Bernanke's Delusions

I don't envy Ben Bernanke his job. He probably affects more people than the president in bigger ways than the Pope while getting more attention than the Queen. Talk about high stress. Given the swamp he's faced, I think he's done as good a job as anyone could at preventing a crisis from becoming a calamity.

But when it comes to QE2, Bernanke's recent plan to buy $600 billion worth of Treasuries, this quote of his from an interview on 60 Minutes earlier this week is off base:

We're not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way. What we're doing is lowering interest rates by buying Treasury securities. And by lowering interest rates, we hope to stimulate the economy to grow faster.

Encouraging words. Just one problem. None of it's true.

First, the money supply is indeed changing, and at a fairly good clip:

Source: St. Louis Fed, author's calculations.

M1, which includes physical currency, traveler's checks, and checking deposits, is currently growing at more than 7% per year. We can quibble over whether that's "significant," but with the economy growing at around 2.5%, it's hard to say it isn't. M2, a broader money supply that includes savings accounts, has grown at a 6.5% annual rate since April.

Now, about the claim that QE2 is lowering interest rates. Here's an update to a chart I made a few weeks ago:

Source: Yahoo! Finance, author's calculations. YOY = year over year.

Interest rates are low, with 10-year yields actually lower than the dividend yields on ConocoPhillips (NYSE: COP  ) , Waste Management (NYSE: WM  ) , and Kimberly-Clark (NYSE: KMB  ) .

But if the Fed is lowering interest rates with QE2, inquiring minds might want to know why they've gone straight up since the plan was launched.

There might be a couple of reasons. The economy could be recovering, which is pushing investors out of low-yielding Treasuries. But if that's the case, why the need to spend another $600 billion chasing investors away from what they're already running from on their own? Rates also could be rising over fears that QE2 will cause runaway inflation, derailing the program's goals if only through market psychology. My guess is it's a combination of both.

What do you think? Let your fellow Fools know using the comments box below.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Waste Management is a Motley Fool Inside Value recommendation. Kimberly-Clark and Waste Management are Motley Fool Income Investor recommendations. Motley Fool Options has recommended a written covered straddle position on Waste Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (17) | Recommend This Article (14)

Comments from our Foolish Readers

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  • Report this Comment On December 09, 2010, at 12:47 PM, Kurt0001 wrote:

    If inflation expectations are raised, doesn't that lower real interest rates?

  • Report this Comment On December 09, 2010, at 1:43 PM, cmfhousel wrote:

    "If inflation expectations are raised, doesn't that lower real interest rates?"

    If nominal rates also rise, no.

  • Report this Comment On December 09, 2010, at 2:14 PM, ByrneShill wrote:

    Jeremy Siegel's explanation is (in a nutshell) that QE will make long term rate go up (recovery/inflation, as you said) while lowering short term rates (more deposits, as M1/M2 would point out to). Makes sense.

  • Report this Comment On December 09, 2010, at 2:58 PM, cmfhousel wrote:


    That would make sense, but the securities the Fed is buying via qe2 are longer dated, as rates on treasury bills are already at zero and hence can't go any lower. Rates of mid-duration bonds have also risen since the program was announced:^FVX+Interactive#chart1:s...

    Also, this sentence from Seigel's piece: "The impact of quantitative easing comes through its effect on the supply of reserves and therefore lending and deposit creation, not interest rate reductions" is the exact opposite of bernanke's claim, although i tend to agree with Siegel.

  • Report this Comment On December 09, 2010, at 3:15 PM, ByrneShill wrote:

    Yeah, the "We're not printing money" stuff from Ben is complete baloney, I agree. Quantitative Easing is pretty much by definition printing money.

    The higher rates on 5 and 10 years bonds isn't surprising imho. I always thought that since those markets are forward looking, the mere announcement of QE2 would make long term bonds sell (raise rates) through expected future inflation. I don't think they would even need to do any easing for Long term bonds rate to rise, as long as they look credible when they announce QE. Kinda like when a central bank announces its monetary policy, everyone knows beforehand what it's gonna be, all the market is looking for is hints on future announcements.

    A comment such as "we're not raising the overnight rate, but we might need to raise it at the next meeting" is a lot more tightening than an actual rise with a comment such as "we're done raising rates for now". Just the same, a comment such as "we're gonna print 600G$ and buy bonds to increase liquidity" is a lot more effective in creating expected inflation (raising long term bond rates) than the actual printing of the money.

    In this particular case, I think the expected inflation created by the announcement of QE2 (to which we still need to add the actual possible recovery due to higher liquidity) is much bigger than whatever effect the actual buying of long and mid-term bonds has on supply and demand of those bonds.

  • Report this Comment On December 09, 2010, at 4:44 PM, TMFDiogenes wrote:

    Hey Morgan, when the Fed lowers short term rates, don't they use the same mechanism -- credit a counterparty's account and take ownership of their bonds? Is duration the only major distinction between QE2 and regular monetary policy, or is there a different mechanism that makes QE "printing money" and ordinary monetary policy "lowering rates"?

  • Report this Comment On December 09, 2010, at 6:03 PM, cmfhousel wrote:

    Same mechanism, yep. Duration is the only difference. But normal monetary policy, when it's expansionary, is printing money (hence the name "expansionary").

  • Report this Comment On December 09, 2010, at 6:45 PM, lctycoon wrote:

    Another reason might be that any investor with half a brain knows that the USA can not possibly pay off its debt. At best, for much of the future, it will have to borrow money to make interest payments on the debt. Would you loan money to an entity like that at near zero rates? I sure wouldn't...

  • Report this Comment On December 09, 2010, at 9:05 PM, ynotc wrote:

    The more important point is that the Fed must buy our debt because no one else is willing to!!

