Saturday, January 5, 2013

Bernanke’s Legacy Problem




The surprise of the week was not the goofy ending to the cliff. It was the minutes from the Fed.


The meeting in question took place on 12/12, just 23 days ago. Some very major announcements came as a result of that meeting. A new, and much more aggressive Fed policy was revealed. For the first time ever, the Fed set a target for when monetary policy would change.


The Fed said it would keep its foot on the monetary gas pedal until unemployment fell to 6.5%, and maybe even lower than that. The economic forecasts that the Fed released showed a consensus estimate for unemployment staying above the magic 6.5% until at least 2015. So that set a bar for any changes in monetary policy years into the future.


The Fed backed up its new long-term commitment to boost the economy by doubling up with QE4 – another $45b a month of POMO buys. In December the Fed set the “needle” for monetary steam at the same level that existed during the dark days of 2009. All in, the last Fed meeting was a precedent setting commitment to extended monetary easing. At least that is how I read it.


And then we get the minutes from the meeting where all these dramatic steps were taken. The minutes read completely different. What the hell happened?  I have the sense that there was a conversation that might have gone like this:



Okay, we will go forward with QE4. This is our last chance to do anything for a long time to come. There will be no more QE on my watch as head of the Fed.



But, but Ben…..We just promised…..



You’re kidding? I love it! But I don’t understand. What’s up?



I’m looking at the calendar. I’m outta here it 18 months. Before I leave, and turn the keys over to the next guy, I have to “regularize” monetary policy. So that means we end the LSAP’s this year.



But, but, Ben, the markets will be disappointed.  The S&P could fall, interest rates might rise. We wouldn’t want that, would we?



Yeah Ben, we don’t want to upset the apple cart just at the time we have it righted. Remember 1937?



I’ve made up my mind. I will not leave the Fed with a policy that is still in an extreme position. I want to give the new guy a fighting chance. Greenspan did the same thing for me before he handed over the reins.



I’m very sad. I thought we would be able to have fun goosing markets for another two years. Now you’re taking away the punchbowl much earlier than anyone has thought. How will we be able to communicate this to the market? It will be a big shock if we just come out and say that QE is over.



We can control the markets; I’m not worried about that. We’ve being doing it for years now, we should have no trouble doing it for another year.



Gee! What happened to my plan to target monetary policy to unemployment? I thought we agreed to that! Now you’re doing a 180 on us.



I’m not suggesting a 180. We will not reverse any QE. I’ll leave that up to who ever sits in this chair next. I would like to bring policy closer to neutral.

We will just have to manage the news flow.  We can, and will, control that. We will use our usual sources, guys like Hilsenrath, to help introduce this slowly. After all, we don’t want any knee jerk reactions.


We will sanitize the minutes of this meeting. We can introduce the possibility of a change in policy with the words we use. We just have to vague about it…plant a seed. Yes, we will cause some confusion, but that can’t be helped. Most analysts are so confused at this point, I doubt that too many will take the suggestion we are changing direction seriously.



But, but Ben….this is all coming as a surprise. I’m very disappointed.



(Sobbing) So am I!



Well, all I can say is tough! I have a legacy at the Fed, and I want to preserve that legacy. I will not allow my term at the Fed to end with a policy that must be reversed by someone else on the first day he takes over.


Unless something very significant happens over the next half year, “my” Fed is going to move toward a neutral monetary policy by 2014.


We will continue to drop hints for the next few months, and I will make my final speech in August, at Jackson Hole. I will use that opportunity to confirm what we have agreed to today.



But, but, but Ben….



Drop it Janet. My mind is made up. Meeting over.




Okay, I’m kidding a bit. But this is not so far fetched. Why would the Fed send one signal on December 12 and quite a different one on January 4? When it comes to the Fed, there is always a motive for its actions. The motives are not always clear.


I do believe this development is connected to the “legacy” issue. Bernanke’s term at the Fed will set many historical precedents. To a significant extent, history will judge Bernanke on what he did while chairman of the Fed. But the books will also look at what happened after he left.


