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Fed on Overdrive

It’s not easy keeping the financial world in perfect balance.  It’s especially hard when you are the only one trying.

The role of the Fed and its chairman, Ben Bernanke, has been increasing dramatically and it rightly scares many people – especially those who think it is doing the wrong things.  But the criticism highlights a much bigger problem – in many ways, the Fed is the only institution actually doing something.  That has naturally led them into places that they should not be and would not be if our government was functioning properly.

Let’s start with what the Fed is supposed to do, which is price stability.  Our Fed, like any other central bank, exists to keep inflation in check and guarantee that the US Dollar is worth about the same tomorrow as it is today.  When prices start to rise too much interest rates go up and the economy cools down, keeping everything on an even keel.

This is especially hard for our Fed because the US Dollar is the standard currency around the world.  A stable value to the buck inside our borders, measured by the inflation rate, has to be squared with international demand for the currency as global trade increases.  It’s not a simple job.

But that is not all that the Federal Reserve does.  Since early 2008 they have increasingly propped up the financial system, keeping banks and investment houses solvent with massive injections of cash.  To date that includes about $9 trillion in loans and other arrangements.  The Fed has also forced banks to increase their assets on hand, conducting “stress tests” that evaluate the condition of investment houses and determining what they must do to be declared healthy.  Ben Bernanke and crew are now the de facto chief regulators of the financial industry.

Price stability and financial system stability are in constant conflict.  The need for cash to prop up the system does not make for a sound US dollar and has often stressed the strange relationship between the currency we use everyday inside our borders and the global system of exchange.

While that’s difficult enough, there is still more for Bernanke.  In 2011, the Fed became the largest buyer of US public debt, or treasuries – the bonds that the government issues to cover our deficit and all the accumulated debt.  All together, 61% of it was bought not by China or Brazil but by our own Fed.  This has never happened before.

The main driving force of this unprecedented role in our public debt is called “Operation Twist”, where short-term treasuries at zero interest are sold and the same amount of long-term debt is bought in order to reduce interest rates in the economy.  Even if it is successful, critics of Berananke worry that this will only magnify the “liquidity trap”, or fear that the return on investment is so low that it does not in any way justify the risk – a situation where investors sit on money rather than do anything at all with it.

The net result of all this buying of treasuries is that the Fed is now the manager of US public debt, and by extension the government finances that require so much debt to be issued.  Congress has not passed an actual budget in 3 years, relying instead on “continuing resolutions” that simply keep everything keepin’ on.  The US government keeps moving largely to the extent they can issue more debt – and by the Fed’s ability to absorb it, given that they are the largest purchaser.

If that arrangement confuses you into a headache, you probably understand it about as well as anyone ever could.

This means that the Fed now has, by default, three often conflicting roles to perform:  price stability, financial stability, and public finance management.  The idea that one agency could possibly do all of this well is ridiculous.  The fact that this agency is not elected and meets entirely behind closed doors is a serious threat to everything in our financial and political lives.

Price stability is indeed the Fed’s job.  Financial stability needs to be put into the hands of an agency chartered to save financial institutions, ideally modeled after the FDIC and manged by elected officials.  Managing our public expenditures and debt can only be done by the Congress, which has to start doing their job.  Ben Bernanke may get a lot of criticism for what he does, but a lot of it are things that have to be done – despite the fact that our government has become paralyzed to the point of uselessness.  That’s the real problem.

I, for one, am glad Bernanke is on the job.  I just wish that job was a lot less than it is.

22 thoughts on “Fed on Overdrive

  1. Doesn’t all this just scare the hell out of you? It sure does scare me. But I have to do my taxes and thats bad enough to think about for one day.

  2. To think that one man is holding everything together while congress whines like babies really stinks. But that is what is happening, right? Nothing surprises me anymore.

  3. the fed is by and for the 1%. bernanke throws around trillions of dollars like they were nothing and it is all for the rich elites who rule us. this did not wind up behind closed doors on accident – that is how the world is run by the oligarchs who are really in charge. bernanke is their tool – the public face who is supposed to make people think there is someone they can name in charge. the real power is hidden away in goldman sachs and places like that.

    • I largely disagree. The Fed Board of Governors certainly has very different friends than you and I do, for sure. Yet I do believe that they are at least sincere in their efforts to do what has to be done – regardless of the simple fact that they really don’t have the charter or the tools to do it well. That does not mean that they are looking out for ordinary people per se, but for what they think is the right thing for ordinary people. In some ways, they are right – a functioning financial system employs millions and makes life as we know it possible. But it is damned unreasonable to have them do everything with the secrecy that they operate under – and a genuine threat to everything that created this world in the first place.
      And yes, Goldman (along with JP Morgan, et cetera) do try to run the world as much as they can. A reasonable government does far more to stop them than to try to use them for good – the latter is pretty much a lost cause, as per Greg Smith (the former employee).

  4. Sometimes I think you could use a stronger sense of panic in what you write about. This is really scary the more I read it. But you make it sound like it’s just what the system does.

    • This is supposed to scare you, but I want to leave it to the reader to decide how scared to be. I do think this is a serious problem, but there is enough sensationalism in the popular media. I’m trying to provide context as much as news that you might not read somewhere else.

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