  • Report this Comment On December 09, 2010, at 9:34 PM, jpaa74 wrote:

    @Ictycoon: If a country has a much stronger currency, trade surplus instead of a huge trade deficit, and at the same time lower interest rates than the US (e.g. Japan and the Japanese Yen), and the loan was made out to be paid back in Yen, then why not? The US couldn't pay it back by merely printing fiat US dollars... Same as what the US and other developed countries have done when lending money do developing countries via the "nice: organizations like the World Bank and IMF... But I digress...

    So who's gonna win the little game called "the race to the weakest currency" our world leaders are pretending not to be playing? My bet's (though not my money) is on the Chinese Yuan...!


  • Report this Comment On December 09, 2010, at 9:56 PM, xetn wrote:

    The interest rate is already up on the 10 year bond, in spite of Bernanke's efforts to keep rates low. Simply put, Bernanke is a liar. The fed failed to see the bubble in housing and the resultant financial crash. If you watch the 60 Minute interview, he was clearly worried but afraid to admit he doesn't know what else he can do to aid the economy.

  • Report this Comment On December 09, 2010, at 10:57 PM, jpaa74 wrote:

    Yeah, it's not an easy situation helicopter-Ben is in, but I wouldn't really blame him for it, but rather attribute it mainly to Mr. Greenspan, who essentially created the housing bubble by keeping interest rates artificially low. Which in turn caused clever i-bankers to buy up "low risk" mortgages from commercial banks, bundling them together, and calling these structured products as CMOs (Collaterized Morgage Obligations), and trying to sell them as a type of bond. When the housing bubble burst though, and even low risk people defaulted on their mortgages that they had been "lured" into believing they could afford more than they really could, these CMOs weren't worth that much anymore... And if you're a highly leveraged i-bank, and with these CMOs as worthless collaterals, then you're bound for trouble...

    As Yogi Berra would say "it feels like deja vu allover again...!"

    People will never learn... It's always "different this time..."

  • Report this Comment On December 10, 2010, at 12:26 AM, predfern wrote:

    10 year treasury rates jumped 30 basis points primarily due to an increase in real interest rates caused by economic growth. The deficit will shrink as growth increases. Kudlow explains. Buy Stocks. Sell Bonds.

  • Report this Comment On December 10, 2010, at 1:34 AM, jfrankh57 wrote:


    Do you think it was a combination of Greenspan, Congress, several Presidents, and Bernanke??? To attribute this mess to one man, Greenspan does a disservice to many involved parties...pointedly many who pushed for universal home ownership and many of those same culprits are involved in pushing for universal everything. I personally think the move to deficit spending by the Feds as a normal modus operandi was and is stupidly short sighted! That method of madness should be reserved for emergencies not everyday living!!!

  • Report this Comment On December 10, 2010, at 4:28 AM, jpaa74 wrote:

    @ ifrankh57:

    Yeah true! I just think it was mainly his fault, but it's also easy for me to sit here and criticize someone after the fact. Hindsight is always 20-20.

    I very much agree with your last two sentencies too. That just seems so obvious to me, even with hindsight knowledge.

    @ predfern:

    I'm not a big fan of the "lightning round" financial shows (I believe Kudlow works for CNBC, or at least used to), where they try to analyze why the market went down yesterday, and where the market's heading today, this month, quarter, etc... As if any of them had a clue...

    He's right about one thing though. Stocks in general are VERY much cheaper than bonds right now, The Oracle Himself said that was pretty obvious early Oct. and the market hasn't moved that much since, so it's not like Kudlow is coming up with this himself as something groundbreaking... Also, over time (I can't remember the minimum time period), stocks have ALWAYS outperformed bonds in the long-run!

    Who would want to lock in their money for 30 years for a paltry 3.25% annual return (which may just barely pay for the REAL inflation... not CPI or something the FED is trying to convince people was the inflation number for last month/quarter/whatev), when many companies pay that and more in dividends to their shareholders. And that's without including the chance of capital gains.

    Buying any type of long term bonds now would be complete madness, as they'd tank as soon as interest rates move up to more normal levels...

    My own stock portfolio has an average of 4% annual dividend yield, all DRIP (Dividend Re-Investment Plan) enabled, so I get the dividends compounded too, and working in my favor as well (DRIPs are completely free too, and most brokers support partial shares, so most of the dividends can get reinvested)...

    You can find consistently high paying dividend stocks with a low p/e too (or the inverse, earnings ratio, which makes it easier to compare them to other investments such as bonds), and some with ROE consistently in the 30's or higher, ROA in high teens or in the 20's, so low LTD, and low cap.ex. and high free cash flow. Again, consistently, for last 10 years at least. I only use either S&P's (page 3) or ValueLine's reports which has all this neatly summarized for the last 10 years. Both are real page turners!


  • Report this Comment On December 10, 2010, at 11:00 AM, bhessel wrote:

    Hey, so long as the bills come out misprinted and have to be burned, what’s the downside? I mean, besides (as Jon Stewart pointed out) the contribution to global warming?

  • Report this Comment On December 11, 2010, at 8:57 PM, DDHv wrote:

    This kind of thing is why we do as much of our investing in fruit trees, more effective heating & cooling, backyard garden, etc. There is a limit to what can be done this way, which is why we are investing in probable gainers.

    It is very useful to plan to take advantage of volatility. With the help of a spreadsheet, it is easy to set a buy price and sell price between the high and low for the last two years. A Saturday adjustment allows following of slow changes. Another weekly adjustment moves said prices closer to the current price until an event occurs. At that point, the appropriate price is adjusted a bit away from the current price. This has a good combination of encouraging time for a bargain to happen, and ensuring an eventual action.

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