I believe that Bernanke would very much like to leave his successor with a Fed that had policy choices. As of today there are no options left.  Just more useless QE. I doubt that Bernanke wants to exit with the Fed’s foot planted firmly on the gas pedal. The next guy does deserve a cleaner plate than now exists.


Is the Legacy factor influencing Bernanke? I think it has some sway in his thinking. Consider what Greenspan did before he left. After years of soft monetary policy he ratcheted up the Federal Funds rate 17 times in 22 months. He took the funds rate from 1% all the way up to 6%. Part of that rapid increase was driven to get monetary policy “neutral”, so that Bernanke could do as he wished. Not long after Bernanke took over, he took the funds rate down to zero.




Clearly, Greenspan tried to get monetary policy back to neutral before he left, I don’t see any reason why Bernanke would think differently. Are we watching a repeat of history? At a minimum, his legacy, and where he wants the Fed to be when he leaves,  is part of Ben’s thinking today.


Readers may conclude that I’m all wet with this. That Bernanke’s Fed will never end the easy money policies. And the idea that his legacy has anything to do with current policy, is just gas. Readers might be right in that observation. But those who think that the legacy issue is not a factor, have to answer the question, “What the hell happened at that meeting? Why are we getting hints of a change in policy at this time?”

If there is another excuse for the Fed’s apparent change of heart, I would love to hear about it. I can’t come up with anything else. Something has changed, and it isn’t the economy. So what is the motivation?



Reading the Fed’s tealeaves is a bit of a fool’s game. The chances of being right are about 50-50. But for the sake of discussion, assume that the Fed was telling the truth this past week. Monetary policy will change over the course of the year. It will go from 4th gear and full gas, to “neutral”.


When I say neutral, I mean that the monthly QE programs would come to a gradual end. It’s even possible that there could be some very small backup in the Federal Funds rate early in 2014. To me, this sets up a very interesting scenario.


There are two schools of thought on the Fed’s QE activity:


- All of the Fed Governors (specifically, Bernanke and Yellen) have stated their belief that it is the size of the Fed’s balance sheet that matters when it comes to measuring monetary stimulus. The vast number of folks who opine on the Fed, also believe this is the case. So the markets, and the Fed believe that “neutral” means that the Fed’s balance sheet remains static.


- A small, but vocal minority, lead by Tyler Durden at Zero Hedge, see it differently. This group believes that it is not the size of the Fed’s balance sheet that is the issue. It is the daily, weekly, monthly flows that the Fed creates with QE that is the critical metric when measuring monetary policy.



The two different views are remarkably divergent in their conclusions. And only one camp will be proven right.


I happen to agree with Durden. It’s the flow, not the size. We have a capital market that has a $20B “bid” in it every week. With each POMO buy, the primary dealers have cash money in their pockets, and they have to spend it. So they buy “stuff”. The stuff they buy with the loot from QE ranges from Treasuries, to junk, to equities. I believe that the constant demand from the Fed is the gas that makes these transactions happen. I believe that when POMO stops, so does the merry-go-round.


The Fed will not stop QE abruptly. There will be a 3-6 month wind-down of the POMO buys. We have been here before, with QE1. Well before the Fed stopped buying, markets started to react to what was then perceived to be the end of the QE party.


To a significant extent, this question, and how the markets answer it, will resolve the fate of the markets, the broader economy and Bernanke’s legacy. So this is a very big deal.


The view of the Fed, that it is balance sheet size not flow that matters, is supported by 95% of the market today. So when Steve Liesman tells you that the Fed is moving to “neutral”, and that’s not a big deal, be wary. The “consensus view” is rarely right in these matters. I think the Fed’s neutral is going to feel as if we are in reverse, and moving backwards pretty fast.


Note: I have long felt that Greenspan’s rapid reversal of the Funds rate in 2006 led to the collapse in 2008. Alan tried to “regularize” what he did after the Dotcom bust. Bust went to bust as a result.




