slouching toward bethlehem

The best lack all conviction, while the worst
Are full of passionate intensity.
-- W. B. Yeats

In 1999, Mr. Bernanke wrote a piece called, Japanese Monetary Policy: A Case of Self-Induced Paralysis?. It lays out perfectly well our dominant Monetarist's thinking on Japan's popped financial bubble and the following decade long, now decades long "slump". The paper exactly lays out the response Mr. Bernanke has thus far taken in response to America's popped financial bubble. More importantly, it reveals the next steps Mr. Bernanke appears ready to undertake. It is a very rational, though quite radical piece, with a very irrational conclusion -- if dumping a bunch of money onto the financial system hasn't worked, the solution is to dump more.

Mr. Bernanke begins,

I tend to agree with the conventional wisdom that attributes much of Japan’s current dilemma to exceptionally poor monetary policy-making over the past fifteen years.

He then proceeds,

Having pushed monetary ease to its seeming limit, what more could the BOJ do? Isn’t Japan stuck in what Keynes called a “liquidity trap”?

He answers,

I will argue here that, to the contrary, there is much that the Bank of Japan, in cooperation with other government agencies, could do to help promote economic recovery in Japan....far from being powerless, the Bank of Japan could achieve a great deal if it were willing to abandon its excessive caution and its defensive response to criticism.

Japan must continue the same actions, only more. Mr. Bernanke then lays out what these actions must be, and they are important because they are the actions the Fed has undertaken in the US with little impact. Now, Mr. Bernanke prepares to up the ante.

In the 1990's, the Bank of Japan dropped interest rates from 6.5% to less than 1%. In 1999, when Mr. Bernanke wrote his paper, interest rates had been below one percent for five years. This was also accompanied by Japan's version of "pretend and extend", where the banks and corporations did not have to account for the bad loans on their books. In short, it was the exact same policy the Fed and Treasury have undertaken here, with very similar results. While, Mr. Bernanke acknowledges one of the great problems Japan faced was lack of demand, despite all the present and historical evidence to the contrary, he advocates greater monetary action will solve the demand problem.

Bernanke's first suggestion is in the realm of traditional central banking, mixed with a call for active propaganda. The bank must keep interest rates at zero and then propagate a high inflation target. He simply dismisses the idea that a central bank has no real ability to meet any given inflation target, as long as it's a solid number he states, it will work.

His second action, now familiar to the US and the rest of the world, is devalue the currency. He writes,

Through its effects on import-price inflation (which has been sharply negative in recent years), on the demand for Japanese goods, and on expectations, a significant yen depreciation would go a long way toward jump-starting the reflationary process in Japan.

Noting currency policy is not under the aegis of a central bank, Mr. Bernanke writes,

On legal authority, it is true that technically the Ministry of Finance (MOF) retains responsibility for exchange-rate policy. (The same is true for the U.S., by the way, with the Treasury playing the role of MOF. I am not aware that this has been an important constraint on Fed policy.)

And there you have it. In the monetarist's mind and no doubt Wall Street's and the banker's, legality is simply a technicality. All power should in fact lie with the Fed, banks, and financiers, and of course, that is exactly what has happened over the course of the last couple decades.

Next, Mr. Bernanke gives his argument against such currency manipulation being viewed hostilely by other nations,

The “political constraints” argument is that, even if depreciation is possible, any expansion thus achieved will be at the expense of trading partners—-a so-called “beggar-thy-neighbor” policy. Defenders of inaction on the yen claim that a large yen depreciation would therefore create serious international tensions...Moreover, the economic validity of the “beggar-thy-neighbor” thesis is doubtful, as depreciation creates trade—-by raising homecountry income—-as well as diverting it. Perhaps not all those who cite the “beggar-thy-neighbor” thesis are aware that it had its origins in the Great Depression, when it was used as an argument against the very devaluations that ultimately proved crucial to world economic recovery.

Again, this is essential to understanding the Fed's actions today. It is the monetarists' revisionism of the Depression era currency turmoil. An important point to make is the devaluations of the 30s took place against an "objective" standard, gold. Today, there is no objective standard, all money is relative, though by devaluing the dollar, the defacto global reserve standard, you're not simply devaluing a currency, you're devaluing the reserve standard itself. In short, the currency turmoils of the 30s were indicative of the great global imbalances developed over decades. Currency turmoil was more an effect, than a cause, and in the end was not solved by further currency manipulations. But when you wield a monetary hammer, every problem looks like a nail.

Mr. Bernanke's final action is one he already has undertaken and is about to expand, Quantitative Easing II, in which the Fed buys government and corporate debt to inject more money into the financial system. Mr. Bernanke writes,

In thinking about nonstandard open-market operations, it is useful to separate those that have some fiscal component from those that do not. By a fiscal component I mean some implicit subsidy, such as would arise if the BOJ purchased nonperforming bank loans at face value, for example (this is of course equivalent to a fiscal bailout of the banks, financed by the central bank). This sort of money-financed “gift” to the private sector would expand aggregate demand for the same reasons that any money-financed transfer does. Although such operations are perfectly sensible from the standpoint of economic theory, I doubt very much that we will see anything like this in Japan, if only because it is more straightforward for the Diet to vote subsidies or tax cuts directly. Nonstandard open-market operations with a fiscal component, even if legal, would be correctly viewed as an end run around the authority of the legislature, and so are better left in the realm of theoretical curiosities.

This is the nut. Here Mr. Bernanke lays out extra-constitutional actions, that far from "theoretical curiosities", he aggressively implemented two years ago, loading up the Fed's balance sheets with garbage paper from the banks. As these actions proved both illegal and insufficient, he is about to embark on a new endeavor, having been met with no rebuke, in fact, he was reconfirmed in his position by the President and the Senate.

The Fed's policies are blowing bubbles in financial markets across the planet, this in turn is further removing the financial markets from the realities of the physical economy. This most likely can go on for quite a long time, but the longer it continues, the more volatile the financial system will become, causing further and further destruction to the real economy, and it must be noted, the rule of law. We need to take new actions. First, people need to go to jail. Second, we need to start writing bad money off the books, not continue creating more of it. We need to restructure the financial system and the big banks need to be broken up. We can take all the excess housing and commercial real estate and use it to create new local "savings and loans", actively controlled by local public entities and private interests, which can only invest in local activities.

There comes a time in history, where the establishment's actions seem to be quite insane. It is a continuing of the actions of the past, despite the obvious fact they aren't working. This recognition is met not with change, but a doubling up on the same actions hoping for different results. Welcome to the Fed's funhouse.