What’s In Bernanke’s Toolbox?

We got this message from out friend JR:

“Bernanke said the Fed has three tools left in the box to promote growth. He can reduce the rate the Fed pays on reserves banks deposit overnight with the Fed. He said the Fed can communicate its intentions differently. And he said further asset purchases could happen.”

Thoughts? I think we already discussed Door #1. Door #2 – well, ok… he can wear a clown suit in his next speech. That might be more effective; Door #3. That’s the Lusitania door. Or maybe the Bismark. You know, it lost its rudder, then finally got blown out of the water.

Rather than limit our reply to an email, we thought we would share it with others.


Bernanke has noted before the importance of “communication” in controlling market psychology. Maybe he can read Fed intentions backward or in French or something to be different, but the effect goes stale.

To get economic growth he needs the consumer to spend. We showed why this is unlikely in Portrait of the American Consumer. In fact if you read The Policy of Doom, Lacy Hunt explains why the huge debt will be an important factor in limiting growth for the next 2 decades. The Fed can help the Treasury create more debt by buying Treasuries but it cannot reduce debt. In short, the Fed can influence and move markets but it has lost its ability with ZIRP (see Living In a Hypothesis, particularly Figure 6) to influence the economy.

Asset purchases can be sterilized or unsterilized. Both are types of QE. Essentially Operation Twist and its most recent bastard child Operation Twist 2 are of the former. The idea was to drive down long term rates making mortgages more affordable. The effect has been minor to insignificant (in the mortgage market, although it has flattened the yield curve, screwing savers and pensioners in the process) because the intent is to encourage households to take on more debt – the very problem currently defeating their policy effectiveness.

In the unsterilized form they expand their balance sheet. That’s what the stock market (and gold) wants. But what can that achieve? When they buy an asset they are buying something that the owner could sell if he needed the liquidity (cash). So why buy more producing more liquidity? And they buy only from primary dealers (PDs), not Joe the plumber. Joe the plumber would have to sell to a PD to transfer an asset to the Fed. What has Joe got other than an underwater mortgage? Mind you this is what the Fed took as collateral from the banks but would they do the same for Joe? Maybe. We doubt it.

The key point is the PDs have $1.5 trillion of reserves sitting in the Fed that they can’t spend as we have discussed. If QE3 buys another trillion in assets then the PDs’ reserve accounts go to $2.5 trillion. This would blow hell out of virtually every market and do nothing for the economy.

Right now the US needs jobs – the coincident factor to economic growth. The only tool the Fed has that can help business is low interest rates and that tool has been used and broken (ZIRP remember?). So what can the Fed do to help business – especially small business? Nothing. Squat. Bernanke has an empty toolbox. The Emperor has no clothes.

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