A comment I published on a skype group. I thought I’d publish here more widely:
I don’t want to try to defend the Fed, but I don’t think we should claim a false public and a real hidden purpose. I think the purpose of the Fed is simply to provide and manage the liquidity in a member-only fiat/credit network. I think the Fed’s role is – through its theoretical independence – to build confidence that the Treasury will not abuse its force to spend more than the economy can take. The Treasury doest not need the Fed to monetize spending: the Treasury has simply ageed to do so as a confidence-building trick, in exchange for the ability to provide stability backed by the full credit of the US to the banking system in times of crisis. All that said, I think what is legitimate to point out is that their mandate is difficult if not impossible, their power enormous, their independence … theoretical, and the unintended consequences of their actions enormous as well. Chief problem with the Fed is the belief and expectations by each and everyone on capital markets that they can and should try to solve every problem.
Fred Hickey was recently quoted with some similar sentiments, but specific to the Fed's recent actions, in a Société Générale research report (from August 9th) by Albert Edwards that a friend sent to me:
“With 28 days and counting before the end of the Fed’s “quantitative easing,” round 2, or “QE2” program, I thought it might be worth my while to re-read Fed Chairman Ben Bernanke’s speech titled: “Deflation: Making Sure ‘It’ Doesn't Happen Here” for clues as to what the Fed’s next move may be. For some years now, I’ve called this speech “The Playbook” for its usefulness in predicting Bernanke’s next moves. It has not disappointed.
“One attribute that Bernanke certainly does not lack is conviction. When reading his November 2002 speech it becomes very clear that there is no wavering of opinion. His statements are absolute. Consider the lead-in paragraph above. The central bank “should always be able to generate increased nominal spending and inflation even when the short-term nominal interest rate is zero.” “Always” is a powerful word. There’s no wiggle room in it. Similarly, Bernanke left no wiggle-room in his now-infamous December 6, 2010 CBS “60 Minutes” interview in which he stated: “We've been very, very clear that we will not allow inflation to rise above 2 percent.” Asked by CBS interviewer Scott Pelley what degree of confidence he had in his ability to control inflation, Bernanke responded, “one hundred percent.”
“By reading these statements we can conclude that Bernanke absolutely believes that the Fed can ultimately create just the right amount of inflation (about 2%). If deflation threatens, he has a whole assortment of tools (spelled out in the 2002 speech) to always be able to generate inflation. Should he create too much, he’s 100% certain he’d be able to bring it down to acceptable levels by raising interest rates.
“In the 2002 speech, Bernanke addressed the most glaring exception to the idea that central bankers should be able to control the economy (spending) and inflation – Japan. Towards the end of that speech, Bernanke commented on the long-running Japanese recession/deflation problem. He began by asking, “The claim that deflation can be ended by sufficiently strong action has no doubt led you to wonder, if that is the case, why has Japan not ended its deflation?”
“Bernanke noted that “Japan's economy faces some significant barriers to growth besides deflation, including massive financial problems in the banking and corporate sectors and a large overhang of government debt.” Editors Note: Do these conditions sound familiar?
“Second, and more important, I believe that, when all is said and done, the failure to end deflation in Japan does not necessarily reflect any technical infeasibility of achieving that goal. Rather, it is a byproduct of a longstanding political debate about how best to address Japan's overall economic problems.”
“Bernanke further blamed “political deadlock,” where “strong policy actions are discouraged” and concluded: “In short, Japan's deflation problem is real and serious; but, in my view, political constraints, rather than a lack of policy instruments, explain why its deflation has persisted for as long as it has. Thus, I do not view the Japanese experience as evidence against the general conclusion that U.S. policymakers have the tools they need to prevent, and, if necessary, to cure a deflationary recession in the United States.”
“As stated in that speech, Bernanke believes that the Fed has the tools to “cure” deflationary recessions. The problem with the Japanese was that they just didn’t use the tools available.”
Edwards concludes:
“As Charlie Munger said, to a man with a hammer everything looks like a nail. For the US and UK governments one key lesson from this crisis yet to be learnt is: do not appoint an academic to head up the Central Bank. Their certainty of view (often an academic characteristic) is simply far too dangerous.”
Thanks Anthony. It will be interesting to see whether the political debate gets in the way of the Fed before Bernanke can press some more red buttons.
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