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Bernanke's Big Talk: Here's What You Need to Know

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Love him or hate him, you should listen when Fed Chairman Ben Bernanke speaks. He affects your finances regardless of whether you agree with him.

While Bernanke sat through a three-hour grilling by the House Budget Committee this week, I pulled up a chair, readied a pot of coffee, and took notes. Here are a few Bernanke remarks that caught my attention. (Bolded text is mine; everything else is Bernanke.)

Don't call QE2 monetizing the debt: Monetization would involve a permanent increase in the money supply to pay the government's bills through money creation. What we're doing here is a temporary measure, which will be reversed so that at the end of this process the money supply will be normalized, the Fed's balance sheet will be normalized, and there will be no permanent increase either in money outstanding, in the Fed's balance sheet, or in inflation.

Also, don't blame QE2 for global inflation: Inflation is taking place in emerging markets because that's where the growth is. That's where the demand is. That's where, in some cases, the economies are overheating. It's the responsibility of the emerging markets to set their monetary and exchange-rate policies in a way that will keep their economies on a stable path. The increases in oil prices, for example, are entirely due -- according to the International Energy Agency -- to increases in demand coming from emerging markets. They are not coming from the United States. The bulk of the increases of commodities prices is a global phenomenon. Inflation here in the U.S. is very, very low.

QE2 is responsible, however, for job creation: A very careful study done by Federal Reserve system economists suggests that the total job impact of all the of QE programs could be up to 3 million jobs. It could be less. It could be more. But the important thing to understand is that it is not insignificant. It is an important contribution to growth and job creation.

Some blame a weak dollar for stoking commodity prices, which in turn sparked the Egyptian riots. Nonsense: It doesn't matter what commodities are priced in. What matters is the currency of the country that's making the purchases. And they don't use dollars in Egypt. They use Egyptian pounds. When the dollar weakens, which it has done very slightly, that would make the pound stronger -- it would make [Egypt] better able to buy commodities. But I think the real issue in Egypt, for example, is the fact that Egypt is the world's leading importer of wheat. And we've just seen very bad harvests in Russia and Eastern Europe, which are their primary sources of wheat. And that's what's really happening -- on the agricultural side there have been droughts and other problems around the world that have affected crops. Monetary policy can't add one bushel of corn to the world. It's determined by agricultural productively and by weather ... and increasing demand from emerging markets, [which] has put pressure on supplies. Monetary policy in the United States has very little to do with the price of wheat in Egypt.

Some countries talk about wanting to price oil in something other than dollars. Big deal: The currency in which goods are invoiced is really of not much consequence. A broader question is: What currency is the reserve currency -- the currency that countries hold their international reserves in? And the fact is that the U.S. dollar's share of 60%-plus has been pretty stable, and I really don't see much likely change in that. In fact, as of lately, given the problems of the euro, etcetera, the dollar has actually been looking more attractive relative to some of the other currencies of the world.

QE2 was meant to lower interest rates. Instead, they've risen. Big deal: The bulk of the increase in interest rates has been on the "real" side of the interest rate, which means that, like the stock market, the bond market is expecting greater future growth and is more optimistic about the U.S. economy, and I think that's a good thing obviously, and I think our policies contributed to that.  

On QE2 not causing trouble: We've been very careful to not distort the bond market. We've paid a lot of attention to that issue. We've monitored market functions. We've made sure that we don't own too high a fraction of any particular issue of government bonds. And our clear sense is that Treasury markets are functioning very normally. They're very liquid, and we don't see our policy -- which is a temporary policy -- as creating any particular problems for the market itself.

QE2 was $600 billion. How'd you come up with that number?: We asked the hypothetical question: If we could lower the federal funds rate [below zero], how much would we lower it? And a powerful monetary policy action in normal times would be about a 75 basis point cut. We estimate that the impact on the whole structure of interest rates from $600 billion is roughly equivalent to a 75 basis point cut. So on that criterion, it seemed that that was about enough to be a significant boost, but not one that was excessive.

It's going to take a while to bring unemployment down: It takes about 2.5% real growth just to keep [unemployment] even. You need about that much growth just to make jobs for new entrants to the labor force. If we were to average, hypothetically, 4.5% growth -- which is quite ambitious -- it would still take us another four years or so to get down to the 5%-6% [unemployment] range.

Congress, don't play games with the debt ceiling: The risk of not raising the debt ceiling is that interest would not be paid on outstanding government debt. And if the United States defaulted, it would have extraordinarily bad consequences for the financial system, and it would mean we would face higher interest rates essentially indefinitely because creditors wouldn't trust us to make our interest payments ... it would be very destructive.

On China's currency games: The renminbi is undervalued. It would be both in our interest and in China's interest for them to raise the value of their currency. It would help them with inflation … One of the things that's happening, which is a little surprising in a way, is that they have an inflation problem, and the way they're addressing it is not by raising their currency value -- which would reduce the demand for their exports. Rather, they are leaving it where it is, and they are instead trying to reduce domestic demand through higher interest rates. It would seem like a better strategy would be to let domestic be what it is and let people enjoy a higher standard of living in China, and reduce their exports via a higher exchange rate. It is a counterproductive policy both for them and for us, and it is contributing to the still-large global imbalances.

On learning from history and knowing what you're doing: Since the early '80s to 2007, when central banks began to understand the critical importance of keeping inflation low and stable, the U.S. economy not only had low inflation, but it also had a much more stable economy. And that was a 25-year experience. We have no illusions about letting inflation rise. We are strongly committed to keeping inflation low and stable, and we will do so.

