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03/05/2010
"The Spy Who Loved Me"
By
Fred D. Snitzer
There’s a famous line from the 1977 James Bond film “The Spy Who Loved Me”, delivered by the actor Roger Moore as he is removing the warhead from a nuclear missile. Asked if he really knows what he’s doing, he replies: “Well, there has to be a first time for everything”.
And so there has to be a first time for Federal Reserve Chairman Ben Bernanke, as he attempts to carefully withdraw all the cash he has pumped into the American financial system as part of the emergency measures he instituted during the panic of late 2008.
It is, no doubt, more than a bit of a stretch to compare James Bond winging it with a nuclear warhead to the challenge facing Ben Bernanke. Even if Mr. Bernanke blows it, what may result is another round of 1970’s stagflation, not a nuclear winter.
Still, like that scene from The Spy Who Loved Me, there is a first time for everything. And in this case the honor has been bestowed on Mr. Bernanke and the Federal Reserve, as he and his colleagues are faced for the first time in the Fed’s history with this very specific challenge of removing all of this money before we see a sharp rise in inflation, and without chocking off the incipient recovery. To use an obvious reference, if Odysseus had his Scylla and Charybdis, Mr. Bernanke has his expected inflation and his current recession.
In fact, there is no shortage of metaphors that can be used to describe the position that the Federal Reserve currently faces:
Medicine: The Fed’s Doctors are getting back to work. We’re the patient. Are we ready to be taken off life support?
Nautical: We are entering uncharted waters. Can the Fed navigate an unprecedented perfect storm?
War: What is the Federal Reserve’s exit strategy?
Arguments for continuing to keep interest rates low include an unemployment rate in double-digits, a moribund consumer, growing Federal and State deficits, and timid corporations. On the other side of the balance sheet, you don’t have to look too far to see indications of a turnaround – the rise in the financial markets that begin last March, the improvement in GDP and profit margins. Still, a reasonable person may ask, how can the Federal Reserve even think about raising interest rates during a time like this?
While we are feasting on metaphors, another way to conceptualize the situation is to think of a dam. In this case, the banks are sitting on lots of cash to lend out, but they won’t lend it out, or they can’t find enough people or corporations who actually want to borrow. Supply is great, but demand is low. At some point, some economists fear, the banks will start lending all that money, and corporations and consumers will start spending all their money and borrowing more. Cash will fly out of banks, off of corporations’ balance sheets, and out of consumer’s wallets. The dam will burst, and a torrent of cash will flood the system. Inflation will appear suddenly and more dramatically than we’ve seen in our generation. The Fed wants to carefully remove this potential excess liquidity before it can create inflationary havoc.
We’d prefer to not have to live through an experiment – whether it’s medical, nautical, or financial - but we have no choice. To some extent, that’s life. Every day is an experiment. Every day we confront new circumstances.
For now, we can expect the Fed to keep its most powerful tool – the federal funds rate – at its current level for the foreseeable future. Bernanke’s raising the discount rate was a communication tool – a message that no more emergency medicine will be applied, even as the life support system remains in place.
Economists who study these issues have concluded that the growth that follows a financial crisis is usually slow. In this case, the recovery may be slower than usual. For now, the Doctor is watching us carefully. We’re still on plenty of meds, but we’re on the mend, and at some point down the road, we will be fully healed. When the time comes, we will be able to breathe a little easier, and dispense with the heavy-handed metaphors.
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