Yesterday I talked about Ben Bernanke's interview on 60 Minutes. It is still a fascinating topic. Here is one of the most powerful men in the world. I won't say that he is the most powerful because he can't launch a nuclear attack, but he could certainly fund it. This is a guy that essentially controls the nation's money supply.
The interviewer asked some decent questions, but the problem is that he had no follow ups. This makes him almost useless as an interviewer if he is not going to challenge Bernanke on the things he says. I keep going back to Bernanke's comment that he is not changing the supply of money in circulation. How can he make this comment and not elaborate? How can the interviewer not follow up? Up until this point, his statement is true. The monetary base has not risen, even after his QE2 announcement. I'm not sure when it will start to rise.
But if he goes through with QE2, then the monetary base has to go up. It will be an increase in the supply of money. The Fed is technically not printing money, but they are doing the equivalent and creating money out of thin air. It is done on a computer instead of a printing press. But the key word in his comment is "circulation". He is saying that the increased money supply won't be in circulation. If he really means this, then that means that banks will continue to accumulate excess reserves. But then if they are doing this, then that defeats the whole purpose of him lowering interest rates.
This whole thing has to be price inflationary at some point. The velocity of money has been low since the fall of 2008. This has helped keep prices down. At some point, some of this money will end up in circulation. Bernanke cannot time when he is going to withdraw the money. He will get into a situation, something like the 1970's, with high price inflation and a stagnant economy. He will eventually have to choose between massive inflation and depression.
The problem, as I've pointed out before, is that he will not be able to withdraw all of the new money. In 2008 and early 2009, the Fed bought assets from the banks in the form of mortgage backed securities. Some of these are now only worth a fraction of what the Fed paid for them. Selling them back into the market will only withdraw a portion of the money that was used to buy them in the first place.
Bonds are the same way. If interest rates go up, the bonds they have bought will be worth less. They can withdraw some of the new money, but not all of it, if interest rates rise. I really don't think Bernanke knows what he is doing now. He cornered himself in many years ago when he apologized to Milton Friedman on behalf of the Fed for allowing the Great Depression to happen. Bernanke thinks that it was the Fed's fault, not because of the initial artificial boom, but because the Fed did not print enough money once it was there. This is his legacy. He is trying to make sure that he doesn't allow another Great Depression on his watch. In the process, he will just about destroy the U.S. dollar.