  1. Hi Bruce-

    The minutes are propaganda as you know. Bernanke and friends wanted to put the fear of God into hedgies who might otherwise load up on gold and oil. It’s nonsense. Manipulation at it’s finest.

    Meanwhile, we won’t know what they really said for another 5.3 years, when the transcripts are released in February 2017 and no one will give a crap. [Of course by then the transcripts from earlier in 2012 will be nearly 6 years old.]

  2. Excellent post, thank you. It was really puzzling to read the minutes. I agree that the Fed won’t release such a statement “by accident”. It was intentional. Bernanke’s legacy, yes, but what about the legacy of the other voting members? Would they allow Big B to build himself a pedestal while the rest of the FOMC gets the blame for tanking markets just while the debt ceiling issue boils up? One man’s ego versus the economic well-being of 310 million? Greenie’s reputation is all but destroyed, so I am not sure if Big B wants to copy him by handing a tanking economy to the next guy (is that a favor?). The only other explanation I could come up with was to pour some water onto the boiling stock market (and keep gold & silver under a lid?). Or maybe they were all high during that meeting.

  3. I am not sure there really is anything new here. The Fed has constantly prattled on about an exit strategy, and I see diminishing reasons to ever believe it.

    • The fed minutes were to tamp down the gold price. Gold is the fed watchdog, as it rises calling attention to the money printing and future inflation that it brings. A falling or flat gold price takes the spotlight off the negative effects of the fed actions. As with interest rates, the fed believes it can manipulate all financial aspects of our economy.

  4. Bernanke may also be tired of the bickering coming from Congress and the White House in which nothing is accomplished. I suspect it’s his way of telling our representatives that he has been pulling the economy along all by himself, and he’s just had enough. Time to share the load.

  5. I think the Fed is watching major indices and important commodities (oil, copper, lumber) going vertical in the last 4-6 weeks and are getting very scared and are trying to jawbone the rate of asset inflation.

  6. Obama bin Biden says:

    The hubris level of the Fed permits them to believe they actually control the economy, that the US economy is actually responsive to their “planning” and arbitrarily set deadlines for this and that.

    The arrogance is appalling, but not surprising.

  7. weren’t they talking about how to exit qe2 at this time last year? we know how that worked out.

  8. Head Fake. Just to test the waters. If no reaction, your plan is in motion, Bruce. If there is a reaction, they’ll come up with a Plan B. No worries, mate, these MBA’s know what they’re doing!

  9. Bruce, two things.

    The Fed will not be able to get out of MBS purchases this year. The market is not there to supplant the Fed purchases at the interest rates needed to support housing valuations.

    !937 has been misunderstood or misrepresented. The year 1937 started off with strikes in the auto industry. By the end of 1937 auto, steel and other major industries had been unionized. Labor costs soared in 1938. This was a result of the Wagner act passage and increased union activity.

    • The crack about 1937 was directed directly to Bernanke. I think there is a chance he may read this. This has made it to a number of emags, and is being re-tweeted a fair bit (for me).

      Bernanke once said that he would never make the “mistake” of 1937. There is a chance that he is, if in fact he is moving to neutral by year end.

      Tks for yr input. Nothing is ever as simple as one factor. The Re-Depression/Crash of 37 was no different. However, the Fed raising margin requirements certainly had something to do with it.

  10. There was a repeat show over the holidays with Robby “Evil” Kenieval and his son / family — talking about all the prep work before they jump a motorcycle over the grand canyon or the burning pit filled with alligators or whatever. There is a point on the approach (clearly marked so the rider can see it) — when the rider hits that mark, he must be in control of the bike and must be traveling *X* miles per hour with the bike in nth gear and rpm’s at whatever number. All those numbers are known and worked out in advance. If the rider sees those numbers at the approach mark — everything after that (except the landing) is physics. If the rider sees any numbers are wrong at the approach mark — he must abort or die.

