This morning it was announced that the Nobel Prize in economics, one of the most prestigious and valuable awards one can receive (winners get $883,000 each), was given to former Federal Reserve Chairman Ben Bernanke, along with economists Douglas Diamond and Philip Dybvig
Nobel prizes are awarded to heroes.
Bernanke currently serves as a Distinguished Senior Fellow at the Brookings Institute. He is most known for serving as Chairman of the Federal Reserve from 2006 to 2014. He is credited with implementing the policy tools of quantitative easing (QE), forward guidance, and transparency, which have become the primary tools by which the Federal Reserve conducted monetary policy over the last 15 years.
For those that love central bankers, the Nobel Prize award for Bernanke makes sense.
There can be no doubt that Bernanke’s additions have played a significant role in our global financial system over the last 15 years. Every major central bank in the world has adopted its QE and forward guidance approach. No matter how you view Bernake but I wouldn’t say this makes him a hero of any type, not in my opinion or how history has historically picked who a hero was.
What is appalling, especially to those who see the central banks as the disease, not the cure, is that Bernanke’s contributions would be recognized as heroic, particularly today as we are beginning to see the horrific consequences that occur when central banks attempt to reverse course and wean themselves off of QE.
Before passing judgment, either way, it’s helpful to understand what QE is and how it has impacted financial assets and the global economy.
QE is a “tool” that allows the Federal Reserve to manipulate the financial system. The Fed buys bonds and then holds them as assets on its balance sheet. As they purchase these bonds, they inject capital into the banking system, which adds to the money supply and reduces interest rates.
In short, QE adds a massive amount of liquidity to the financial markets. It also drives capital flows. When investors know that the central bank will buy bonds, it incentivizes them to do the same. As the demand for bonds increases due to massive commitment from major bank purchases, interest rates fall, and bond values rise.
It’s a no-brainer to buy what the central bank is buying. Central banks have an unlimited supply of money to buy “stuff” with.
When QE was introduced, it sparked a massive demand for Treasuries. The 30-Year Treasury moved nine handles in a single day when the program was announced. In just two months, from November through December ‘08, the yield on the 10 YR dropped from 4% to 2.25%, marking one of the most significant moves higher in the value of Treasury bonds in the last 40 years as investors front ran the massive buying promised by the central bank.
It wasn’t just bonds that benefited. By suppressing interest rates, QE also fueled a huge demand for stocks. It allowed corporations to borrow for free and use the borrowed money to buy back their stock.
The initial expectation in ‘08 was that the massive amount of new money printing would cause hyperinflation like it had in Weimar, Germany, one that we would begin to see the Consumer Price Index (CPI) surge higher.
That never happened. At least not while QE was being implemented. All the newly created QE money, expected to slosh around the system, was deposited as excess reserves back at the Fed. This reality kept a lid on goods inflation as the money printing wasn’t directly distributed to people.
Instead, it all went to one place: Wall Street.
Bernanke should get the credit for taking on a very controversial policy when few knew how it would turn out. However, before anointing him a hero, we must appreciate that it isn’t only about getting to the top of the mountain safely; we also need to get back home to the bottom of the hill for the journey to be classified as a success. It’s one thing to decide to run a crazy monetary policy and then double, triple and quadruple it over 15 years. It’s another thing to get that crazy policy back home every day.
Unfortunately, most investors are just now learning about the negative consequences of QE.
The more we learn, the more likely it will be that Bernanke will be seen by history as a villain, not a hero. One who will one day be blamed for fostering the program that bankrupted the world.
When Bernanke began the Fed’s QE program, the Fed’s balance sheet, which had historically only increased at an average pace of 2.5% a year, stood at about $900 billion. In the 15 years since QE, the Federal Reserve balance sheet rose ten times to highs of $9 trillion and increased at an average rate of 17.8% per year.
Nobody would have believed in ‘08 that a 10x expansion of the balance sheet would create zero inflation in consumer goods, but that’s precisely what has occurred. From September 2008 through December 2020 and four separate rounds of QE, inflation of consumer (CPI) goods has risen an average of only 1.5% per year.
