Bernanke vs Greenspan?

Submitted by Andrew Fruth of AcceptanceTake

Bernanke and Greenspan appear to have differing opinions on whether the Fed will monetize the debt.

Bernanke, on behalf of the Federal Reserve, said in 2009 at a House Financial Services Committee that “we’re not going to monetize the debt.

Greenspan, meanwhile, on Meet the Press in 2011 that “there is zero probability of default” because the U.S. can always print more money.

But they can’t both be true…

There is only 0% probability of formal default if the Fed monetizes the debt. If they refuse, and creditors refuse to buy bonds when current bonds rollover, then the U.S. would default. But Ben said the Fed will never monetize the debt back on June 3, 2009. That’s curious, because in November 2010 in what has been termed “QE2” the Fed announced it would buy $600 billion in long-term Treasuries and buy an additional $250-$300 of Treasuries in which the $250-$300 billion was from previous investments.

Is that monetization? I would say yes, but it’s sort of tricky to define. For example, when the Fed conducts its open market operations it buys Treasuries to influence interest rates which has been going on for a long time — way before the current U.S. debt crisis.

So then what determines whether the Fed has conducted this egregious form of Treasury buying we call “monetization of the debt?”

The only two factors that can possibly differentiate monetization from open market operations is 1) the size of the purchase and 2) the intent behind the purchase.

This is how the size of Treasury purchases have changed since 2009:

Since new data has come out, the whole year of 2011 monetary authority purchases is $642 billion – not quite as high as in the graph, but still very high.

Clearly you can see the difference in the size of the purchases even though determining what size is considered monetization is rather arbitrary.

Then there’s the intent behind the purchase. That’s what I think Bernanke is talking about when he says he will not monetize the debt. In Bernanke’s mind the intent (at least the public lip service intent) is to avoid deflation and to boost the economy – not to bail the United States out of its debt crisis by printing money. Bernanke still contends that he has an exit policy and that he will wind down the monetary base when the time is appropriate.

So In Bernanke’s mind, he may not consider buying Treasuries — even at QE2 levels — “monetizing the debt.”

The most likely stealth monetization tactics Bernanke can use — while still keeping a straight face — while saying he will not monetize the debt, will be an extreme difference between the Fed Funds Rate and the theoretical rate it would be without money printing, and loosening loan requirements/adopting policies that will get the banks to multiply out their massive amounts of excess reserves.

If, for example, the natural Fed Funds rate — the rate without Fed intervention — is 19% and the Fed is keeping the rate at 0%, then the amount of Treasuries the Fed would have to buy to keep that rate down would be huge — yet Bernanke could say he’s just conducting normal open market operations.

On the other hand, if the banks create money out of nothing via the fractional reserve lending system and a certain percentage of that new money goes into Treasuries, Bernanke can just say there is strong private demand for Treasuries even if his policies were the reason behind excessive credit growth that allowed for the increased purchase of Treasuries.

Maybe Bernanke means he will not monetize a particular part of the debt that was being referred to in the video. Again, though, he could simply hide it under an open market operations 0% policy or encourage the banking system to expand the money supply.

Whatever the case, if you ever hear Bernanke say “the Federal Reserve will not monetize the debt” again, feel free to ignore him. When he says that, it doesn’t necessarily mean he won’t buy a large quantity of Treasuries with new money created out of nothing.

Remember, Greenspan says there’s “zero probability of default” because the U.S. can always print more money. Does Greenspan know something here? There’s only zero probability if the Fed commits to monetizing the debt as needed. If Greenspan knows something there will be monetization of the debt, even if Bernanke wants to call it something else.

18 thoughts on “Bernanke vs Greenspan?

  1. My questions:

    1/ What difference will Bernanke’s adoption of sterilised QE, as well as the Fed’s ability to pressure banks into not lending out excess reserves make to the ability of the Fed to continue to extend and pretend? It seems more likely to me that the Fed will manage to keep the monetary situation under control, while failing to control the economic situation. The American economy still feels much more vulnerable to a middle eastern war or a Chinese trade shock (i.e. realities that the Fed cannot fudge or sterilise or manage) than it does to internal hyperinflation coming directly out of the Fed’s monetisation.

    2/ What is the “natural” Federal Funds rate? Paul Krugman’s and Brad DeLong’s view is that that the “natural” Federal Funds rate without the Fed’s interventionism right now would be negative, i.e. deflationary. In graphic form:

    Now, the Keynesians believe deflation is poison, because of debt deflation (i.e. positive real rates in the context of falling GDP and productivity). They believe instead that they should “offset” the lower zero bound by printing a lot of money and having negative real rates. My view is that this just tends to channel money into junk, preserving bad companies and systems, resulting in economic zombification.