    We can all argue about whether QE1 (the first “emergency” monetary policy) was necessary. It was described by the doves on the Fed as “emergency” policy, not a regular on-going thing that should drag on for five years and then some. Perhaps QE2 was necessary, perhaps it was the lessor of however many evils, perhaps it was a mistake.

    When the Fed started thinking about QE2, they really needed to get their ducks in order. They needed to check their speed, gear, rpms, etc as they approached the jump ramp. If everything was not in order — they should have aborted.

    QE3 (aka operation Twist) was the moment halfway across the grand canyon where the rider knows the stunt has gone horribly wrong. The landing is going to be a disaster. It is the “oh shit!” moment — more experienced riders see the problem first, then the newbie riders, and eventually the public. Bernanke has zero real world experience, so he wasn’t the first person to realize the stunt had gone horribly wrong.

    QE4 (aka QEinfinity) is the moment the motorcycle smashes into pieces and on-lookers see the rider’s body being mauled by Newton’s laws of motion. That’s when the TV commentators start discussing Evil Kenieval’s legacy, and maybe his son will take over the family business?

    Don’t know who will take over Bernanke’s “legacy”. Unlike the physics behind motorcycle stunts, monetary policy is more an art than a science. Smarter men (and women) than Bernanke will refuse the job.

    But for now, TV viewers should sit back and watch the fireball and twisted corpse that was Bernanke’s dim-witted economic stunt. Historians will argue whether jumping the grand canyon was stupid, while academics will argue whether Bernanke should have known to abort the stunt before he hit the ramp (as though this was a science?). Economic central planning is much easier in the classroom than it is in real life.

    The US economy is going to be in a body-cast, under traction pulleys, and in immense pain — for a very long time. Make sure you all remember that Washington DC did this to us, and Bernanke helped.

    That is Bernanke’s legacy.

  11. Experienced poker players know how to goad rookie players (with losing hands) into increasing the pot anyways. Experienced poker players know when to hold’em and when to fold’em — live to play the next game. You don’t see them adding to the pot 3-4 rounds after it is obvious their hand sucks and the fold isn’t going to help.

    The pastry chef at a five star hotel knows instinctively when he/she has a bad batch of batter. When they sense something is wrong, they throw out the batch and start over — do it right or don’t do it at all. You don’t see a five star pastry chef screwing up 3-4 batches, and then tinkering with the recipe at 7pm when the first diners are asking for desert menus.

    Experienced traders know when a trade doesn’t feel right, and they just close the position. Some call this risk control, others call it money management / living to fight another day. It is the difference between a trader who is a “book expert” and someone who has actual trading experience. You don’t see a successful hedge fund trader “second guessing” himself 3-4 times on the same trade.

    The fact that the Fed is sitting here doing “emergency” monetary policy — for the 3rd and arguably the 4th time — is evidence of amateur hour. Its obvious they don’t know what they are doing. Its obvious the zero rates + QE idea isn’t working in the USA any better than it did in Japan.

    Last summer was the point where an intermediate skilled poker player or junior pastry chef or junior trader — would ask the senior guy for help and advice. Of course, if you are the head chef or the head trader on the desk, you have a bigger problem. Someone is bound to realize you belong in that position and you are in way over your head, and to say so publicly.

    A person with integrity would resign or step aside and let a more qualified person attempt to fix the problem. Of course, a more qualified person is not going to assume responsibility for your error — they will demand that you admit failure first. This isn’t their first rodeo.

    If you are a politician (or pseudo politician, or a big bank CEO) — you ask: How do I cover my tracks? How can I pass the blame onto someone else? Issue a press release that no one could possibly have foreseen this outcome. Maybe blame Turbo Tax or some radio shock jock.

    Bernanke is neither qualified, nor a weasel politician. Having a Know-it-all academic title makes it difficult for him to admit he is unqualified (even though most of the audience already has figured this out). Not being a slimey weasel politician makes it more difficult for him to blame it all on TurboTax or some other nonsense (not that anyone would believe this excuse anyhow).

