Friday, November 11, 2011

Buy Ben Bernanke a marijuana pipe and an Hawaiian shirt

Edward Harrison annoyed me this morning. He writes the useful but sometimes disagreeable Credit Writedowns blog and he has a post up on why the Fed should never buy Italian Government bonds. His conclusion - which sounds reasonable but is dead wrong is repeated below.

First of all, a central bank’s buying dodgy assets is always a solution to a liquidity crisis that is fraught with peril. if those assets go bad and losses are crystallized, it could render the central bank technically insolvent and undermine confidence in the central bank. Fear of this technically insolvent outcome was a major reason the Europeans did not allow the ECB to participate in the ‘voluntary’ haircuts that it has attempted to coerce onto the private sector in the latest Greek bailout. 
Clearly, the ECB could just print money and use the seigniorage from that printing to earn its way back into solvency without having been declared insolvent. But you can see the problem. To maintain the ECB’s credibility it would need to be recapitalised. 
But if the Federal Reserve were to load up on Italian bonds, then the seigniorage route is out. The Fed would be exposed to default on foreign currency assets. If Italy defaults, then the Fed is on the hook. Officially, the Fed is under Congressional jurisdiction. The US Congress has oversight of the Federal Reserve and Congress should never allow the Fed to make unsecured loans to foreign governments without prior and specific Congressional approval. 
The Fed should never buy foreign currency assets. And if it does, Congress should intervene.

America's monetary problem however is that they are in a liquidity trap.

Six or seven years of 6 percent inflation, 2 percent interest rates and to stick the losses to the Chinese who (in their mercantilist fashion) own the debt would be a wonderful way out of America's malaise. And you would think you could induce 5 percent inflation by printing money. You would think the option is open. Indeed you would swear given how much money the Fed has printed that it would have happened.

But it has not happened.

Sure the Fed has printed money. And when it finished that it printed some more. Soon we will get to QE4 and yet another round of "quantitative easing" and we will still not manage to induce 5-7 percent inflation, 2 percent interest rates and to stick the losses to the Chinese.

If you had - without any understanding of monetary theory - been told that the Fed could increase money stock from say $800 billion to $3 trillion and not result in an inflationary torrent you would not have believed it. It would have sounded like nonsense.

But you better believe it because it happened. And that requires an explanation.

The explanation is simple enough. The Federal Reserve has too much credibility. Each time it increases the money supply it buys some asset (say a government bond or even a foreign security) and issues cash. And people hold the cash because it is a reasonable store of value. And it is a reasonable store of value because they trust - at the end of this cycle - that the Federal Reserve will eventually take its vault full of assets, sell the assets for hard cash (which it will destroy) and will thus suck the excess liquidity out of the system.

If people really believed the cash was trash they would all try to get rid of it (ie buy something) but collectively they could not get rid of it (every time they buy something it would have a new owner) and the result would be inflation. Inflation would then reduce the real value of the money stock to a level where people were comfortable holding it.

To get inflation you need to damage the Federal Reserve's credibility. You need the Federal Reserve to make a credible promise to be reckless.

And Ben Bernanke - despite the helicopter speech in which he outlined this view of the world very clearly - is not your man. Maybe it is the facial hair - but he looks - well just too responsible.

When he got on 60 Minutes he proved the point. He was asked point-blank whether the Federal Reserve could print all that money and control inflation and he said it could. He was right of course - but it was the wrong message. He had his one-mass-market-opportunity to be credibly reckless and his media-conservatism meant that he squibbed it. He should have just said that he did not know but that it was a risk that was necessary to take...

When he appeared all media-conservative I knew he blew it. I was thinking then of asking for his resignation because he was just not up to the job that he himself outlined in the famous helicopter speech.

But the European crisis gives the Fed Chair the opportunity to get it right this time being being credibly reckless. Indeed what I want is for him to be incredibly reckless. He should not only announce that the Fed is buying Italian debt. He should do it whilst wearing an Hawaiian shirt and carrying a marijuana pipe. (I would even buy him the pipe...)

