities, stock futures, and other financial instruments that today would not enjoy sufficient market demand otherwise, is in itself a very significant structural change in the economy.  The market has said “no thanks” to much of our worthless or devalued debt.  Rather than let the market price the assets behind the debt correctly, however, the Fed has stepped in and kept prices artificially high.  That doesn’t sound cyclical either, does it?

The United States of the Federal Reserve?

Why is the Fed doing this?  It is a very fundamental shift in the American economic landscape.  The Fed’s mandate is to control inflation and help maintain full employment in the American economy; it is not, however, to take full ownership of the American economy.  But that is what is happening.  The latest recommendation is that the Fed have “open-ended” bond purchases whenever it was necessary.

Did I not get the memo? The Fed can now buy more of the country whenever it decides to?  The explanation is to support the economy, of course, but in theory--hopefully only in theory--the end result could be the Fed’s ownership of virtually everything.

Think about it; your bank may no longer own your mortgage; but the Fed quite possibly does.  The Fed also own big chunks of corporate America, as well; not to mention the possibility that it also owns the bank that issued your mortgage.

This where the Dire Straits Effect is even more evident:  not only do the banks get “money for nothin” from the Fed; but the Fed gets its money from nothin’.  Its ownership of all that it sees and wants comes from creating money out of...nothin.’

How do you make a bad economy worse and pick up the pieces for free?  In the words of Dire Straits, “That’s the way you do it.”

And those are…The Gorrie Details.

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