Ben Bernanke is no magician

He promised to lower mortgage and corporate bond rates, but quantitative easing doesn't work like magic.

Three months ago, Ben Bernanke promised lower mortgage rates and lower corporate bond rates.

He promised.

Quantitative Easing – i.e. the Fed’s scheme to print money and buy bonds – would deliver these benefits, Bernanke promised in a November 4, 2010, op-ed piece for The Washington Post. “Easier financial conditions will promote economic growth,” the Chairman declared. “For example, lower mortgage rates will make housing more affordable, and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence…”

But the Chairman was wrong. Three months after issuing his promise, interest rates are rising steeply, which is causing mortgage rates to rise as well. Quantitative Easing is not magic. It is a shell game that is producing predictably inflationary results.

The prices of stocks and commodities are soaring, while the prices of long-dated bonds are tanking (which means bond yields are soaring). This is “Inflation 101,” folks. Nevertheless, Bernanke credits QE2 for all things good.

“The Chairman reviewed his Quantitative Easing, Second Inning (QE2) at the National Press Club on Thursday, February 3, 2011,” writes financial market observer, Fred Sheehan. “His conclusion: ‘The economic recovery that began in the middle of 2009 appears to have strengthened in recent months… A wide range of market indicators supports the view that the Federal Reserve’s securities purchases have been effective at easing financial conditions. For example, equity prices have risen significantly, volatility in the equity market has fallen, corporate bond spreads have narrowed… Yields on 5- to 10-year Treasury securities initially declined markedly as markets priced in prospective Fed purchases; these yields subsequently rose, however, as investors became more optimistic about economic growth…”

As to bond yields, Bernanke’s assessment of his handiwork seems a bit disingenuous. While true that “yields…initially declined,” it is also true – and more to the point – that yields subsequently soared. Therefore, to claim success because yields “initially declined” would be a bit like declaring the Titanic’s maiden voyage a success because the ship initially floated.

“The yield on 10-year Treasury bonds has jumped from 2.48% on November 4, 2010, to 3.65%,” Sheehan points out. “That’s a 47% boost, during the period in which the Federal Reserve bought approximately $200 billion of Treasury bonds to reduce mortgage rates… Accordingly, since November 4, 2010, Freddie Mac 30-year fixed-rate mortgage rates have risen from $4.10% to 4.81%. Housing – which accounted for 40% of new jobs during the ersatz-boom – is sinking, partially due to the higher rates since Bernanke’s November 4, 2010, manifesto.”

Elsewhere in Washington, the Executive and Legislative branches of our democracy are busy making Bernanke’s job even more hopeless. Enormous deficits are extending far, far toward the horizon, like amber waves of grain. As our colleagues at The 5-Minute Forecast observed earlier today, “The White House has given up any pretense: Its latest forecast for the fiscal 2011 deficit is now $1.65 trillion – which would set a record. And at 11.3% of GDP, the deficit’s share of the overall economy would be the highest since World War II.

“Today the Administration unveils a plan to cut $1.1 trillion from the budget…over the next 10 years. These 10-year projections, no matter which political party trots them out, are always a ruse to distract you from the fact that ‘budget cuts’ never seem to be ‘deficit cuts.’ If you want to talk about the next 10 years, here’s the only number that matters: Under the White House plan, the official national debt would grow by 50% over the next decade, to $21 trillion.”

Hmmm… Since it might be a little tricky to borrow all of those dollars, we may have to print a few extras for ourselves.

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