The Bernanke Blind Side

You want to know what really scares me? That the money-printer-in-chief — the man in charge of the printing press for the world’s dominant paper currency — the chairman of the U.S. Fed is so completely beholden to the mainstream macro consensus that he is entirely incapable of even comprehending that his policy could do more harm than good.

Case in point: The July 13, 2011 exchange between the Austrian-schooled Republican who “gets it” Whiskey bar favorite Congressman Ron Paul and the Fed chairman.

What strikes me is not Bernanke’s struggle to explain the monetary function of gold, but something else. It’s something that scares the living bejesus out of me whenever I hear Bernanke testify.

Before I say what it is, let me stress that I don’t much like the widespread demonization of the Fed chairman. I think he was sincere when he said that he never cared about the management or the shareholders of the Wall Street firms he invariably bailed out and is generously subsidizing. He really believes that what he is doing is helping the U.S. economy and the U.S. people.

The problem is not that he is evil or dumb – I think he is neither – the problem is much bigger. You can deal with people who are evil and dumb. Deeply-convinced do-gooders in positions of almost unchecked power, those are the ones we should worry about. The good intentioned can suffer from tunnel-vision, incurably in awe of their own theories and are incapable of even grasping how what they are doing could make things worse.

Market manipulations — keeping rates artificially low and bank reserves expanding – are creating momentous dislocations, vast problems with as-yet incalculable consequences – even if they do not generate instant hyperinflation or intolerable expansion in the wider monetary aggregates.  This only looks deceptively harmless through Bernanke’s narrow prism of national account statistics.

Mr. Bernanke suffers from a blind side: He can’t see that ‘elastic’ money is always destabilizing. In my forthcoming book, Paper Money Collapse, I show how any expansion in the money supply (including bank reserves) distorts relative prices, always and everywhere. Even if some fortuitous rise in money demand cushions some inflationary impact and if inflation measures therefore remain contained.

Every money injection disrupts the market’s setting of interest rates, thus disorienting the process of coordination between true savings and investment and capital formation.

Bottom line: Interest rates are market prices, Mr. Bernanke, and you interfere with them at your peril!

I didn’t discover this, of course. I owe much to Ludwig von Mises and the young F.A. von Hayek. Ron Paul understands them, Bernanke doesn’t.

Bernanke: Man on a Mission – To the Wrong End

Bernanke upholds the original mission of the Federal Reserve: to avert credit contraction and debt deflation at all costs. During the Q&A, he reminded the laissez-faire Congressman Paul of the bank runs of the 19th century. Instability in banking — and in the wider economy as a result of banking — should come as no surprise to anybody who understands the practice of fractional-reserve banking.

Today, banks are money-producers. But here’s the problem: whenever the economy slows, the nervous public ditches deposit money for ‘real’ money. In fact, we want money that is not somebody else’s liability, such as gold or, even, state paper tickets. The banks then have to contract the supply of deposit money — shrinking the supply of what is used as money in the economy — thus exacerbating the recessionary forces in the economy.

The Fed Reserve wanted to avoid recessions — or shorten them –and avoid credit contraction. What they thought was needed is some form of elastic money so that in economically challenging times the banks do not have to contract the supply of credit.

It is almost comical how Mr. Bernanke seems to say, why are you criticizing me? I am spending all this money, but it doesn’t add to the federal deficit. I am printing this myself. I just press a button. Money printing is costless. And I can help the economy.

The Austrians know that such a powerful threat to the banks is brought about by the banks themselves! The lowering of reserve ratios and the creation of deposit money leads to a credit boom which always creates imbalances — in the saving-investment equation — and thus must end in bust.

What the Fed is trying to do is destined to fail. It cannot solve the problem. It must exacerbate the problem. Bernanke believes that with his all-powerful printing press he can always buy another recovery. For him his job appears to require an astute balancing act between the two things his macro-tunnel vision allows him to see: the trade-off between growth and inflation, both — so he believes — neatly observable with macro-statistics (the fetish of the economics profession). He cannot grasp the distortions in prices he creates, the misallocations in capital he furthers, and the accumulation of debt he encourages. None of them register on his statistical radar.

The debt-ceiling debate in the U.S. is trivial. What matters is this: as long as there is a Federal Reserve and as long as it is run by men like Mr. Bernanke — dedicated, smart but hopelessly committed to a flawed belief system — the economy will not be a capitalist one, benefiting fully from saving, entrepreneurship and true capital accumulation but will always be addicted to easy money, cheap credit and propped up asset markets.

What Will Happen Next?

Like a little hamster in his hamster wheel, Mr. Bernanke will only run faster and faster. Next, the interest rates that banks get on their deposits at the Fed will be cut to encourage more lending. The Fed will conduct QE3, and then QE4, and so forth. Maybe they will not call it that, but in effect that is what the Fed chairman’s own belief system will force him to do.

The size of the accumulated dislocations is already too gigantic today to allow any politically acceptable correction. Nobody had the stomach for it during Lehman. Nobody has the stomach for it today. In the monetary environment the Fed maintains, deleveraging will never be accomplished. Mr. Bernanke digs himself deeper into a hole that he won’t get out of when the market demands higher interest rates to maintain confidence in the paper dollar.

Paper money systems collapse — and they have all collapsed, throughout history and without exception — not because the money printers don’t understand inflation. They simply always reach a point when they fear the immediate impact of turning off the monetary tab more than the further printing of money. Of course, the disaster in the end is only bigger.

Bernanke is no James Bond villain out for world domination or even a big Wall Street payout. He is more the mad  professor in some sci-fi B-movie, unwittingly in cahoots with the forces of destruction not out of mean-spiritedness but out of intellectual hubris and infatuation with his own theories and technical wizardry.

Utterly convinced that he has worked out all the effects of his manipulation of the money supply and of interest rates, Bernanke can’t see why anybody would not want him to go on manipulating. In the meantime, debasement of paper money continues…


Detlev Schlichter