    On the other hand, I think that there would be considerable upward pressure on rates without the Fed acting as a buyer of last resort and a price floor. So I am really not sure either side can really say what the “natural” rate would be. It seems like an extremely complex equation, that cannot really be modelled, because there are so many (visible and hidden) variables (e.g. GDP, employment, world events, etc).

  2. According to, this sterilized QE3 would use reverse repos – with reverse repos the Fed buys Treasuries and then drains the liquidity it injected into the banking system when buying Treasuries. When the Fed buys Treasuries it would normally “print money” to do so, but in this case, while the Fed prints money, it all takes out an equivalent amount of money out of the monetary system. It sells those Treasuries to buyers with the promise of buying it back later at a higher price.

    Two problems with this: 1) It ultimately adds more reserves into the system and the more imminent problem 2) there’s essentially an interest rate attached to the reverse repo. The buyer of the reverse repo gets x% return from his money for doing so. However, let’s say rates rise to 10% on Treasury bills. Banks / others aren’t going to do these agreements voluntarily for less than the % on Treasury bills because they are both risk free assets (assuming the Fed won’t let the Treasury default)

    So while the sterilized QE would not have any immediate inflationary effect, it still doesn’t solve the problem.

    Let’s say I’m a bank and I do this repo agreement at 0.5%. Now let’s say inflation starts to go up and the bank wants 7%. Well, unless the Fed will raise rates that high – which they can’t unless they want default, the Fed has to desterilize – in other words, that liquidity + the original interest rate is added to the money supply. So, it just comes back to the same old decision – do you want to inflate the currency away or default on the debt. The Fed can’t tighten, and sterilized QE will blow up in their face when they need to and can’t.

    The Fed can only “pressure” the banks so far – it can’t raise rates on excess reserves that much because then there’s the problem of default again.

    They could raise reserve requirements too, but again, that tightening would likely lead to default.

    It always comes down to the simple choice at the end of all this Fed-jargon: Do you want to default on the debt or do you want to destroy the currency?

    I would say the natural Fed Funds rate is the rate banks would lend to each other overnight if the Fed didn’t exist. The real natural Fed Funds rate would be much higher than it is right now.

    That graph you have I think shows what the Fed Funds rate should be if some rule is applied (something Mankiw came up with or was it the Taylor rule?). It is not showing what rate it would be without Fed interference.

    If the Fed wasn’t printing money then the real natural rate would be higher for sure. Less money in the system to loan would lead to a higher rate. Yes, that could cause deflation because banks could bust, but the REAL natural rate would be higher for sure.

    • I would say the natural Fed Funds rate is the rate banks would lend to each other overnight if the Fed didn’t exist. The real natural Fed Funds rate would be much higher than it is right now.

      We would have a completely different financial system, and that comes with lots and lots of hidden variables. The bottom line I think is that we don’t have a natural system; we have a centrally planned system. If we did, we would have natural interest rates, but that would radically change lots of other things.

      That graph you have I think shows what the Fed Funds rate should be if some rule is applied (something Mankiw came up with or was it the Taylor rule?). It is not showing what rate it would be without Fed interference.

      What the graph shows is that there is a liquidity trap. The blue line is a rough estimation by Krugman of where rates would be in a perfect Keynesian world where the Fed can lower rates below zero during a liquidity trap (QE is an attempt to do this, of course). That is their view of the “natural” rate, which of course is different to your definition.

      I don’t even know where rates would be without all the money printing. My best guess is that we would have had a severe deflationary shock which (sans money printing) would have wrecked the system, America would defaulted and by now we would have a new system with a new set of fundamentals.

      Let’s say I’m a bank and I do this repo agreement at 0.5%. Now let’s say inflation starts to go up and the bank wants 7%. Well, unless the Fed will raise rates that high – which they can’t unless they want default, the Fed has to desterilize.

      You’re assuming the banks are independent entities. Systemic stability (i.e. doing what the Fed says when the Fed says it) is more important I think to bank CEOs who like suckling on the teat of the Bernanke put than punitively raising rates on the Fed. That’s called biting the hand that feeds you. Same thing as pushing excess reserves beyond what the Fed wants. That’s biting the hand that feeds you too. I am open-minded to this happening at a later point, but I think to prove your case you need to find some evidence that the banks are willing to — in the name of extreme short termism — bite the hand that feeds them.

  3. Both are wrong, because they have chosen careers that have not benefited mankind. Central Banks are a confirmed failure! Why?