Ok, the marijuana pipe is not happening - but I dream of a day when a central bank knows that the best way out of a debt-deflation is inflation induced by deliberately and credibly reckless policy rather than an endless austerity-recession and deflation.

In this case - where the debt is held disproportionately by the Chinese the Fed has an opportunity to stick the losses to someone else. Come on Ben - what do you say about that?

And when we are done we can sit down, you can have a joint and I will have a beer.


Post script: Edward Harrison reminds me (fairly) that he is not generally opposed to inflationary solutions and he (fairly) thought that this post implied he was. I am diametrically opposed to his view about the necessity to maintain Federal Reserve credibility. Indeed few things have annoyed me quite as much as the referred to post. However we are closer much of the time.

Post post script: Ed Harrison thought that the issue was democracy - congressional oversight of buying of foreign bonds. That I think is peculiar - central banks have been buying foreign bonds since - well - forever. It is how they hold foreign reserves. But he does think it unreasonable and subject to oversight for a central bank to buy stressed foreign bonds. Respectfully I disagree - but that is another story.


Jim said...

Umm, doesn't 6% inflation also 'stick the losses' on any US citizen who has been prudent and saved money, for their retirement perhaps?

John Hempton said...

Yep- it sticks it to anyone foolish enough to save in cash or bonds.

Its also not good for shortsellers because presumably I am short some real businesses (with real equipment that should increase in value wiht inflation) and long cash.


John Fischer said...

Wouldn't adopting a gold standard at the right conversion ratio achieve inflation and screw the Chinese without the intermediate steps of screwing American savers and the poor (and enriching bond traders)?

John Hempton said...

Ain't there four choices when you have too much debt.

(a) repay it
(b) default on it
(c) inflate it away so you repay a smaller amount or
(d) extend and pretend.

Choice (d) is mostly over -

Choice (a) has the problem that if you do it too hard you actually repay it PLUS MORE because of deflation.

Choice (b) is pretty ugly.

Choice (c) looks the best of a bad lot.

But any half measure does not seem to work. You can't inflate some of it away as per Namazu.

David said...

Whilst it is almost certainly true that, if a (credible) Bernanke were to come out and say that he expects a ton of inflation, people would switch out of fixed interest and into equities and commodities, having Bernanke in a jester hat come out and say that he's going to go absolutely nuts on QE will do nothing for inflation without a "transmission mechanism" for the cash to actually get into the economy.

The reason why QE thus far hasn't caused inflation is that you can't "push on a string" to create demand - unless people actually want to borrow money to start or expand their businesses then the cash just sits as excess reserves in the banking system, which is where it is right now.

Edward Harrison said...

This post is completely misguided. You mischaracterise my view at every turn.

1. I never mentioned inflation so the whole post is attacking a straw man. I am not worried about inflation. I'm surprised you don't know that.

2. I DON’T CARE ABOUT FED CREDIBILITY! I care about democracy. The Fed is under Congressional oversight and this move demands Congressional approval.

3. My only concern is not allowing the Fed to purchase foreign assets in a currency it does not control without Congressional approval.

4. The ECB could be buying Italian and Spanish bonds (or as I have repeatedly said they eventually will, offering an explicit target) but that's for the ECB to do and not the Fed. If the Fed did it, it should have Congressional approval.

You have your view and I have mine. These rules of engagement for the Fed are political questions, not economic ones.

Bottom line: Stick to making your own arguments without hauling me into your posts with straw man arguments and erroneous references. If you believe in your argument, that should suffice.

Anonymous said...

A marijuana "pipe" is far too mellow to impart the required image. What Ben needs to do is lines of cocaine or speed off a big conference table in front of all the fed heads.

By the way, the beard thing worked for Corzine, looking impeccably academic while loading up on leverage 40 to 1. Who knew?

