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In past Money and Markets columns, I have been skeptical of Ben Bernanke’s and the Federal Reserve’s policies of keeping interest rates low and purchasing trillions of dollars of securities in an attempt to heal the badly damaged U.S. financial system.
In my Oct. 30 column, I wrote: “The Fed’s actions have encouraged large banks to engage in strategies that are actually harming the economy and damaging the financial system at the same time.”
On Nov. 6, I followed up by saying: “We live in an upside-down world where the actions of central banks are destroying savers who rely on interest payments and fixed coupons from their bonds.”
But in the same column, I defended Bernanke when I used an analogy created by Jefferies & Co.’s chief market strategist, David Zervos, comparing Bernanke to Col. Nathan Jessup — a character played by Jack Nicholson in the movie A Few Good Men — who was guilty of using unconventional approaches to discipline to preserve America’s freedom.  Â
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| Ben Bernanke is regarded as one of the world’s foremost experts on the Great Depression. |
Upon closer examination, Bernanke’s background reveals that he is a soft-spoken academic whose personal story is inspiring. He grew up in the Southern town of Dillon, South Carolina. Through his natural intelligence and hard work, he was admitted to Harvard, where he graduated with distinction, and soon thereafter began a distinguished academic career at MIT and Princeton.
Often when Bernanke is speaking to Congress, his voice cracks slightly, making it appear that he would rather be writing academic papers or lecturing to a class of graduate students than dealing with a group of cynical politicians. However, he is regarded as one of the world’s foremost experts on the Great Depression. And as a student of history, he knows that too much debt in the financial system can be disastrous.
He genuinely believes that, without the Fed’s current easy-money policies, he would be condemning America to a decade of breadlines and bankruptcies. Thus, he has vowed that he will not allow another Great Depression to destroy the American economy.
Bernanke understands that the world has far more debt than it can repay. That’s because debt can only go away by: 1. the borrowers defaulting; 2. paying it down through economic growth; or 3. eroding the burden via inflation or currency devaluations.
In the past, we would have seen defaults. But defaults are painful, and no one wants them. We don’t like pain.
Growing our way out of our problems would be ideal, but it isn’t an option. Economic growth is, at best, anemic everywhere you look.
That’s why Bernanke is left with one unconventional solution to the debt problem that plagues the U.S. and the rest of the world. It’s a solution that I described in my June 26 column, but it’s so fundamental to what’s currently happening that it’s worth repeating with a little tweaking for Bernanke’s benefit:
Imagine a small town on the East Coast where the holiday season is in full swing. But like in the rest of U.S., there is not much business happening.
Everyone is heavily in debt.
Luckily, Federal Reserve Chairman Ben Bernanke arrives in the foyer of the local hotel. He asks for a room and puts a $500 cash deposit on the reception counter, takes a key and goes upstairs to inspect the room.
The hotel owner takes the money and rushes to his meat supplier to whom he owes $500.
The butcher takes the money and races to his supplier to pay his $500 debt.
The wholesaler rushes to the farmer to pay $500 for the pigs he purchased some time ago.
The farmer triumphantly gives the $500 to a local business owner who gave him services on credit.
The business owner goes quickly to the hotel as he owes the hotel operator $500 for the conference room he used to meet with customers.
At that moment, Bernanke returns to the reception desk and informs the hotel owner that his room is unsatisfactory. So he takes back his $500 and leaves.
There was no profit or income, but everyone in the town no longer has any debt, and the townspeople can look optimistically to their future. It’s a brilliant solution.
That imaginary anecdote demonstrates how the creation of new money, combined with the power of monetary velocity — that is, the speed at which money moves through the economic system — could work together to solve the financial crisis.
Indeed, Bernanke’s monetary policies do provide hope. And it’s hope, combined with more easy money from the Fed, that is pushing the U.S. stock market to all-time highs. Let’s keep our fingers crossed that these levels are sustainable, but I highly doubt it.
Best wishes,
Bill
Bill Hall is the editor of the Safe Money Report. He is a Certified Public Accountant (CPA), Chartered Financial Analyst (CFA) and Certified Financial Planner (CFP). Besides his editorial duties with Weiss Research, Bill is the managing director of Plimsoll Mark Capital, a firm that provides financial, tax and investment advice to wealthy families all over the world.
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Your example doesn't make sense. Where did the hotel owner get the 500 to repay Ben? He doesn't have the cash any more because he paid his meat supplier. Either he had the extra cash in which case he now has 500 less in his pocket or he went out and got a loan! No new money created in the end.
The $500 starts with Bernanke and it goes to the meat supplier/the butcher, who then takes it to his meat suppler, who in turn takes it the farmer, who then pays a local businessman, who returns it to the hotel owner because the businessman rented a conference room at the hotel. And then it is returned to Bernanke. It's a complete circle.
Best,
Bill
If the solution is so brilliant, why isn't it working (for Main Street)? Isn't it because the new money never leaves Wall Street?
Yes, that's absolutely what is happening — it never gets to Main Street. That's because the money multiplier has collapsed. This week's article on Wednesday will explain it in great detail. Please stay tuned.
Best,
Bill