Election 2012 Means the Real Bernanke Bombshells Won't Fall Until December

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If you were expecting big news from this week's Fed meeting it looks like you are going to be in for a long wait. This week's FOMC meeting was business as usual.

There was no change in interest rates, no change in the determination to keep rates low into 2015 and no change in the Fed's latest solution, otherwise known as QE infinity.

The truth is the real bombshells won't likely start until the Fed's next meeting in December. By then, the landscape could be completely changed.

With Election 2012 still at stake, it's who controls the Oval Office that matters most when it comes to Fed policy.

You'd never know that if all you did was watch the debates.

Ben Bernanke may well be the second most powerful person in the country, yet his name was never mentioned-not even once. Remarkably, monetary policy was completely absent from the debates.

Election 2012 and the Fed

That's true even though the two candidates differ substantially when it comes to the Federal Reserve.

For instance, Mitt Romney has repeatedly said he would not reappoint Ben Bernanke when the Fed chairman's current term ends in January 2014. Conversely, President Barack Obama has indicated his support for Bernanke and his easy money policies.

For that matter, Bernanke himself is in an open question. He may retire in January 2014 no matter who wins Election 2012.

However, at the December meeting one major thing will have changed: the time horizons of both investors and policymakers.

Election 2012 and the Fed

That's true even though the two candidates differ substantially when it comes to the Federal Reserve.

For instance, Mitt Romney has repeatedly said he would not reappoint Ben Bernanke when the Fed chairman's current term ends in January 2014. Conversely, President Barack Obama has indicated his support for Bernanke and his easy money policies.

For that matter, Bernanke himself is in an open question. He may retire in January 2014 no matter who wins Election 2012.

However, at the December meeting one major thing will have changed: the time horizons of both investors and policymakers.

By December, the political course will be set until January 2017, with only modest changes possible in November 2014. At that point people will start planning policy around that period.

In fiscal terms, that will force politicians to take the budget deficit seriously. The prospect of another $5 trillion of debt by January 2017 will simply be too awful to contemplate.

On the monetary policy front, people will care less urgently about short-term moves in the unemployment rate and more about the long-term damage caused by Bernanke's policies.

With interest rates well below the inflation rate, savers are being forced to take horrendous risks in order to preserve their capital and earn a modest real return.

That's why the country's pension funds are in such bad shape, and why Bolivia, a very poor country run by a Marxist thug, can borrow 10-year money at a mere 5% interest rate this week.

Over the medium term, Bernanke's policies are also likely to lead to rising inflation. When people's sights suddenly become set on January 2017, that medium term will quickly appear all too real.

Of course, the Fed can't raise interest rates in December – that would shoot to pieces its promise not to raise them before mid-2015 (actually it's not quite a promise if you read the fine print; as always there's some wriggle room, but not that much.)

However, there's an alternative strategy, outlined in the last month by two regional Fed presidents, Minneapolis Fed president Narayana Kocherlakota of Minneapolis and Charles Evans of Chicago.

They have both suggested using the unemployment rate and inflation rate as triggers for raising rates, rather than a specified time period. Kocherlakota has suggested rates should rise when either inflation hits 2.25% or unemployment hits 5.25%, while Evans has suggested raising rates when unemployment hits 7% or inflation hits 3%.

Kocherlakota had the idea first, but given that unemployment is currently 7.8% and core inflation 2%, Evans's targets look more balanced and realistic.

Setting Evans' targets for raising rates in December would have one important effect: on the current trajectory, with inflation trending upwards and unemployment having fallen by 1.2% in the last year, we would hit Evans' targets not in 2015 but well before the end of 2013.

That's a monumental something the market has not priced in. At that point, policy would depend on who was president.

Under President Obama, Bernanke would probably be replaced by a monetary "dove" like Fed vice-chairman Janet Yellen, so rates would rise only slowly, as they did in 2003-06.

Well before rates could reach the level of inflation, it's likely either inflation would have taken off or the economy would have fallen back into recession, allowing the Fed to return to zero rates.

Either way, the damage of current policies would continue, although at least extra flexibility would have been gained.

What the Romney Fed Might Look Like

Under Romney, the position is less clear.

One of his top advisors, Glenn Hubbard, has said Bernanke should be reappointed, so if he became Fed chairman he would probably continue Bernanke's policies, more or less.

Another potential Fed chairman under Romney is John B. Taylor. He invented the "Taylor rule" for setting interest rates.

The Taylor Rule is unfortunately very easy to fudge. It's based on "potential" GDP and unemployment, rather than working from hard data. Still, most variants of it would push interest rates higher than they are today.

Then there's the possibility that Romney throws the "Tea Party" a bone and appoint Ron Paul or, more likely, John Allison, the hard-money head of the Cato Institute (and former chairman of BB&T Bank.) Allison would abandon Bernanke-ism entirely and push rates up rapidly, to the great benefit of savers and the economy generally.

