When Federal Reserve chairman Ben Bernanke rushed to the aid of President Obama with an act of raw partisanship called QE3, the media ignored the political implications of this latest plan to print massive amounts of new money to boost the stock market.
“Ben Bernanke has joined Chief Justice John Roberts as a Bush appointee working for the reelection of Barack Obama,” Donald Luskin, the chief investment officer of Trend Macrolytics, said. Luskin was one of the few who understood what Bernanke was up to. The presidential election was eight weeks away, and the Fed boss had jumped in to boost Obama. Roberts had done the same as the swing vote in the Supreme Court’s 5-4 decision upholding Obamacare.
Roberts may have acted for institutional reasons, seeking to protect the Court’s reputation as nonpolitical. Bernanke doesn’t have that excuse. Apart from the risk inherent in such aggressive monetary expansion when interest rates are already at record lows, Bernanke has hurt the Fed’s reputation for being politically neutral. He could have waited until after the election to act. Instead, he will now be seen by many as the Arthur Burns of the 21st century. Burns as Fed chairman flooded the economy with money in 1972 to make sure Richard Nixon was reelected.
Like Burns, Bernanke was under pressure to help the president, especially from New York Times columnist Paul Krugman, his former Princeton colleague. “He doesn’t like Krugman beating him up,” a prominent investment adviser told The Scrapbook. “You have to hand it to Krugman’s intimidation. It worked. But history books are going to beat [Bernanke] up.”
The decision to pump a massive amount of money into the economy, QE3, follows two earlier Fed actions to do the same. (QE stands for “quantitative easing.”) Those actions inflated the stock market but failed to help the economy much or raise domestic demand appreciably. The economy has stagnated. The dollar has weakened, losing 18 percent of its value against a basket of commodities in the 13 months after QE2 was announced in June 2010. Since Bernanke revealed his QE3 plans, the dollar has dropped 6 percent from its July high.
But that’s not the worst of it. QE3 calls for buying $40 billion in mortgage bonds monthly and to continue doing so until there’s a significant drop in joblessness. Interest rates are to be kept near zero at least through 2015. The policy risks being as inflationary as the U.S. economy was in the 1970s, ushering in soaring prices in energy and other commodities. But the policy also could be deflationary. The massive money injections could lead to a series of bursting financial bubbles and a Japan-like scenario of economic lethargy. Bubbles burst when financial traders realize the economic fundamentals underlying the artificial bubble economy are weak. Markets crash and the impact on the real economy can be devastating.
Either way, the Fed’s loss of its reputation for integrity—that is, staying out of politics—is real and alarming. Compared with the Fed, the European Central Bank, despite its bailouts, now looks to be the prudent, restrained institution. The euro is stronger against the dollar. And the Fed’s trustworthiness, at least for the time being, is shot. That’s what happens when an institution known for basing its decisions on economic factors alone lets politics intrude.