Anonymous said...

Your blatant, and often time ignorant comments make me laugh. Granted, once in awhile you catch some good corporate stuff but even then..

Now, tell me again how do you define inflation?

and what are the components of it?

and what makes you think, if you can, that those components are the true reflection of the expenses of the ordinary US citizens?

and while at it, explain further, where do you get that inflation numbers from?

and what makes you think those numbers are reliable?

and last but not least, did you happen to follow food, commodity and what have you price changes (note, i am sparingly using the word :changes)

Oh yeah, i know where you might go now, if you understand that kind of things obviously, "output gap", "debt deflation", "balance sheet recession", etc...And while they are all good arguments, there might be different parts of the economy acting differently.. and depending on which part you are looking at, results may vary.


Anonymous said...

Harrison has the pedigree of a spook.

Anonymous said...

Choice (a) has the problem that if you do it too hard you actually repay it PLUS MORE because of deflation.

Better to flip the problem on its head? Look at where excess savings are piling up and taking monetary velocity to zero?

The $1.5 Trillion in US corporate cash sitting overseas may be a good starting point. With appropriate tax policy it could be possible to encourage corporations to divulge cash hoards and force them to turn to the markets for fund expansion plans.

If some of that cash made it to shareholders on a regular basis even I may be encouraged to stop being foolish enough to save in cash or bonds.

Corporate boards may even be forced to go to capital markets to fund corporate kingdom building (Gasp!). Even though the old Coal Town Company Store model has served us so well some of that cash may actually have to come from middle class savers (The Horror!).

Removing some uncertainty around retirement would also help. Make the hard decisions so Social Security is credible again. The current benefit hardly keeps you in cat food let alone cover assisted living needs.

Flip it into a deferred annuity with 3x the yearly benefit that kicks in a 85. Include a means tested graduated basic benefit that kicks in at 67 to keep granny off the street. Remove the fear of being out on the streets at 95.

Heck, solve that and we may even be brave enough to address Asian mercantilism.

Sorry this is such a US centric post but we are talking about the Fed.

Anonymous said...

The FRB used to collect 20 billion/yr in coupons on their Treasury holdings. Now that number is now almost 80 billion/yr (2.7% on 3 trillion). This is a tax on money, it is felt immediately and is a strong driver of inflation.

This additional 60 billion/yr in interest doesn't come out of thin air, it comes out of the pockets of recent bond purchasers.

The Chinese and Japanese monetary authorities feel this loss in the form of reduced coupons on their recently purchased bonds (after all, they are paying up to outbid the Fed). Their coupon losses are in the range of 15-25 billion/yr.

Your concerns about repayment of principle are less likely to show up as inflation because the FRB's balance sheet may be wound down prior to any default.

FRB receipt of coupons is the immediate driver of inflation, principle repayment (and expectations thereof) is a much slower secondary factor.

John Hempton said...


It was your post that annoyed me.

You did mention central bank insolvency. That is the credibility thing writ large.

I disagree with you about Federal oversight of foreign bond buying. Federal reserve has been buying bonds for a long time. That is what foreign reserves are.

I disagree with you about political oversight of the fed being a good thing either.

I am unconcerned about democracy here too - but hey - we differ on almost every point in your post.

I think the ECB should have taken the discount on Greek debt.

You get the idea. Yes I disagree with you. And I think your post is awful, flat wrong and destructive.

I most certainly disagree that Congress should stop the Fed buying Italian bonds.


Rich said...

Two suggestions:

- You might want to read Richard Koo's work. In short, if there is a balance sheet recession, cash generated goes toward debt paydown, not spending. No multiplier there!

- If you want a credible inflation threat, you need a person who would make an honest effort to get the job done. Silvio Berlusconi happens to be available!

Tom said...

But Bronte Capital is 76% net long. Surely that's adequate position against inflation.

(Incidentally, the October 2011 client letter on the site is linked off "September" -- which appears twice.)