The ideal policy would set the federal funds target at 2% immediately, around the current level of inflation.

That would stop penalizing savers (though it wouldn't reward them much) and would lessen the upward pressure on inflation, while at the same time still being a loose policy. In real terms, money would still be free.

A sharp jump to 2% would, however, end all the speculative games played by the banks, the mortgage REITs and the rest of Wall Street.

That would cause havoc in financial markets, and would quickly kill off all the players that only exist because of Bernanke-ism. After a period of pain, the rest of the economy would benefit from their demise, because capital would be freed up.

So yes, the direction of the Federal Reserve in 2013 is still a big unknown.

But I have to tell you, the Fed's December 11-12 meeting is likely the beginning of the fireworks.

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Join the conversation. Click here to jump to comments…

  1. Edouard D'Orange | October 26, 2012

    Nice analysis. I knew the candidate's preferences for re-appointing the Bernank, but I didn't know how the economy would be affected. This can help give macro-economic guidance.

  2. Bob Hamrick | October 26, 2012

    Another ominous near-term date is December 12, 2012, or 12/12/12. This has special significance to the jihadists, since they are expecting the appearance of their bogus "12th Imam" any time now. But not a word about it anywhere in the news.

  3. George | October 26, 2012

    Martin, Doesn't the Federal Reserve have some kind of 99 or 100 year contract that ends its existance in Dec 2012? If so, will they continue business as usual in spite of its supposed termination since most people dont know about it? Ron Paul wouldnt be a choice at all since he knows the crookedness being perpetrated and has said he would do away with the Federal Reserve.

  4. Dimi Chakalov | October 26, 2012

    "… the direction of the Federal Reserve in 2013 is still a big unknown."

    I don't think they have a choice:

    Dimi

  5. fallingman | October 26, 2012

    Where to start?

    The candidates don't differ at all when it comes to the Federal Reserve. That's shadow boxing. As you say, Hubbard loves the bernanke.

    Should rates be raised? Of course. And it should be done by the market, not some egghead Princeton academics who are fronting for the bankster combine. Romney has no intention whatsoever of changing anything material when it comes to the Fed. That's pure fantasy.

    Please don't even mention Janet Yellen. I was eating while I was reading this and now I feel sick.

    Ron Paul as Fed chairman. Hahahahahaha. I need some of whatever you've been drinkin'. The chances of that happening are somewhere between Romney donning a tutu and dancing with the naked cowboy in Times Square and the temperature in hell reaching a refreshing 32 degrees.

    Do you understand nothing about what the Fed is and who controls it? Saying Romney would tap Ron Paul is like saying the Kremlin is thinking about having free and fair elections.

    No, no, and no. We'll get more of exactly the same policy no matter who's the puppet in chief.

  6. kathryn bickford | October 26, 2012

    I am tired of all the sales pitches you have on this program.

  7. buffalokandravi@aol.com | October 29, 2012

    Nothing better than a Golden Fire place lased with Silver. Mr. Ive's Christmas song without the bells and head on over to Misfit Island for some toys R CHINA. We still need to protect our Ambassadors and stop the flag burning and I care about our allies but the US has to look strong to be strong which comes with jobs like the Keystone pipeline , Canada is dong there part but if China keeps throwing our interest money that we pay for our loans with and inflation keeps rocking . How much is Dynamic Fuels charging the biggest fuel user in the world per gallon (THE US NAVY) hundreds of thousands of gallons made out of Bio fuel, What is that price for clean air, Tyson Foods is one of the three owners along with a penny stock company and a private company, they say he spent 90 billion on green energy who got those jobs private or public or Govt? The World follows us but not if we are falling down even if they are just slowing the process the problems will get worse. But they say the health sector is going to be good, does that mean everybody will be on a diet even when they don't need to be. The New phrase of the year we are saving for a diet which should really push the food prices lower with those coupons. a little common sense would go a long way, like a budget well maybe we can try to get one before the next 1,000 days, the states have to at least have one, even the ones in the red what is it with the math with the Fed oh that's right not enough math teachers, it will not matter if all they are teaching our children is counting is debt because then they will figure out we can not pay them much longer and the circle goes on. What are the real numbers! Good thing there are investment letters to point us to what is best when the market is falling but I am sure those same letters would rather be helping us invest in a prosperous country. Thanks for being honest about the Gold and the best way to invest besides a money market but the writers I am sure can tell us how to prosper when things are falling but I would say you guys would like to be giving us more picks on companies competing and not all those that we have to figure out who gets the most Govt. money. Like the oil companies it has so much overhead and then there is the word chance to see if something comes out of the ground. I wish there would be a report on the 90 billion $ if that what it was who got it all in the green sector or was Romney just saying that to Obama, he tells his campaign crowds about the oil breaks but what about the green company breaks that would be a good report, I can just imagine the warehouse for that paper work!

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