If the appointment of “Helicopter Ben” Bernanke as Fed chairman portends a major change in monetary policy, it will most likely come in the form of a shift from fighting INflation to guarding against DEflation. Recall that Bernanke burst onto the financial scene two years ago with a provocative speech to the National Economist Club that made clear the central bank’s resolve to fight deflation by any and all means at its disposal. (For the full text of the speech, click here.)  Although no one actually thinks the Fed would resort to shoveling $100 bills out of helicopters, it was Bernanke’s anointed role to convince investors the Fed would try anything just short of that. Trouble is, the flat-out monetization of debt is destined to fail for the simple reason that there is too much debt to monetize. The global financial system is fueled by hundreds of trillions of dollars worth of debt, so it is really hyperinflation that is implied, not run-of-the-mill inflation, when we  hypothesize about bailing out the system in the event of a collapse.

For the time being, though, I have no doubt the central bank can continue to hold deflation at bay by targeting short-term rates, much as it has been doing. This has kept debt manageable, particularly for households. But maintaining the economic status quo has a growing cost and an implied endgame, since total borrowing must continue to swell merely to keep up existing levels of consumption. This must be so because incomes are stagnant and savings non-existent. But the notion that “helicopter money” will save us if the financial system starts to implode is facile at best and delusional at worst. As I’ve pointed out here countless times before, the only way easy credit can have its effect is for it to be “actualized” through the mechanism of borrowing. But if we assume that residential real estate values cannot be inflated much more than they already have been, the question then arises, What will we use for collateral?

Orgy Support

Even if we grant that pushing mortgage rates down to three percent would cause property values to double from here, how would that leave us any better off a few years down the road?  To maintain the consumption orgy that now accounts for more than two-thirds of America’s GDP, we will have to convert most of our new “wealth” into debt via home equity loans, just as we’ve been doing since the tech-stock collapse destroyed our other source of “wealth” five years ago. (Can you see a rather significant liquidity problem taking shape off in the distance?)

I’ll leave you today with some speculative thoughts from a chat group that I frequent. The author is someone who understands the bond markets far better than I, but like the rest of us, he is hard-pressed to calculate how much longer the Fed, under a new chairman, will be able to keep its ultimate-stakes shell game going. He writes as follows:

“[Both Volcker and Greenspan have used] the fed funds target rate to indirectly manipulate money supply.  However, I do not believe there is anything in the Fed’s mandate that requires it to manipulate the…money supply by way of the fed funds target rate.  In point of fact, there is no direct, non-elastic relationship between money supply and the fed funds target rate -- only that this has been the Fed’s chosen procedure and mechanism. The Fed can target the supply of money directly, independently of the fed funds target rate.

Opposing Goals

The real question, then, is not whether they can they do so, but whether they can do so with seemingly opposing goals -- i.e. increasing the money supply directly while simultaneously increasing the fed funds target rate.  If that doesn’t work, the fed could raise banks’ reserve requirements while monetizing new federal debt.  This would ensure that the federal government gets the money it needs to operate and that the banks would be left marginally without the ability to make new private loans except to blue-chip borrowers such as large supra-nationals that carry credit risks similar to the Federal Government’s. Thus would the Fed increase the supply of money available to big business and the Federal Government without having it spill over into the private economy.

Speculation concerning how the Fed can simultaneously monetize the Federal deficit and maintain an inflation target is almost endless. The question is not whether it can be done, but how will it be done, and how the markets will react.  The ramifications of attempting to do what Bernanke has indicated he will do are enormous.  So, is Bernanke lying when he says he will monetize the debt, and once in office refuse to do so?  Or, will he attempt to monetize the debt while maintaining an inflation target?  Or, will he shift toward an inflation target exclusively and oppose monetizing the debt as is the case at the ECB? 

Whom Does Fed Serve?

Whatever he chooses to do is going to make some unhappy, since you can't appease the Federal Government, the banks and the public simultaneously. Trying to guess what’s coming requires understanding what Bernanke thinks the central bank’s role is, and more important, who he believes the Federal Reserve is most beholden to. Is it the Fed itself, its member banks and the value of their reserves?  The Federal government?  The public? Or is it the globalists -- i.e., the Fed member banks’ primary clients, the large supranationals?  They have already co-opted fiscal policy.  Are they now, with Bernanke in charge, about to co-opt monetary policy as well?  I don't know the answer but believe we will get an indication from Bernanke sooner than most think.