Andrew Simms said...

Ben Bernanke can expand the balance sheet all he wants, and in the short term yes, it might create some inflation and an increase in asset prices, but once you are in a liquidity trap, there are limited returns to aggressive monetary policy.

People who think that lowering for instance, the 10 year intrest rate from 2% to 1% will dramatically increase aggregate demand and cause full employment are naive. People base their investment decisions not only on the cost of capital but all on future expectations of growth. No one was fooled for a long period of time after QE2 about the real impact of this monetary expansion, it does not effect output in the longterm and is an ineffective policy action. The only real solution is another New New Deal massive fiscal policy based upon infrastructure spending, not on tax cuts that will not go towards increasing aggregate demand.

Greg Canavan said...


Strictly speaking the Fed cannot create inflation, only the commercial banks can via fractional reserve banking. And the banks can only create credit if there is demand for it. We've just had the biggest credit bubble in history...hence not much demand for more.

Inflation can happen via the Fed if it continues to finance US Govt deficits. But in a debt deflation, this type of inflation is hard to generate as it is transmitted via a weaker currency. And when you produce the world's reserve currency, everyone wants to own it in times of turmoil...making it harder to depreciate.

Also, you say the US owns foreign bonds as part of its FX doesnt, or what it does own is tiny. When you issue the world's reserve currency, you don't need FX reserves.

Ben Bernanke could turn up to every conference channelling Hunter S Thompson...with a joint and a fat glass of rum and grapefruit juice, babbling about helicopters and cash stuffed in envelopes. Yes his credibility might be slightly worse than it is now, but he still wont be able to create the inflation you think he can.

TomTom said...

Since the QE is run through the banking system which is imposing a credit squeeze on the REAL economy any Liquidity is trapped inside the zombie banks rather than circulating.

Inflation is a joke when it is seepage into oil and commodity markets through well-lubricated hedgies rather than Consumers flush with cash that is creating it.

The general public faces a bank-induced credit squeeze. The Central Bankers are transferring real resources from households to banks through low interest rates on deposits and high rates on credit cards.

Helicopter Ben us scattering cash inside the hangar

But What do I Know? said...

You know, I've always thought that the way out of this is for the Fed to raise its rates while Fannie and Freddie (or FHA) offer mortgages with rates capped at 5%. This would keep interest costs to consumers stable while allowing savers to earn something on their money (and consequently spend more).

Jeff Matthews said...

Brilliant. Really good.

Bob the wombat said...

Here's an alternative interpretation: The Fed needs to stop sterilising their asset purchases by paying interest on reserves. When the natural interest rate is negative on risky investments, a 100% risk-free positive return is irresistible. So, yes, the monetary base has exploded, but it hasn't left the Fed's vaults (metaphorically speaking).

John Fischer said...

So for purposes of this argument, you don't care about inflation or democracy. A chacun son gout, but how about arguing your case more clearly? If the Fed can buy anything, it can certainly buy gold up to any arbitrary price. How is this not a more directly inflationary than buying Treasuries? How are the distributional effects worse than what we saw with QE2? How is this not a more direct object lesson for the Chinese in the downside of vendor financing? How does this not improve the Eccles building's chances of not being burnt to the ground?

OT: what do you have against defaults? We still have a bunch of bank bond holders who dodged the bullet last round. We have some fraction of $1T in government-backed student loans that are unpayable. Why should the heads of prudent savers take all the lead?

OOT: Your prescription seems to rely kind of heavily on theory. In that regard, its primary distinction from the establishment doves is that the dope references are explicit (not that there's anything wrong with that).

Anonymous said...

Assuming the Fed manages to print its way out of our current trouble (which I think it can if it wanted to) --

What do you think happens in the long run, after you convince investors/consumers that the Fed's mandate to guard against debasement and inflation only applies only when convenient?

I've been struggling with this question and not sure if I have the answer.

CurmudgeonlyTroll said...

