Bernanke's QE Magic Trick
By Thornton Oglove - July 26, 2013
This article originally appeared on the The Motley Fool Blog Network on July 25, 2013.
In May of this year, Federal Reserve Chairman Ben Bernanke suggested to a congressional panel that the Fed could taper its policy of Quantitative Easing (QE). The obvious happened -- the stock market took a quick hit, and interest rates spiked.
So Bernanke pulled a quick change, saying the Federal Reserve will continue an open-ended policy of QE, which artificially suppresses interest rates but immeasurably helps the housing, bond and stock markets. This was a calculated act to test the reaction of the markets.Their negative response validated what Bernanke already knew to be true, that the Fed is trapped in its magic policy of Quantitative Easing, and it's going to be much harder to make it disappear than anticipated.
Bernanke will be exiting the Federal Reserve stage at the end of his term in January 2014, and returning to academia. I imagine he is glad to do so, leaving the possible tapering of QE to his successor. And, with only months left in his tenure as chairman of the Fed, it’s understandable that he would not want to show his hand and risk rocking the stock market.
Who's next in line?
So who would take Bernanke’s place at the Federal Reserve? One possibility being pulled out of the hat is Larry Summers, who was featured in the brilliant documentary, Inside Job, as being an ardent foe of derivative regulation. I'd set the odds of a Summers appointment at 15:1.
Elizabeth Warren, the freshman senator from Massachusetts and former chair of the Congressional Oversight Panel to oversee the Emergency Economic Stabilization Act, commented that she would be for Paul Volcker to come back as chairman of the Fed. Volcker would be a great pick, but his policies are the antithesis to the current practices of the Federal Reserve. I could imagine the announcement of his return would send the stock market tumbling. I put the odds of that appointment at 100:1.
Most observers of the Fed rank one of its members, Janet Yellen, as President Obama’s likely pick to replace Bernanke. Yellen is even more of an interventionist and inflationist than Bernanke, and can be counted on to taper Quantitative Easing later rather than sooner,thus maintaining the illusion of a thriving economy.
Now, let’s look at the current consequences. Even though the housing, bond, and stock markets are addicted to QE, it has not been a magic cure. The artificially low interest rates on savings are costing Americans over $400 billion each year in lost income.
Bernanke acknowledges this, but claims it is necessary for the greater good of stimulating the economy. We also have higher inflation due to QE. The real inflation rate is running about three times the mythical CPI rate of 2%, and 1% core statistics that Bernanke has repeated so many times he's probably convinced himself they are true.
The Fed’s policy of Quantitative Easing is like waving a magic wand over the economy. Bernanke’s knack for pulling money out of thin air is a neat trick, especially for the multitude of people who take out mortgages, and invest in bonds and stocks. Unfortunately, we have to face the fact that the curtain will come down on QE, either by the hand of the Fed or by the pressures of inflation, and it’s impossible to predict when. All I can say is, if Houdini were alive today, he’d be an economist.
Thornton Oglove is a well-known Wall Street veteran, the former publisher of The Quality of Earnings Report, and the author of the book "Quality of Earnings: The Investor's Guide to How Much Money A Company Is Really Making." He lives in San Francisco with his wife, Susan.