Bernanke's $1 trillion hangover

The Fed chief or his successor will have to wind down the massive supply of new money without sending the economy into a double dip.

EMAIL  |   PRINT  |   SHARE  |   RSS
 
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
By Jia Lynn Yang, writer

Will President Obama reappoint Fed Chairman Ben Bernanke when his term ends in January?
  • Yes
  • No

WASHINGTON (Fortune) -- Business legend Jack Welch has already hailed Ben Bernanke as "a national hero" for the Federal Reserve chief's aggressive moves to pump up the economy, but Bernanke's work is not nearly finished. One of the factors that will influence the decision whether to reappoint him when his term ends in January is the nature of the next task facing him or his successor: to wean the economy off the $1 trillion of new money created by the Fed when disaster loomed last fall.

Like much of what the Fed has had to accomplish recently, it's a scenario without precedent since the Great Depression. And that time, the delicate operation was botched.

"Your timing has to be perfect," says David Jones, former Fed economist and president and CEO of DMJ Advisors LLC in Denver. "If you do it too soon, you keep us in a deep recession. And if you do it too late, you get inflation."

To make the best decision about whom to appoint, President Obama will have to consider not only who has the best command of monetary policy, but also who has the most mettle. Any decision to raise short-term interest rates can make the Fed chair very unpopular. "Your next act is not to refill the punch bowl," says Rob Parenteau, an economic consultant who owns the firm MacroStrategy Edge. "You're going to be taking it away, and you're going to be making a lot of enemies as you do that."

The argument for Bernanke goes like this: he's already on the job, and he also happens to be one of the greatest living scholars of the Great Depression, which is basically a road map for how a central bank should not run monetary policy. One of the lessons of that crisis is that shutting off the monetary spigot too soon can stop a recovery in its tracks. In 1936-37, the central bank started withdrawing excess reserves. This, combined with FDR's decision to raise taxes and cut spending, sent the economy into another tailspin.

Bernanke has indicated that he understands the art of timing. During testimony before Congress's Joint Economic Committee in May, he explained, "I just want to assure the American people that we are very focused, like a laser beam ... on this issue of the exit and of making sure that we have price stability in the medium term."

He added, "It's very important for us to provide a lot of support for this economy right now because it needs support, but at the same time we understand the necessity of winding this down in an orderly way at the appropriate moment so that we will not have inflation problems on the other side."

Bernanke and others at the Federal Reserve are saying inflation will not be a problem in the near future. But investors are already signaling their concern. Ten-year Treasury bond yields hit an eight-month peak in June.

"[The Fed's] models may tell them inflation's not a headache for two or three years but it doesn't matter if investors think it could be a nearer term problem," says Parenteau. "If commodity prices begin to reflect that, you've got a problem on your hands"

The question is whether Wall Street trusts Bernanke to do whatever it takes to avoid the inflation problem. Larry Summers, Obama's top economic adviser and former Treasury secretary, is often floated as another possible Fed chair. People who like that idea view his reputation for a strong will as an asset in a situation like this.

"People may view Summers as more able and willing to execute whatever tightening needs to be done on the Fed funds rate," says Parenteau, "whereas they're used to thinking of Bernanke as 'Helicopter Ben,' where he comes along with the helicopter and opens the suitcase and lets the money fly."

On the other hand, Summers' close ties to the White House could create the impression that political pressure would be brought to bear on him to err on the side of economic growth, rather than inflation-fighting.

Regardless who gets appointed, one thing is certain: this unelected corner of government has never had more power. The Obama administration's proposal to give the Fed more authority to regulate big financial institutions comes at the same time its monetary decisions will decide the economy's fate. And yet all the authority in the world may not be enough to stop the after-effects of injecting such a megadose of money into the system. Some think inflation is inevitable.

"It doesn't matter who you appoint. It doesn't change the fact you're sitting there with a trillion dollars in excess reserves," says Thomas Saving, an economics professor at Texas A&M University and director of the Private Enterprise Research Center. "An appointment doesn't change any of that. That's reality." To top of page

Company Price Change % Change
Ford Motor Co 8.29 0.05 0.61%
Advanced Micro Devic... 54.59 0.70 1.30%
Cisco Systems Inc 47.49 -2.44 -4.89%
General Electric Co 13.00 -0.16 -1.22%
Kraft Heinz Co 27.84 -2.20 -7.32%
Data as of 2:44pm ET
Index Last Change % Change
Dow 32,627.97 -234.33 -0.71%
Nasdaq 13,215.24 99.07 0.76%
S&P 500 3,913.10 -2.36 -0.06%
Treasuries 1.73 0.00 0.12%
Data as of 6:29am ET
More Galleries
10 of the most luxurious airline amenity kits When it comes to in-flight pampering, the amenity kits offered by these 10 airlines are the ultimate in luxury More
7 startups that want to improve your mental health From a text therapy platform to apps that push you reminders to breathe, these self-care startups offer help on a daily basis or in times of need. More
5 radical technologies that will change how you get to work From Uber's flying cars to the Hyperloop, these are some of the neatest transportation concepts in the works today. More
Sponsors
Worry about the hackers you don't know 
Crime syndicates and government organizations pose a much greater cyber threat than renegade hacker groups like Anonymous. Play
GE CEO: Bringing jobs back to the U.S. 
Jeff Immelt says the U.S. is a cost competitive market for advanced manufacturing and that GE is bringing jobs back from Mexico. Play
Hamster wheel and wedgie-powered transit 
Red Bull Creation challenges hackers and engineers to invent new modes of transportation. Play

Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.