Or just a credible inflation target?

Which is essentially what the NGDP crowd are saying.

Just as Volcker's money supply targets were a way of saying, we don't GARA about unemployment right now, we are 100% focused on getting inflation under control, the NGDP target would say, we're not worrying about inflation right now, we need to get demand on track.

Sounds like you would approve.

Geo said...

i impartially(!) agree with Ed Harrison....
there have not been any problems on Greece & Italy bonds which could be interpreted as the Markets'tricky obsessive entertaintment especially on their syntetic spreads....however that you John and all mates in this forum know that the skilled Hong Kong Market stands by to hedge (strategically !!)them as well as quickly..don't they !!??

The Epicurean Dealmaker said...

Okay, say Bernanke triggers inflation by undermining his own credibility. How, then, do we put the credibility genie back in the bottle after we have inflated our way out of the problem? How do we restore the Fed's credibility in the long term, when we presumably will want it again?

Anonymous said...

The Chinese are already being screwed...min wage increases of 20%...this capitalism is quite handy really.

Absalon said...

As a middle aged prudent saver approaching retirement my view is that inflation is theft.

Inflation steals from everyone holding money or debt instruments and rewards everyone who owes money - deserving or not.

Inflation distorts the economy and imposes losses and inefficiencies in places where people never expected to see losses. It drives up short term interest rates.

If governments want to confiscate wealth or do debt relief then they should be done explicitly and in a targeted manner.

dearieme said...

If O needs a reckless bastard to run the Fed he should appoint Slick Willie.

Wilfried said...

Sorry John, this post is hogwash. Just look up John Williams' Shadow Government Statistics ( to find out that inflation in the US is currently running at close to 12% if it were calculated the same way it was in 1990. As to the consequences of inflation look no further than Keynes' "The Economic Consequences of the Peace" Quote: 'Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch its currency.... Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.' End Quote.

Be careful what you wish for.

Anonymous said...


As someone in his early thirties, paying for his own health care because of the breakdown of the employer provided health care system, unable to even think about saving for retirement, I say that theft is what your generation did to my generation. Your generation ran up every credit card bill - the fiscal one, the environmental one, etc. And payback is going to be a bitch.

- Jon

Anonymous said...

There is no reason to inflate to minimize the national debt. As it matures, it will be paid without issue, as the US can create infinite dollars at will.

Anonymous said...

I disagree with part of your thesis, John.

I think that many people are aware that the current shenanigans will cause inflation. Those same people also know that borrowing heavily to investing in real assets is a good idea during inflationary periods. With all the bad news around, however, most people are waiting for things to bottom out before taking the plunge. Likewise, the bad news tends to discourage bankers.

My guess is that when the front pages no longer shout about impending collapse, many people will re-evaluate the position and we should see the pace of inflation increase considerably.

Michael M said...

Krugman loves that hemp on the beach-guy:

Absalon said...


I assume that you are in the US. The US fiscal crisis is really a product of the last ten years and the deliberate decision made by the Republican party at that time to bankrupt the US as a way to put the squeeze on social spending.

The environmental crisis is more a matter of ongoing release of carbon than the past release and that will be the challenge for your generation. My generation had to worry about being vaporized by a nuclear strike over recess or not being able to find a job among a tidal wave of baby boomer job seekers.

The cost of health care is a challenge for the whole developed world but the United States is suffering from certain additional self inflicted problems.

ermen said...


Greg Caravan has partially nailed it. The Fed is NOT printing money, what it is doing is just adding reserves into the system which they though would be lent out by banks. The problem is that banks have few credit worthy people to lend to and credit worthy people don't want the loans - hence the ineffectiveness of the QE programs (just like how Japan is unable to get out of its deflationary spiral). The US has problem of growth and how to fill the output gap created by years of the credit binge in my opinion.

KD said...

The other possible conclusion is that QE has proven the limits of monetary policy. We should be looking to fiscal policy to help repair balance sheets and mobilize productive assets again. Maybe it's congress who needs to start looking more irresponsible!