    You know what makes me sad: Adam Smith in his book Wealth of Nations (1776)

    page 104 “In Great Britain, the wages of labour seem in the present times, to be evidently more than what is necessary to enable the labourer to bring up a family”

    If the meaning of life is life, i.e. passing on your DNA and having a happy life and bringing up children in a happy home environment, free from economic stress, the far as I am concerned, the advent of Central Banks has resulted in a huge failure. What Labourer can bring up a family (Women were housewives then) with savings to spear (Most families are in debt today. From Adam Smith’s accounts we have economically regressed!

  4. Interesting question.
    And near impossible to answer.

    I suppose I’d say, when the bank only buys newly issued bonds, and refuses to buy old ones, that would be a clear monetisation signal.

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  6. Andrew,

    Well done on your eBook “Debtor Ultimatum”

    It is easy to read and logical in flow. Good use of graphs. This will enable readers who normally don’t read this stuff to understand the problem.

    1. How will you get the Generation who follow Kim Kardasian and other vapid air heads, to understand these issues? My solution is to find the next new reality star and get them to understand the issue and want to encourage their fan base to understand.

    2. Convince people on the Government teat, that the countries interest is ahead of their own intersts (Government discretionery spending which influences their vote)

    Greece is an example of what will happen. Greece’s bailout by the EU is equal to the easy solutions US politicians have access to World Reserve Status i.e. ability to fund spending through Treasury purchases.

    I know and you know human nature is flawed and a crises is inevitable. Invest and prepare accordingly! If you are a US citizen I suggest getting a Australian Visa. USA will collapse before Australia does.

    And having worked in Banking, we only lend if there is security i.e. Property. In theory people could apply for loans, hoping for future profit. i.e. risk the farm! Banks hoping for income gain will lend. Inflation wil be released on the back of real assets!

    • There is no simple answer, and I think that human nature tends to suggest that the only exit is a systemic breakdown. People — whether welfare recipients, or defence contractors, or corrupt lobbyists, or anyone on the go’vt teat — will not accept haircuts.

      Ron Paul has shown us that it is possible to communicate effectively with my generation (I am 24) just being persistent and intellectually honest. However I think we will see the benefits after the breakdown, not before.

      And yes — congratulations to Andrew on his book.

    • Thanks guys – I’m really happy you both enjoyed my book.

      For Buddy’s post:

      1. lol. I’m skeptical even that would work. My strategy is to convince those who are willing to listen. Wasting time on people who don’t care is exhausting and unproductive.

      2. Because ultimately the government won’t be able to pay them – whether it be because of default or devaluation of the currency (they won’t get much in real terms)

      Yeh, Greece is what will ultimately happen – although it may happen a bit different in that the dollar will be devalued first. Funding through Treasuries can only last so long. Eventually the dam will break.

      Yes, fleeing the country is not a bad idea. It’s hard, though, to leave friends and family behind.

      The question is how much will they lend and how fast. The current amount of excess reserves is enormous – if that were fully lent out quickly there would be disastrous inflation.

  7. Central Banks are not accidents they exist to empower the elites, they are the source of their power. Of course they do not say this publicly, the PR says it is the ‘best possible way’ for everyone. We the majority of the governed (or the masses) have been mis-educated and dumbed down by the same elites so we never can work out the source of our problems. We are easily distracted and misled by their media systems. It is one giant matrix and most of us are plugged in from birth to death….Dreamtime. This system will only be brought down either by itself and or by a small well informed counter elite. Not the masses, they are doomed to be misled.

    Life generally is full of challenges it is never about endless progress and growth. Elites have tried to construct a world in which their power and wealth continues to grow, and this has led to huge in-balance at all social levels and geographic scales…it cannot last eventually it will break. Small human scale development is the historical norm..small buildings, small private companies and businesses, real money not controlled by any one group, communities not controlled by the nanny state. Until we return to this human scale we are in for a very bumpy ride.

    • Wise words Mo. Now if we can focus our collective intelligence into transmitting the solution to the fundamental problems onto the masses.

      1. How do we get Kim Kardashian to say the Fed is evil and should be disbanded, and perhaps only Ron Paul is the solution fo their problems?
      2. How do we get the actors from Jersey Shore to complain about big government and bureacratic waste?

      There really needs to be a world wide fund or movement which can fund the creation of these vapid characters, which drops subliminal messages, thereby slowly educating the mases abd bringing about social and political change. But we’ll need to buy out all media and movie distribution networks.

      An impossibility! But if by writing in these blogs we gain a sense of hope and control so be it. It really is a form of infotainment.

      The only advantage is in times of war or collapse of the system. But this intellectual group would have to move quick to organise. An impossibility when the internet is shut down!

      Like I said in the About section of Aziz’s home page, a formal in person roundtable meetings in Basle annually are the only way.

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