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Is Bernanke Setting Up Yellen for a Fall?

Written By Geoffrey Pike

Posted January 30, 2014

benyellenThe Federal Open Market Committee (FOMC) released its latest statement on Wednesday January 29, 2014. Its statement was very similar to the previous one in December.

The main thing of interest coming out of the meeting was the Fed’s rate of asset purchases (money creation). At the last meeting, it was announced that the Fed would “taper” by $10 billion per month. Instead of inflating at $85 billion per month, it would inflate at $75 billion per month.

With the latest statement, the FOMC announced it would taper by another $10 billion. So starting in February, the Fed will add “just” $65 billion per month to its holdings.

While this was widely expected, there were growing doubts about the continuation of the taper because of the bad economic news over the last couple of weeks. The unemployment rate dropped, but it became evident that it was only because people stopped looking for work.

In the last week, the stock market has been doing terrible with news of weakening in China, as well as currency crises going on in various countries. It seems that a lot of fear has quickly returned, and this time it included investor fears.

This was Bernanke’s final act as Fed chairman. He will pass over the reigns to Janet Yellen this weekend. I find the situation quite ironic.

When Bernanke took over from Greenspan, the economy seemed to be booming. Bernanke has a bad reputation now as a money printer (even though most of it is done digitally and not by actually printing money). But when Bernanke first became Fed chairman, he actually took a tight monetary stance. It was under Bernanke’s watch that the Fed stopped inflating and kept the monetary base fairly steady.

It was these actions that triggered the whole crash, but it was not the cause. Real estate started to go bust and then we hit the fall of 2008 when stocks collapsed and the whole financial system seemed to be on the edge of a cliff.

This was mostly due to the easy money and low interest rate policies of the Fed under Greenspan. This is what caused all of the malinvestment, including the housing bubble. Bernanke’s action of tightening is what exposed the malinvestment. It wasn’t until after the whole financial crisis became evident that Bernanke started to inflate like crazy.

It seems that Bernanke may now be doing to Yellen what Greenspan did to him. He is setting her up for a fall. Under his watch, the Fed has more than quadrupled the monetary base since 2008. It has caused a stock bubble and a huge misallocation of resources. As the rate of monetary inflation goes down, these malinvestments will be exposed. If the Fed keeps tapering and sticks to it, then we are likely to see a severe recession.

Bernanke started the tapering just before leaving office. Now Yellen will have to deal with it. This isn’t to say that the Fed can’t reverse course. If the economy starts to get really bad, then I don’t think it will shock any of us if Yellen starts increasing monetary inflation back to $85 billion per month, or even more.

When things finally fall apart, I am glad that it will be someone like Yellen who will take the blame. She is a Keynesian (or worse) and she believes that more monetary inflation is the answer to most of our problems. When things go bad, her philosophy can take the blame, just as it should.