Anonymous said...

It's a very dangerous game you propose. The unintended consequences are mind numbing. Savers vs debtors? Prudent vs profligate? Financial vs real asset holders? Just as in Europe, there are losses lurking out there that must be allocated, it's just a question of how, on whom, and in what proportion. What you propose here is allocating it all on the people and institutions who did the right thing in the first place. These ethical questions are not about China and its reserves. Dealing with China is easy: Geithner tells them if they don't start protecting IP rights, piracy/espionage, flagrant home-grown policy bias, and ultimately opening up their capital account (NOT necessarily appreciating its RMB), then we use tariffs, simple and direct. And as free market as I am, I think things have gotten to the point in the US-China bilateral relationship where those wouldn't be disingenuous. Nobody forces them to keep adding to its $3 trillion plus in reserves, and they do so for a reason.

Perhaps even more importantly, what you propose is essentially selling the world's biggest OTM put option with all sorts of potential scenarios should it become 'exercised': upheaval in the fiat currency regime/US$, rioting in the streets that make the late 60s look tame, economic volatility, massive transfers of wealth from the innocent and unwitting to the insiders and more fortunate who can position for it, and maybe even threats to the US democratic system and society. If you are comfortable selling that option, and then somehow as TED points out, stuffing the genie back in the bottle when the Fed deems it right, then by all means proceed.

Given the Fed's recent history on lax monetary policy from 2003-05 and missing the risk in mortgage underwriting ('real estate reflects solid fundamentals' and 'subprime is contained' -Bernank 2005 and 2007), I don't trust the Fed one bit to do the right thing with such an irresponsible policy.

Shawn said...

" John Hempton said...
Yep- it sticks it to anyone foolish enough to save in cash or bonds."

Wow John, did I hear wrong or you are being sarcastic here?

You are implying High/hyper inflation is the way to go? That We, and collectively as a nation does not need to live within its mean?

That prosperity can come with printing money? That prosperity come with living beying your mean and keep printing?

Sooo.... Zimbabwe is the richest nation on earth?

fr said...

You obviously have no experience with politics. If Bernanke or the Fed as a whole acted truly irresponsibly, there is no telling the long-term ramifications.

Anyway, neither the US nor Europe needs reckless, inflationary monetary policy. All they need to do is raise taxes on the rich (who don't consume all their income) and cut taxes on the poor (who do). This is obvious. You don't hear about it because the media are owned by the rich and most people who are capable of speaking intelligently about economics are either rich themselves or work for the rich: "whose bread I eat, his song I sing."

It is best for the recession to go on for several more years. The word must be made flesh among the lower echelons. That is, they must learn the hard way, and over a very long period of time, that their leaders have been leading them the wrong way for a long time. Any attempt to mitigate the suffering will just stop the learning process and make true reform impossible. We are already seeing green shoots. Consider the revolt by voters in Ohio and Mississippi against the referendums put forth by the Republican masters. Whether or not the voters voted in their own interests, it is clear they are revolting and that is a good sign.

Random Blowhard said...

I would not worry to much about the Fed's credibility. Congress is hard at work destroying the United States governments financial stability via crack addict spending and fascist bailouts to cronies.

Give it time, I'm confident they will manage to both increase inflation and force the Fed to print the currency to Zimbucks.

Oh and real inflation in the United States is higher than 6%.

Anonymous said...

the probable reason for the lack of inflation is due to the velocity of money falling <1. the same happened to japan, and they are unfortunately in a self-propagating deflationary cycle.

will this happen to the US? who knows, but the lack of inflation has more to do with the lack of the spending of that cash than other alternative answers.

it is about confidence, the japanese have lost that confidence as they have gotten burnt several times (RE, stock market). the US is not there yet, they are dealing with a lack-of-employment crisis of confidence, supported by falling RE prices.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.