    Benanke’s academic sized ego is scrambling like a cornered animal, trying to find a way to save face.

    The rest of the FOMC (mostly academics and lawyers, plus William Dudley Doowright who’s experience was at Goldman Sach’s economics department) have pretty much the same problem. PhDs and JDs and privileged pedigree up the wazzooo — zero real world experience.

    After you have spent your lifetime telling everyone (including yourself) how friggin genius you think you are … how do you tell them you now realize you are in over your head? How do you tell yourself?

    Psychologists call it a schizophrenic response — the subject appears to act normal, have normal social interactions / ability to lie under oath at Congressional hearings. Yet the subject suffers from a clear inability to reconcile two conflicting views of the world, one of which he wants to believe (I am friggin economics PhD!) and one of which is supported by real world evidence (I totally fucked up the banking system!) — so the subject develops elaborate stories and hallucinations to cope with the glaring discrepancy. Eventually, the real world evidence prevails — and triggers the wacko mental breakdowns that we see on the news…

    Mark your calendars — the real world evidence is intruding on Bernanke’s delusions of grandeur. Mental breakdown ahead.

  12. But What Do I Know? says:

    Very interesting interpretation, Bruce, especially the part about Greenspan’s wanting to “normalize” policy before he left office. Hard to tell on motivations, but what you outline makes some sense. . .

  13. Hi Bruce,
    Jim Sinclair and Steve Saville have both insisted that the Federal Reserve cannot exit QE, at least not without severe economic consequences. Your take? Is this party getting long in the tooth? Does our wealth survive the next 10 years?

    • History Repeats says:

      Like Bernanke, John Law was an “economist” who thought all of society’s ills (England and France) could be solved via the printing press. He nearly bankrupted England — before fleeing to evade murder charges. Then he succeeded in bankrupting France. During the printing press scam, he was the toast of Paris (just like the Bernank). As the scam collapsed, the crowd turned on John Law Princeton PhD. Law supposedly fled France under cover of night (dressed as a woman) and lived out his days a hated fugitive wanted by both UK and French authorities.


      More importantly to the rest of us … the standard of living in France collapsed and continued to suck for many many decades. The suffering caused by the economist’s promises of a free lunch was enormous.

      If only there was a historical precedent that Americans could learn from to avoid this fate?

  14. The Fed needs to manage expectations. They cannot allow gold/silver to explode in early January with the debt-ceiling and spending sequesters coming up in Feb/March. So, they need to cool off the gold market in the meantime. Like Kyle Bass says, the gov’t (and banks) will tell you one thing and then do the exact opposite (e.g., Mexico’s devaluation of the peso in 1994).

    Lastly, who will buy the 10-year+ treasuries without the Fed? If QE4 stops for a prolonged length of time, expect a complete crash of the US Bond market. There is no way out and no way of stopping QE4.

  15. Bernanke is a liar and a money printer. Hat tip Marc Faber
    Bernanke is a thief coward of the night stealing from the middle class, retiree’s and savers via ZIRP. Hat tip Willem Buiter

  16. Bruce,
    In 2006, the Federal Debt was about half of what it is today. Any increase in interest rates will add several nails in the coffin. However, given what is happening with Gold, perhaps it is sniffed out Fed’s newly “announced” neutral policy? Or, on the other hand, the Fed’s goal here is to keep commodity prices down hence the announcement? Or, like you had stated, Bernanke’s Legacy.

    Thanks for sharing you views – as always…

  17. Nonsense! All they did was reiterate what they said they’d do. If the unemployment ticks down more quickly (for the right reasons,not people droping out of workforce) or inflate. 2% than they thought, they are not going to print more than a trillion, which would be into 2014! It’s simple

  18. Everyone loves what you guys are up too.
    This sort of clever work and exposure! Keep
    up the wonderful works guys I’ve you guys to blogroll.