Are Bernanke and Yellen Fed Charlatans Dangling the Carrot of Prosperity?

 This article was first published on Talkmarkets:

The Fed and its main recent players, Ben Bernanke and Janet Yellen are possibly well meaning, but are they charlatans in a way, dangling the carrot of future prosperity in front of the nation? This will be discussed in more detail later, but the more I read Ben Bernanke, the more I know his bluff needs to be called somehow.

In the age of derivatives, the free market cannot be free. The free market for interest rates assumes that demand for bonds ebbs and flows. It assumes that there are more times when long interest rates are higher than short interest rates. Since inflation is more prevalent than deflation, that assumption used to be important.

In the normal economy, Banks loaned money to the real economy based on long rates being significantly higher than short bonds. This is not something we don't all already know.

But, as I said, with the rise of derivatives, the long rate stays lower than it would otherwise be, and that is wrecking havoc upon the financial system.The yield curve for short maturities to the long bond (30 year) is not now inverted, but certainly, from a historical view the long bond has yielded a better return.

Ben Bernanke penned an interesting article he posted at the Brookings Institute that reveals the true Ben. Bernanke. He says long bonds reflect the current economy, and this is all temporary, and it will pass and normalcy will reassert itself.

However, clearly, there are mass shortages of the long bonds for use as collateral in the financial world. Scarcity of bonds makes the prices go up and yields go down. Why Bernanke did not address that issue in his article is perplexing.

But, Bernanke does not believe that we are in a secular stagnation, opposing a view which has been offered by Larry Summers. Ben has said that secular stagnation won't last more than 10 to 15 years!

Secular stagnation is where there is little or no growth in the economy and Bernanke calls 15 years of that malaise just a temporary blip. Bernanke believes the low growth is a temporary situation. He looks to near full employment as proof that we are past secular stagnation. Of course, workforce participation is at near historic lows, so Bernanke likely does not have the employment picture correct.

We have to look at a few components of many that make up secular stagnation. A few major components are  

1. low and possible negative interest rates,  

2. low inflation and  

3. low consumer demand.

We appear to have all these and they have been with us for some time, making Larry Summers right.

But we know Summers is a "dangerous" thinker, as I wrote recently, who is not afraid of the cashless society and the negative interest rates. We know that increasing demand through negative rates comes with massive risk, so much so that Bernanke dismisses the concept entirely.

As I said, I personally believe that negative interest rates are a reflection of the financial oppression caused by the massive derivatives market. Consumer demand is low due to the fact that banks cannot make enough money at the long end to loan out money to main street. There is no inflation because there is low demand and long rates are low.

Bernanke stands behind a study done by economists criticizing Summers' secular stagnation. They do not believe low interest rates will be around long.

However, I believe that the Federal Reserve must dangle this carrot of future prosperity, while never being able to achieve it due to that huge demand and shortage of treasury bonds. Jim Chanos made it very clear on an interview on CNBC, that China or anyone selling into the deep bond market will not cause the market any problems.

Bernanke and his successor, Janet Yellen, dangle token interest rate raises, while boasting about how we have full employment and prosperity. I don't think most people believe them anymore.

Bernanke ends his Brookings Institute article with the not so reassuring concept that somewhere in the world, prosperity will bail us out! I am serious. Bernanke says capital investment somewhere should overcome lack of capital investment here at home.

I am giddily reassured and am stock full of lightheartedness. Not!

Summers, on the other hand, fears deflation, and believes that negative rates in a deflationary scenario would be necessary. I won't get into the economists' grinding discussions of nominal versus real interest rates, but just know that nominal rates could be negative and the real rate could be less negative or positive in deflation.

But Summers has, in a way, called Bernanke's bluff. I don't for a minute trust Mr Summers to be able to manage a complex deflationary situation, but clearly, most major nations are either experiencing a secular stagnation or are slowing considerably.

Summers says you lower rates and you push money into the economy quickly and decisively. While I say I don't like the idea of negative rates as it could lead to totalitarian economics and a cashless society, Summers is dead on calling the bluff of the Federal Reserve. He may not think he is calling their bluff, but he is.

And he is doing it by expressing a desire for hot money to enter the system from the glut of savings worldwide. It isn't that the US consumer is saving, but the world is saving and we here can spend it. I am no fan of hot money, but it is real money, and under the right circumstances, could be used for something other than real estate speculation. That was the mistake of the last decade, that the hot money went into real estate and the toxic pay option arms and other crazy loans fed the foreign investment frenzy.

And Summers wants taxes from the subsequent economic growth used for rebuilding American infrastructure. It isn't like that isn't needed!

Bernanke can't believe in that infrastructure rebuild, because he knows the economy won't grow much. He wants it that way. Yes, he wants slow growth and Summers is a threat to slow growth.

But the bluff is that Bernanke just can't stand the risk of any rapid growth because he knows the Fed cannot stop it by swiftly raising interest rates anymore. Too many banks have bet on the floating, low interest rate side.

And demand for bonds in that multi hundreds of trillion dollar market has ruined any power the Fed has to stop a red hot economy. When the Fed seeks to slow growth, it buys bonds, but there aren't enough of them anyway. So that is out. The Volcker decision was to raise interest rates to the teens, wiping out the S&L's. The Fed cannot do so now, or the big banks will be thrown into chaos.

So, it appears the Fed will continue the way of Bernanke, dangling carrot in the faces of main street Americans while seeking slow and slower growth all the time. That smacks of fraudulent tendencies in the Fed's thinking because it is a promise that looks to be unattainable. 

It appears these Bernanke/Summers discussions never get to the subject of stopping the overheated bubble economy that Summers wants. Summers wants bubbles, and those are not good, but he dares the Fed to grow us out of secular stagnation without them. 

And, we know that the Fed cannot grow the economy any more than Bernanke can blow out all the candles in his birthday cake! It lacks that huff and puff power needed to move the economy.

Here are a few solid and/or wishful ideas about how to avoid negative rates, avoid bubbles and really grow the economy like in the old, normal times: 

1. Ban the use of the long bond for use in derivatives collateral.

2. Ban most derivatives and futures markets Onions and movies have already been banned from the futures markets. It can be done. That would free the long bond and banks so they would lend to the public.

3. Restore Glass-Steagall, forcing banks out of taking such large positions in the derivatives markets.

4. Establish state banks, that would fund commercial banks, bypassing the need for Wall Street to finance anything in the real economy. Ellen Brown has championed this approach and she is a nice lady.

5. Raise the minimum wage more aggressively and/or give regular people a small stipend to spend.

6. Establish a Lend-Lease Act for peacetime, for our nation. It worked for WW2, and made America into an economic powerhouse.

7. While shying away from Mortgage Backed Securities as collateral, as they led to the Great Recession, find common minerals to use as collateral, as is done in Asia, rather than using credit as collateral.

Without freeing the long bond from its derivatives labors as collateral, though, most of these ideas will be doomed to failure or have less sustainable success. But clearly, we can't continue with the long bond being a prisoner to artificial demand, and with the economy destined to bump along in secular stagnation.


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