Federal Reserve Chairman Ben Bernanke is a man on a mission.
He spent years studying the Great Depression and Japan's deflationary malaise. The lessons learned served him well in 2008 as he helped pull the economy and financial system back from the brink. The solution was simple: Print more money to lower interest rates. And, if needed, drop it from helicopters.
So as the depth of the Great Recession became clear, "Helicopter Ben" swung into action. He pushed short-term interest rates to near zero in late 2008 and has kept them there. That wasn't enough. So over the past year, Bernanke's Fed bought more than $1.7 trillion worth of long-term debt, which has the effect of pumping money into the economy. The monetary base more than doubled.
As a result, the financial system was able to recapitalize, consumers were able to refinance and cut their debts, and the economy started to grow again.
Now, with unemployment stuck near 10%, inflation hovering near 1% and Washington gridlock virtually guaranteed after GOP gains in Tuesday's election, the Fed has announced its intention to purchase an additional $600 billion worth of Treasury bonds -- a strategy dubbed "quantitative easing" or "large-scale asset purchases," depending on whom you ask. Call the actions QE2 or LSAPs, the result is the same: An impatient Fed is trying to boost the economy by creating inflation and encouraging people to borrow more money.
But that's a recipe for disaster. It risks undermining the economy and sets the stage for a massive credit-fueled asset bubble that makes the housing downturn look like child's play.
Meltzer isn't alone in his criticism. A collection of famous economists, strategists and money managers, including Jeremy Grantham, Bill Gross and Joseph Stiglitz, have come out against Bernanke's latest plan. Gross calls the Fed's propping up of the bond market with newly created dollars "somewhat of a Ponzi scheme." Even Warren Buffett is warning against buying bonds.
Fighting the wrong war
Despite Bernanke's obsession, our problem isn't Japanese-style deflation. Nor is the economy threatened by a double-dip recession. Recent data points suggest both inflation and economic growth remain well clear of danger. The Dallas Fed's preferred measure of annual inflation has increased from 0.5% in May to 0.8% in July to 1% now. A recent study by the San Francisco Fed found the bond market was pricing in only a 5.3% chance of sustained deflation over the next three years.Recent data have been encouraging. The Empire State and Chicago PMI business activity surveys have come in well ahead of expectations. Economic growth in the third quarter increased to 2% from the 1.7% seen in Q2, thanks to increases in consumer spending and businesses rebuilding inventory. And the October ISM Manufacturing Index jumped on a burst of new orders and strong employment gains. These are all positive signs.
Instead, the current problem facing the economy is deeply entrenched unemployment caused by structural factors like homeowners with negative home equity being unable to relocate, a skills gap between vacant jobs and idled labor, and the ongoing deleveraging of overly indebted households. (They're paying off debt, not buying stuff.)
The Fed has already done all it can; now it must wait for its monetary stimulus to work through the economy.
Continued: Hey, Ben: It's working
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