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Ben Bernanke’s Grand Finale?

We have now had 19 months of near-zero rate interest rates in the United States and there is nothing on the horizon pointing to any change. All the talk of an exit strategy by the media and the Fed has now ended (with slim to non reaction of surprise among the gold crowd) and has instead been replaced with talk of more loose monetary policy and another round of quantitative easing.

QE 1.0, which started in March 2009, has now run its course and the effect of it is fading away quickly. Fed has announced a “QE-light” program where they will start to re-invest maturing mortgage-backed securities (MBS) back into the market. This will help the Fed’s balance sheet not to shrink and also to artificially put downward pressure on interest rates to help the ever struggling housing sector. The first round of QE mounted to 1.4 TUSD of government and agency bonds and I expect the next round to be even larger.

Fed funds target rate the last two years:

Source: Federal Reserve Bank of St. Louis.

The housing sector is crucial for any economic recovery in the US and lately the data has shown that the sector has started to deteriorate again after bumping along the bottom for a while. One big reason for this is that the tax credit for house purchases has expired. The July data was clear as it showed a big drop in New Home Sales and Existing Home Sales. The interest rate on mortgages in the US is based on the Ten-Year Treasury note, so this is a very likely target for the Fed going forward with – what I expect – a large QE 2.0 program. If the Fed can drive down mortgage costs for house owners enough, then the prices will likely stabilize and maybe start increasing again (inflate or die). I think this is something the Fed will try to do by buying large amounts of ten year notes in the next QE-program.

Another recent development threatens to skyrocket the budget deficit next year in the US. I’m talking about the tax cuts that President Bush introduced and that was planned to expire this year. However, it looks like Obama/Pelosi will extend the tax relief because of huge public criticism for raising taxes for the middle class and the wealthy, at a time when the country is going trough one of the worst recessions in modern time. This is good news for the consumers but bad news for the budget deficit, which will be much larger than forecasted. And we all know who will make up for the gap in the budget, his name starts with a B and ends with an N.

The Nobel Prize winner in economics, Paul Krugman, who recently wrote an article for The New York Times, says that the US desperately needs more stimulus now since the leading economic indicators are turning down again and the economy is starting to deteriorate after the previous stimulus effect is drying up. Krugman must be considered one of the top economists in the US and his beliefs is probably widespread among other Keynesians with leading economic positions at the Fed and Treasury. It is therefore safe to say,that whatever measures will be taken going forward to prop up the economy, is going to be something that rhymes very well with the opinions of Krugman.

In the article, Krugman criticizes Obama for not having done enough to stimulate the economy; “Here’s the situation: The U.S. economy has been crippled by a financial crisis. The president’s policies have limited the damage, but they were too cautious, and unemployment remains disastrously high. More action is clearly needed.” He goes on saying that the US is about to repeat the same mistakes made during the depression, when stimulus was too small and withdrawn too early; “the stimulus raised growth while it lasted, but it made only a small dent in unemployment — and now it’s fading out”. The conclusion he makes is loud and clear; “More stimulus is desperately needed”

I have always considered Ben Bernanke to be one of the foremost voices for loose monetary policy, but when I hear what Paul Krugman advices Obama to do to jumpstart the economy, Big Ben fades in spades. Krugman thinks that the US should stimulate the economy in the same way as after the WW2, when the amount of 2 times the GDP was used. Today that would correspond to almost 30 TUSD (!), guess what that would do to the public debt in the US…

There is however a great difference between now and then, because the US was on a gold standard after the WW2. But since Nixon closed the gold window in 1971 when the final parts of the gold standard were removed, the US is now purely on a fiat currency base without any real backing. That means there is no discipline on the monetary policy nowadays, and that is exactly why we are in the dire situation with runaway deficits and fiat money expansion all over the world, not just in the US. Under a gold standard, this would have been impossible.

With all this mentioned above in mind, and with a public and Congress that will be really hard to convince when it comes to passing more stimulus and bailouts, Obama will find himself between a rock and a hard place when he wants to pass more stimulus/bailouts/rescue packages from the White House. My guess is that it will be up to Bernanke from now on. He sees what happened to the economy after the stimulus was removed and he sees what is happening to the really important housing sector after the subsidies were removed (look at the awful housing data from July), it is almost free fall again.

Bernanke is terrified about deflation and with the supposedly smartest economists in the US saying “more stimuli is desperately needed” and with Obama having hard time launching more stimulus, there is little doubt in my mind that Bernanke will step in and crank up the dollar machine. I think this will be Ben Bernankes Great Finale, a massive quantitative easing program (4-5 TUSD?) that ultimately will spiral inflation pressure upwards and pressure the dollar downwards. QE to infinity!

By the way, the deflationists usually points to the shrinking credits for the private sector in the US when they argue for deflation. Well guess what, after contracting since late 2008 when the financial crisis hit, the US commercial bank credit bottomed out in the beginning of the year – took a big leap – and is again increasing.

Bank credit of all commercial banks:

Source: Federal Reserve Bank of St. Louis.

Take a look at the prices for different commodities such as copper, corn, wheat, oil, gold, silver, iron ore etc, they are all at high levels and in some cases at all time highs. This is NOT signaling deflation. There is a race going on between the different currencies of the world, a race to the bottom and they all depreciate against gold. The flood of fiat money that is being created of the central banks around the world is chasing a finite supply of gold.

Rarely has there been so easy to be invested in the right sector…


This article is written by Scoris, and with his kind permission, O B Research has been privileged to publish his work on our website. Scoris runs one of the most popular and most visited blogs in Sweden in its genre. To find out more about his work, please visit: Scoris Aktieblogg