It wasn’t until years later that we began to understand that QE wouldn’t create goods inflation at all. Because the new QE experiment didn’t “create inflation,” it became one of its most significant selling points. It has been easier for central banks to continue printing more money whenever we face financial uncertainty.
There have been four rounds of QE. Each has been implemented to “spur economic growth.”
The first began in November of “08 in response to the housing collapse and added $1.3 trillion to the Federal Reserve balance sheet. This initial QE action helped the stock and bond markets but did little to spur economic growth.
Once markets began to languish, the Fed started QE 2. It began in ‘10 and witnessed the Fed adding another $600 billion to its balance sheet.
The QE program didn’t end there.
QE 3 was initiated in response to the “taper tantrum,” a reactionary panic that triggered a spike in U.S Treasury yields after investors learned that the Federal Reserve was putting the brakes on its QE program in ’12. This third round of QE was open-ended and sparked a massive run-up in stocks and bonds until it ended in ’14.
QE 4 began in 2020 in response to the coronavirus crisis and witnessed the Federal Reserve balance sheet rise from $4.2 trillion to over $9 trillion. While massive balance sheet expansion did not create runaway consumer goods inflation, it has created runaway financial asset inflation.
From November ‘08 through December ‘21, the S&P 500 rose from 930 points to 4725, an advance of 400% and an average annual return of 13.3% per year. These are the investment returns associated with GDP numbers above 4%, like in the ’80s and ’90s.
The sum result of four rounds of QE? Stocks exploded higher.
QE1 – (11/08 – 03/10) S&P 500 increased 35%
QE2 – (11/10 – 06/11) S&P 500 rose 10%
QE3 – (09/12 – 10/14) S&P 500 raised 34%
QE4 – (03/20 – 12/21) S&P 500 increased 87%
Despite massive money printing, growth has been nowhere to be seen. Over the last 15 years, the real GDP of the United States has averaged growth of only 1.8% per year.
QE turned out to be a great trick. It witnessed stocks and bonds boom while commodities remained flat and inflation was nowhere in sight. QE allowed investors to make massive returns in a crappy economy.
It’s also created tremendous inflation. Financial asset inflation.
By now, we all should have learned, “it’s not how much money gets created that drives inflation. Inflation occurs where that money flows.”
QE has fueled the net worth of the investor class and, at 13% annual average returns, has allowed investors to double their money every 5.5 years from ‘08 through ‘21.
So what’s the problem? It sounds like Bernanke’s contributions to global finance have been a smashing success, correct? Investors should give this man a Nobel prize every year, no?
Well, let’s take a moment to think about it.
Quantitative Easing was sold to the world by the Federal Reserve the same way oxycontin was sold to the medical profession by Purdue Pharma as a master drug that relieves pain and has no side effects. QE, we were told, was a genius Fed policy tool that created “good inflation” by driving financial asset prices higher while keeping “bad inflation” suppressed.
This wasn’t the whole story, as we are learning.
Ten months ago, most investors might have signed the “make Bernanke a hero” petition too. With stocks and bonds down roughly 25% on the year and with no end, most realize how lousy QE may have been for everyone.
Just like OxyContin, there are adverse side effects to QE.
It’s not the oxycontin that hurts. It’s getting off it that does. Particularly when you’ve continued to double, triple, and then quadruple the doses, the addiction becomes unbreakable. It’s the same for QE and the massive addiction the world now has to debt.
Because of Bernanke’s QE policies, global debt has skyrocketed.
According to a recent report by the Institute for International Finance, total global debt amounted to nearly $300 trillion in 2021, equalling 356 percent of global GDP. This extraordinarily high debt level represents a 30 percentage-point rise in the international debt-to-GDP ratio in the past five years and a more than 82% increase in debt-to-GDP levels since 2008.
This massive increase in debt is directly related to the creation of QE.
Keep in mind that in the 15 years before the creation of QE, global debt-to-GDP ratios grew by only an average of 0.5% percent per year. Since the QE experiment began in ‘08, global debt-to-GDP ratios have increased by an average of 4% per year.
This means that global debt growth had increased 8x faster after QE than before QE was launched.
