The era of Bernankeism
By Hossein Askari and Noureddine Krichene
Financial markets were again jubilant with the announcement that the US Federal
Reserve would resume a new round of massive liquidity injection that could
exceed US$600 billion. Optimism was fueled with the promise of a river of
dollars flowing into markets with traders betting on a strong US economic
recovery. It was to be business as usual: the same policymakers and the same
Yet after the markets absorbed the full implications of this second round of
quantitative easing (QE2), interest rates instead of declining increased
rapidly! The bond markets and the bond vigilantes have spoken and they show
little confidence in the Fed's announced policies.
As noted by the late Charles Kindleberger, cheap money would
be pouring into Wall Street and financial markets, causing speculative euphoria
and soaring asset and commodity prices. After two years of such policies,
President Barack Obama's unprecedented stimulus and record fiscal deficits
combined with Fed chairman Ben Bernanke's zero interest rates and unlimited
money injections have failed to restore employment and economic activity.
The blind application of the standard Keynesian model has failed to produce the
promised magic of full-employment. Disappointed, the US Main Street in November
voted out the democratic members of the US House of Representatives.
Accordingly, Bernanke appeared on a TV show to present his case and his
supporters claimed that record fiscal deficits and expansionary monetary
policies had worked and saved the US economy from Great Depression number two.
Supporters rightly claimed that massive liquidity injections had averted a
bigger fall in housing prices and had rescued banks from general bankruptcies.
However, by re-inflating the housing bubble, the housing crisis has been
In the supporters' imaginary simulations, without Bernanke's monumental
liquidity injection and near-zero interest policies, US gross domestic product
would have fallen by 12% in 2009 and unemployment would have been over 16.6
million. Hence, they credited Bernanke for creating 10 million "imaginary"
It would be inconceivable for Wall Street and Bernanke's supporters not to
praise his rescue efforts. Undoubtedly, without the Fed's massive liquidity
injections as lender of last resort, many unsafe banking institutions would
have gone the way of Lehman Brothers.
While Bernanke is credited for creating 10 million fictitious jobs, it was his
policies that in the first place endangered the banking sector, inflicted
severe damage to the US economy, and pushed fiscal deficits to record levels.
In large part it is the Fed that has caused the economic and financial chaos;
it is the Fed that is credited for rescuing the financial system and averting
Great Depression number two; it will be the Fed that will lead the US back to
Why, then, the lack of confidence in the Fed's announced policies?
Bernanke and the Fed create money out-of-thin air, meaning that there is no
real counterpart in commodities such as corn, crude oil, industrial products,
or medication. This is purely redistributive and identical to counterfeiting;
it confiscates real purchasing power from a group of economic agents in favor
of another group that receives the money created by the Fed. The redistribution
of wealth is achieved through inflation and higher external deficits, and in
the process creating economic distortions. The group that loses purchasing
power will have to consume less and invest less. The group that receives
purchasing power will enjoy wealth without creating real output.
A new round of money creation by the Fed would appear to have no justification.
US banks have been holding about $1 trillion of excess reserves for the last
two years, while their excess reserves were almost zero before September 2008.
American corporations are flush with $3 trillion in cash. Interest rates are
near zero and largely negative in real terms. Inflationary expectations are
intensifying as exemplified by the price of gold rising beyond $1,400/ounce.
Another $600 billion or more of Fed liquidity may turn out to be simply
The reason advanced by Bernanke for his new monetary stimulus is that the US
economy was not creating enough jobs while the rate of inflation is very low,
both in contradiction to the Fed's mandate to ensure full-employment and
increase the rate of inflation to a level consistent with full-employment.
Hence, in accordance to the Fed's mandate, Bernanke is compelled to inject as
much liquidity as required for achieving full-employment. He stressed that
monetary injection could even exceed $600 billion if employment rate is not
brought back to the full-employment level.
The Fed's full-employment mandate has proven to be unfortunate. By strict
adherence to this mandate, Bernanke's policies for stimulating the economy have
led to the worst financial crisis since the Great Depression. The US banking
system, after suffering monumental write-downs and surviving only after
trillions of dollars in bailouts, would not be in a position to lend its excess
reserves plus an additional $600 billion and in the process acquire more toxic
assets. At the same time, the subprime sector is over-indebted and is not in
the position to absorb $600 billion in a sound manner. As in the past, the Fed
seems to have largely ignored the safety of the banking system and more
generally that of the financial system.
A possible hidden reason behind the new round of quantitative easing is to
depreciate the real value of US debt through inflation and a depreciation of
the dollar. This would also generally depreciate the real value of debt and
enable debtors and mortgage borrowers to pay less in real terms for servicing
their loans. The debt hangover will be a burden for some time as the Fed
attempts to re-inflate the economy and reduce real debt.
