At least that is what economist Tyler Cowen argues in his recent New York Times column. Due to the unprecedented increase in excess reserves held by banks, Cowen claims that the Federal Reserve has provided a nice cushion for threat a destabilized Europe might bring:
Starting in late 2008, as a response to our financial crisis, the Fed bought government and mortgage securities from banks on a very large scale.Bank reserves at the Fed rose from virtually nothing to more than $1.6 trillion. Then the Fed paid interest on those reserves to help keep them on bank balance sheets.
It is estimated by Moody’s that America’s biggest banks now have liquid assets that are 3 to 11 times their short-term borrowings. In other words, it’s the cushion we’ve been seeking. Furthermore, a lot of those reserves sit in the American subsidiaries of large foreign-owned banks, protecting the European system, too.
THE Fed’s stockpiled liquid reserves have met some heavy criticism. Hard-money advocates contend that they are a prelude to hyperinflation — although market forecasts and bond yields don’t bear this out — while proponents of monetary expansion have wished that banks would more actively lend out those reserves to stimulate the economy. That second view assumes that the financial crisis is essentially over, but maybe it’s not. As the euro zone crisis continues, it seems that Ben S. Bernanke has been a smarter central banker than we had realized.
Cowen is right about one thing, just take a look at excess reserves sitting on the sidelines at the Fed, via FRED:
Calling Bernanke, who’s widely praised scholarship amounts to nothing more than a childlike fear of deflation, a smart central banker is protesting too much. If anything, Bernanke’s incredible liquidity injection was sheer dumb luck as it now provides a nice buffer from the EZ. But then again, any promise to print on demand ultimately provides a backstop for banking crises. Why should large financial institutions fret about losses in the long run when their balance sheets have a direct line to the printing press? This question is never answered by central banking proponents.
Even so, Bernanke’s “Man of the Year” solution wasn’t actually a solution at all. It was simply another shot of high-grade heroine to stave off the after effects of the previous bout of low interest rate fueled gorging. It prevented the rotten mortgage debt, the by-product of the housing bubble, from being liquidated. Losses that should have happened didn’t. One day they will be realized but hopefully we will all be “dead” by then; just as Keynes hoped. Future generations will end up having the bill passed to them.
Cowen mentions that central banking “is the most powerful and most influential financial regulator..” He is correct but surprisingly doesn’t make the connection that central planning is exactly what got us into this mess. Central banks have no other tools at their disposal besides printing money. If printing money to suppress interest rates got us here, why would it ever get us out? It’s kind of like when former Treasury Secretary Lawrence Sumner declared:
The central irony of a financial crisis is that while it is caused by too much confidence, borrowing and lending, and spending, it can be resolved only with more confidence, borrowing and lending, and spending.
Can these guys be any more Orwellian?
While Bernanke’s great showering of liquidity may provide some protection from Europe, it’s just one of many unintended consequences such a policy brings. Turning the printing press on its “high” setting and paying banks not to lend in order to control inflation took no real talent. Bernanke will only prove his worth as central banker if he is able to wind down the Fed’s balance sheet ultimately without sparking another recession. Judging by his past record of deflation fear mongering, let’s just say I am skeptical of his willingness to do so.
Tags: Ben Bernanke, Central Bank, economics, Federal Reserve