Milton Friedman simplified inflation for everyone to understand. He said, “inflation is when we increase the money supply at a greater pace than when we increase our productivity.”
Over the last 15 years, global GDP growth (productivity) has averaged 2.58% annually. This is against debt growth (money supply) of 4% annually. Our debts are growing faster than our productivity by more than 1.5X per year.
This is the definition of inflation.
It’s also a recipe for insolvency when interest rates rise.
The opposite of QE is QT or quantitative tightening. Rather than add to the supply of money and credit, the Fed does the opposite and shrinks the money supply. They do this in two ways; first, through raising interest rates. Second, through actual QT, which occurs when the Federal Reserve stops buying bonds and allows them to roll off their balance sheet.
In short, QE expands the money supply. Ending QE shrinks the money supply.
If we follow Friedman’s rule on inflation, we can see that expanding the money supply has fueled financial asset inflation. Shrinking the money supply has led to the opposite; a deflation in financial assets.
The Federal Reserve is currently undergoing its second round of QT. What happens during QT?
QT1 – (06/18 – 12/18) S&P 500 dropped 13% before quitting
QT2 – (06/22 – today) S&P 500 fell 14% and is still ongoing
Many investors are hoping, particularly as stocks continue to get hammered, that the Federal Reserve will soon end its QT2 program. If it does, we might expect stocks and bonds to regain an upward trajectory.
There’s more to life than the size of our portfolios. Bernanke’s program has come with far worse side effects.
QE has been the leading cause of the massive wealth inequality and has witnessed the rich getting richer while the poor languish. Don’t forget that wealth inequality is the number one cause of revolutions. It has undoubtedly fueled our politically polarized America and has pushed us to the verge of civil war.
Can we ever get off this QE drug? Not likely without far more pain.
Last week, Scott Minerd of Guggenheim Partners said he expects that the Fed will not stop hiking rates until they break something, and he sees cracks and that the Fed could be forced to stop as early as November.
Today, Jamie Dimon, CEO of JP Morgan Chase & Co., warned investors that the S&P 500 could easily fall another 20% from today’s levels. “Rates going up another 100 basis points will be much more painful than the first 100 basis points.”
Economist Mohammed El Erian sees a high probability of a recession.
“When central banks provide liquidity all the time, keep interest rates artificially low for a long time — too long, in my opinion — they become the market’s Best Friend Forever. And there are, at some point, the unintended consequences of distorting the system for so long. It starts to become problematic; then central banks lose credibility.”
The mistake has already been made. The only way to avoid getting stuck where we now find ourselves was never to arrive here in the first place.
Now there is no way out.
Just in case you missed what I just stated, Now there is no way out.
Vigilante central bankers have made a “pivot” virtually impossible before the stock market collapses further and the real economy gets destroyed.
This leads us to question whether the invention of QE, a drug that’s impossible to quit without also killing the patient, is worthy of a Nobel Prize. Anyone who thinks so may want to consider what happens in the next three to five years as our costs to service our debts explode higher than our annual military budgets.
What does Bernanke have to say about it all? Like most democrats, he passes the blame to the current Federal Reserve without taking any responsibility for being the Chair that fostered it all.
“Forward guidance” was a mistake, and I think they know it was a mistake. One of the reasons for it was not to shock the market. J. Powell stated during the taper tantrum in 2013 that he wanted to avoid that type of thing by giving people as much warning as possible. That gradualism is one of the reasons the Fed did not respond quickly to inflation. He spoke the truth, something not many men chose to do anymore, especially the ones in the political arena where divisiveness gets votes, so they would rather divide individuals all across the country instead of attempting to heal the wounds that have been sewed into the nation over the last few years.
That is spoken with the traits of a real hero. That’s why everyday Americans have always been heroes. Instead, they get the recognition or not because we’ve always attempted to speak the truth, live by our moral compass, and admit our faults. That’s America. If you haven’t hedged against the coming storm, I will encourage you to do so. Here at Prosperity Gold, we wholeheartedly believe things will get ugly soon. Just how ugly, well, that’s the question that’s kept us all up at night. My grandfather said,“ Always pray for the best and prepare for the worst.”