The Fed's QE2 has added more fuel to the fire and has further heightened
instability and currency wars. Other central banks have become more vigilant
and cannot afford to be passive and see the value of their foreign exchange
reserves wiped out. They will try to manage this risk by holding gold as a
hedge against the falling value of reserve currencies. The new excess liquidity
created by the Fed will most likely find its way to speculative markets pushing
housing and commodity markets to levels far in excess of wage incomes,
squeezing purchasing power and choking the economy. Suppliers of commodities
could hoard commodities with a view to hiking up prices or hedging against
inflation. Inflationary expectations have gained strength worldwide
irrespective of Bernanke's representations to the contrary that inflationary
expectations as measured by long-term interest rates are non-existent.
Bernanke has in essence downgraded any relationship between housing prices,
commodity prices, exchange rates, and interest-rates. In this approach,
interest rates act only on employment - the lower the interest rates the higher
is employment; they have no significant effect on housing and commodity prices
or exchange rates.
Regardless of the price of gold and the consequent sharp depreciation of the US
dollar, the Fed has decided to increase its monetary injection. Since the Fed
pushed interest rates to near zero in December 2008, commodity price inflation
has resumed at rates rarely seen in the past. Over the last two years, under
the effects of near-zero interest rates and ample dollar liquidity, gold prices
have jumped from $756 an ounce in December 2008 to $1,430 in December 2010 (up
89%); crude oil from $44 per barrel to $91 (up 107%); copper from $1.29 per
pound to $4.2 (up 230%); sugar from $308 a ton to $738 (up 154%), soybeans from
$786 a bushel to $1,300 (up 65%); wheat from $457 a bushel to $730 (up 60%);
corn from $294 a bushel to $595 (up 102%); and coffee from $1.02 a pound to
$2.17 (up 113%).
Assuredly, Bernanke will not renounce the Fed's monetary stand, initiated under
the Bush administration and now fully endorsed by the Obama administration. If
we extrapolate the trend of the past two years, at the end of 2012 gold could
be around $2,700 an ounce, crude oil at $188 a barrel, copper at $14 per pound,
sugar at $1,990 a ton, soybeans at $2,158 a bushel, wheat at $1,211 a bushel,
corn at $1,202 a bushel, and coffee at $4.61 per pound.
Of course, the prices of these commodities are of no concern to the Fed, which
considers only core inflation. Food price inflation has been raging at 12% in
China and at the two-digit level in many countries, with governments becoming
vigilant about the risk of commodity price inflation for economic growth.
Rarely have economic growth and full-employment in the US or in other major
industrial countries been associated with two-digit commodity price inflation.
Durable economic growth and sustained employment creation have generally been
associated with stable or declining commodity prices. Hence, it would be
unlikely for the US to achieve full-employment in such an explosive
commodity-price environment. Vital commodity prices, such as energy, could go
to levels that stifle growth in key sectors, as happened in 2008, dragging down
economic activity and employment.
In the past decade, US policymaking has been dominated by fallacies built on
excessive monetary expansion, near-zero interest rates, and sizeable fiscal
deficits. These have turned out to be very costly for the US economy.
Presidential advisor Larry Summers, who has claimed that the US economy would
suffer from a lack of demand for a number of years to come, has recently echoed
these same fallacies. He was oblivious to the excessive size of the budget and
current account (external) deficits, both indicating excessive demand in
relation to output that is financed by external borrowing. US policymaking has
emphasized demand and has neglected structural and sectoral policies and
policies to generally promote productivity and in turn growth and employment.
The question that matters is how much durable growth and permanent employment
creation can be achieved in such a lax monetary environment? Even if one
believes in Bernankeism as a way to achieve full-employment, it clearly
necessitates a reversal of such expansionary monetary policy to pre-empt a
renewed wave of financial failures. The economy will gyrate from booms to
It would be more desirable to achieve employment in the context of sound
monetary policy that would preclude such gyrations. Three-years into the
crisis, the economies in Europe and the US remain stagnant with renewed debt
crises, indicating the inability of Bernankeism to bring about the
instantaneous recovery it has long promised.
From a different perspective, the contemporary crisis engulfing the US, UK,
Iceland, Ireland, most of Europe, and a number of emerging countries could not
be attributed to real causes playing uniformly and at the same time in so many
countries. It could only be attributed to imprudent monetary policies. From
this perspective, there is no need for either monetary or fiscal expansion;
prices ought to adjust, and monetary policy should be made stable and safe. An
escalation of loose monetary policy to re-inflate asset bubbles can only delay
recovery by aggravating economic distortions and increase uncertainty.
Obama's endorsement of Fed policies has certainly also endorsed George W Bush
era policies. Obama forcefully defended Bernanke's QE2 at the Seoul Group of 20
summit in November this year. Restating Bernanke's theory, he was convinced
that renewed monetary injection would create jobs in the US and in the rest of
Bernanke, Obama, and their economic supporters appear to see no other way for
creating jobs and restoring full-employment than by printing more and more
money, running larger and larger fiscal deficits, and forcing interest rates to
zero. It would be good to remember that in the past, whenever money printing
succeeded in boosting economic activity, it inescapably also ended in financial
turmoil and deep economic recession.
Hossein Askari is professor of international business and international
affairs at George Washington University. Noureddine Krichene is an
economist with a PhD from UCLA.