So much for the U.S. economy and the free market

Ben Bernanke's Hubris Has Him Attempting To Challenge The Laws Of Gravity

By Moshe Silver

Why is America’s top central banker standing in the way of economic growth and a strong U.S. dollar? If you’re wondering what the answer is to this, and why the monetary madness shows no sign of stopping, you’re not alone. Many Fed observers remain aghast at the power our unelected Fed Chairman has arrogated to himself since being appointed.

Case in point: Last month’s head-scratching “Taper-Not-Heard-‘Round-The-World” when Ben Bernanke challenged economic gravity by refusing to curtail the mind numbing scope of unprecedented Fed asset purchases. Unlike his predecessor (Alan “I made a mistake” Greenspan), Professor Bernanke has yet to admit error. Like New York’s fabled Mayor Fiorello LaGuardia, when he does… it’ll be a doozy! To be clear, the markets were signaling their willingness to charge ahead under their own steam – until Bernanke’s shrug reignited bond prices and depressed an already depressed dollar.

Surely, a Princeton economics professor knows that the U.S. economy is driven by production; the latter traded for U.S. dollars that producers use to exchange the fruits of their labor for what they don’t have. As domestic consumers watch the value of their dollar savings dwindle because there is zero return on their (insured) passbook accounts and (uninsured and inherently unstable) money market funds, where’s the growth to come from? Apologists say the recent drop in our currency “is good for U.S. growth” because it will drive growth by making our exports cheaper. Are you buying this?

Economists say we should be upbeat because Treasury debt held by individuals continues decreasing as a percentage of total U.S. debt outstanding. This is positive, they say because outsiders are buying our debt, instead of their own.

But the Fed already owns over $2 trillion of Treasury debt, and counting. The Treasury is set to issue $444 billion of new debt by the end of this year. At the current QE pace of $45 billion per month, the Fed will purchase $270 billion of this new debt, or roughly 60%. Theoretically this helps keep our sovereign cost of capital low (artificially depressed Treasury yields), and the Fed remits its interest earnings back to the Treasury, further reducing the need for more debt to be issued.

At mid-year, we saw a pattern of rotation out of fixed income as rates rose. Financial firms trimmed their bond inventories, signaling a seismic shift. Bond prices started to fall, the Dollar began to strengthen, and the scene looked set for growth both in the U.S. equities markets, and in the economy. We had real hope. But Hope, as we have learned, is not an investment process.

Still, as long as Bernanke can overpower the force of gravity, rates will remain low, and interest income will rise faster than interest expense. But the Fed balance sheet continues to balloon, which skews the metric of “percentage of Treasury debt owned by U.S. individuals.” Treasurys bought by the Fed are not owned by U.S. individual investors. But the taxpayer is on the hook for every newly-minted penny of it, meaning that on the Fed’s books we owe ourselves $3.7 trillion, and counting.

Spooked by how much Treasury debt foreigners own? You can relax. Nobody holds as much Treasury debt as you. And it’s guaranteed. Also by you. Check it out: the Social Security trust fund holds over $2.7 trillion, various federal retirement and insurance funds collectively own over $800 billion, military and uniformed services funds own $600 billion… the list goes on. These agencies can argue that they bought Treasurys to fund future payments to their beneficiaries. The Fed holds over two trillion dollars’ worth of Treasurys, just so the Treasury doesn’t have to issue even more. (Are you following this…?)

Who benefits? Holders of the largest bond portfolios – many with a notable Washington presence – can’t easily divest billions of dollars’ worth of bonds. Now they don’t have to. Another example could be energy master limited partnerships. They thrive on interest rates and are often short on fundamentals. A low rate environment means they don’t have to increase the yield on their payouts. And so it goes. Until it doesn’t.

The Fed’s buying program also moves $45 billion a month through the system, generating transaction fees for the Treasury primary dealers, some of Wall Street’s biggest financial firms.

If we survive this year, 2014 will see a new Fed chair – most likely Janet Yellen, a highly qualified central banker who, many predict (read: “fear”) looks set to continue in the Bernanke mold “for as long as the economy needs.”

Where will this end? Once Yellen takes over, the good news is that President Obama is not running for a third term, so she might feel less political pressure to push the incumbent’s agenda. The bad news is, Yellen will have to second-guess the political agenda of whoever is most likely to end up in the Oval Office. This means that keeping her job would become Yellen’s full-time job. Welcome to Washington.

So much for the U.S. economy and the free market. So much for the consumer and their pittance. So much for the Dollar. We have met the Chinese, and they are us.