My comments (Morgan here): The main criticism of Fed policies is that they'll eventually cause runaway inflation. Zimbabwe. Weimar. That stuff. When I hear Bernanke talk, I'm left reassured of how unlikely this situation is, but no less worried.

See, I think Bernanke is serious about not letting inflation get out of control. Whenever asked about it, he sits up straight. His brow furrows. His beard flattens. He interrupts questioners to remind them how steadfast he is about preventing runaway inflation, and that the Fed will do everything to prevent it. And I believe him. But getting there could mean having to hike interest rates to draconian levels -- that's what scares me. A House member asked Bernanke if he was worried about mortgage rates recently jumping to 5%, implying this was somehow high. Five percent. What happens if interest rates hit 10%? 15%? I shudder. The process of preventing runaway inflation might end up being just as painful as the inflation itself.

That's what scares me.

What about you?                                             

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. 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 (8) | Recommend This Article (19)

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  • Report this Comment On February 12, 2011, at 12:48 AM, dave665 wrote:

    Here are the problems with some of the Bernanke comments. For one thing, he focuses too much on comparing currencies against each other. The real issue is that money is being printed in nearly all these currencies in an attempt to keep exchange rates stable with THE reserve currency (the dollar). So yes, QE2 is directly responsible for most commodity price inflation, and this signals the weakening of nearly all currencies. It is just that the results of food and energy inflation are most obvious among poorer countries.

    Another issue is the 0% short-term interest rate that is designed to enrich banks. If a bank borrows money at 0% interest and lends it right back to the central bank (which is granted the power to never run out of money) or the fed gov at, say, 3-5%, nothing has really changed hands but now the bank is getting 3-5% interest on that theoretical loan, consisting entirely of new (printed) money.

    Also, I agree with Morgan's basic conclusion: Although Bernanke claims he can raise interest rates whenever he needs to, the need will be so great and so sudden that the potential consequences of doing so will be catastrophic. So better to deal with some pain now than put ourselves in an impossible currency situation down the road. I also recommend people read the Ron Paul book 'End the Fed', it is very informative on the whole topics of central banks and fiat money creation.

  • Report this Comment On February 12, 2011, at 2:31 PM, plange01 wrote:

    bernanke is one of obama's lap dogs once obama is removed from office the rest of his trash will crawl back into their holes...the brave people of eygpt had the right idea hopefully the american people can find a little of the courage they had and start working on getting their country out of its growing depression...

  • Report this Comment On February 12, 2011, at 9:58 PM, slpmn wrote:

    plange01 - Bernanke was appointed by Bush.

    Dave665 - Good points until you start to make definitive statements like "the need will be so great and so sudden that the potential consequences of doing so will be catastrophic." Too much hyperbole, too much worrying about something everyone who's ever taken a high school Econ class is aware of. If something comes back and bites us in the behind from Bernanke's policies, its not going to be as simple as inflation. Its going to be something unexpected.

    As it happens, I think interest rates are way too low for the simple reason I think artificially low interest rates helped get us into this mess. I understand why they're doing it, I'm not afraid of runaway inflation exploding out of nowhere, but I do think it wouldn't hurt if it cost more than 4.25% to buy a house, and it would be nice if people could earn more than 0.50% on a 3 year CD, or, god forbid, more than zip on a money market account. Debt should cost something meaningful, and conversly, one should be able to earn something by saving.

  • Report this Comment On February 13, 2011, at 5:54 PM, fredgei wrote:

    ". . . one should be able to earn something by saving."

    Chinese households, on average, save about 30% of their income. ( ) This is so much money that, even the way China's economy has been booming, there's not enough investment demand to absorb it all. A few years ago, it seemed like the best way for Chinese to "earn by saving" was to invest in US mortgage-backed securities, and we all know how well that worked out.

    The only way someone can earn by saving, is by turning the savings over to someone who puts it to more productive use. When we're out of productive uses, all that's left is earning inflation, more-or-less. (Less, when the economy is severely depressed.)

  • Report this Comment On February 14, 2011, at 11:53 AM, lctycoon wrote:

    Higher interest rates are a very good thing if you don't have any debt and are a net creditor... just saying. That doesn't apply to most Americans, though.

  • Report this Comment On February 14, 2011, at 2:20 PM, Turfscape wrote:

    I'll agree in totality with one assertion: the Egyptian riots were not sparked by the dollar or U.S. monetary policy. People (I'm looking at you Coulter, Palin, Limbaugh and Beck) need to pack away the stupid American politics and realize that the Egyptian riots were caused by decades of a repressive, unresponsive dictatorial oligarchy.

    "Gee, if Obama had better monetary policy, we could have kept a friendly dictator in control in we'll be forced to listen to the Egyptian people!"

  • Report this Comment On February 14, 2011, at 3:08 PM, mtf00l wrote:

    Actually, if the CIA or Homeland Security is unsuccessful in placing the next dictator in Egypt, we'll be invading, like we did in Iraq, in the near future...

    The interesting prognostication is, will the military relinquish power now that they have it?!

  • Report this Comment On February 15, 2011, at 11:18 AM, TMFDiogenes wrote:

    Have people really been claiming QE2 caused Egyptian riots while I was abroad? Strange idea -- I must have missed a lot of our national navel-gazing.

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