Bernanke’s Mind

I have been following his works since my graduate days. In recent months, I re-read his pieces to have a better understanding of his main beliefs are. It is clear to me Bernanke has one, single overarching goal i.e to avoid the policy mistakes that he believes caused the Great Depression, and that will have significant impact on the US dollar.

Bernanke believes that overly tight monetary policy at the outset of the Great Depression was the key reason for the event. Despite the absence of any signs of inflation, through 1929, the Federal Reserve unjustifiably raised its discount rate from 4% to as high as 6% with the explicit aim of deliberately pricking the stock market bubble was a policy mistake. The decision to lower rate to 1.5% in October 1931 was too late and worse, the Fed doubling rates within the next four months to 3% by February 1932 was another tight monetary blunder. It kills off any possibility of a recovery.

If that being transposed into today’s environment, it highly probable that Fed will not raise rate until there are abundant signs of a rock solid economic recovery.

Bernanke also believes that nearly all policy blunders by Congress and the Fed during the Great Depression were driven by a single misguided goal i.e. to protect the dollar by defending its underlying gold reserves. That policy, according to Bernanke, had devastating unintended consequences. Other countries around the world were worried that they were going to lose reserves that fled to the US seeking the higher interest rates and to maintain the status quo, the began to raise their own interest rates competitively without regard to deteriorating economic fundamentals, hence self-fulfilling and self-perpetuating global depression. He argued that the sooner a country abandoned the gold standard during the Great Depression – and effectively devalued its currency – the faster the economic recovery.

Ergo, today, Bernanke’s plan is to do nothing to support the dollar. Quite to the contrary, he is intending to let the dollar fall as quickly as possible, no matter how low it goes and no matter what the long-term consequences may be.

Fed said it will stick to its plan to buy $1.45 trillion in mortgage-backed securities and ‘agency’ debt sold by the likes of Fannie Mae and Freddie Mac. The message is clear – Party On! Starting with Alan Greenspan two decades ago and continuing under Bernanke, the Fed has become a gigantic enabler of financial risk-taking.