More Fed Easing? What Could Bernanke Be Thinking?

Ben Bernanke
Ben Bernanke

Apparently the bar has just gotten lower for Ben Bernanke.

The central bank chairman stunned financial markets Wednesday when he told Congress that the next round of stimulus—much like objects in the rear-view mirror—is closer than it may appear.

While there were plenty of caveats and continued references to the slowdown being nothing more than a “soft patch” for those 14 million Americans without jobs, that bar for doing even more quantitative easing suddenly doesn’t look so high.

“Bernanke thinks the answer to everything is money-printing,” says Michael Pento, senior economist at Euro Pacific Capital in New York. “He thinks that’s what saved us from the Great Depression part two and that’s what could have saved us from the Great Depression part one. He’s doing what he said he would do, which is print money.”

“I can’t fathom the logic,” Pento adds.

Pento’s voice is a particularly important one on this issue because he’s one of the few economists of any stature who has been unrelenting in predicting a QE3 —or a third round of Fed easing.

Pento also has been one of the loudest voices warning about inflation dangers, even as the Fed has been working overtime to combat a perceived deflation threat and as most of Pento’s colleagues brush his concerns aside.

“Look at first quarter GDP and second quarter GDP. They will have a one handle,” Pento said as he watched Bernanke’s speech. (The “one handle” means GDP will be in the 1 percent range.) “It clearly puts Bernanke on the spot. I think he does what he does best, which is counterfeit the US dollar.”

The central bank chairman posed two scenarios: One in which the economy improves more than expected and requires tighter monetary policy, and another in which unemployment and housing weakness persists and the Fed is wrong about inflation pressures being “transitory.”

That would require more Fed intervention and, hence, QE3 .

You can guess which side the market took.

The Dow industrials surgedas soon as Bernanke began his speech, rising about 100 points along the way as the dollar got hammered and gold and silver prices rallied.

Since Bernanke delivered his seminal remarks at Jackson Hole, Wyo., last August signaling QE2, the dollar has lost nearly 10 percent of its value against the world’s currencies.

In the meantime, import prices have jumped about 13 percent and inflation has risen 3.6 percent, tamped down primarily by sagging housing and rent costs, which make up 40 percent of the government’s main price gauge.

The menu Bernanke laid out on Capitol Hill promises more of the same should the Fed come off the sidelines with the last pile of dirt only recently shoveled on QE2’s grave.

He is considering more asset purchases to lengthen their average duration, providing “more explicit guidance” on how long the Fed balance sheet will remain in its current state, and, perhaps most significantly, cut the interest paid on bank reserves at the Fed, a move aimed at jumpstarting lending.

“What I find most disturbing is he could lower the interest paid on excess reserves, which would be a huge impetus for commercial banks to make goofy, crazy loans,” Pento says.

Pento is surprised mostly by the timing—he figured QE3 wouldn’t rear its head until late this year or early in 2012 as Bernanke had indicated “he would be dragged kicking and screaming to QE3, but he would be dragged there.”

Most other economists who had dismissed the possibility of more easing figured Bernanke would only begin discussing it after a steep drop in the stock market, a rise to double-digit unemployment and signs that deflation again was a threat.

That’s not the way it went, as the Fed appears to have few concerns about inflation and more worries about trying to prop up an economy that so far has resisted the central bank’s intervention efforts.

“Can someone explain how the processes he used to combat deflation—lowering interest rates and expanding the money supply—if those processes are going to be intensified what makes him think inflation is going to be transitory?” Pento said. “The gentleman talking about exit strategies a little while ago is now talking about asset purchases and cutting rates on reserves. That sounds schizophrenic to me.”


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