Ben Bernanke: 100% Wrong.

Bernanke made an appearance on “60 Minutes” the other night (Part 1, Part 2). This is a soft interview for Bernanke. There are no tough questions because the interviewer does not understand economic science or finance.

First, I would like to remark on what is apparently Bernanke’s profound nervousness — at least that is how I interpret his trembling voice and his quivering lips. I’ve seen a lot of Bernanke footage, albeit not often so close up on his bearded mug. He often sounds shaky, even back in 2006-2007 when his forecasts were all rosy, but not this shaky. This is not the look of a man who is 100% sure of his actions. But enough of my pop psychology, and on to a few matters of substance.

“This fear of inflation is overstated,” he says. Is it really? It looks like Bernanke did create lots of money, but has not yet translated into a rise in M1 — instead, it is stockpiled as excess reserves of commercial banks. The monetary base has been basically flat the last several months.

Yet, when the banks do start to lend and the magic of fractional reserve banking kicks in, prices will be bid up to epic proportions. Export economies such as Canada will in turn have to inflate so they can push up the US dollar and push down their own currencies. That is why QE2 is a big concern to many people. What Bernanke says in defense of QE2 is important:

“We are not printing money,”

This comment drew a few snickers from my peers, but I think this might be a rare case of Bernanke speaking the truth. The “QE2” announcement did not actually mention quantitative easing at all, it merely said the Fed would buy long-term Treasuries. Since then, it has increased its holdings of Treasuries but sold other assets. Net effect – no real change in the base. I suspect this will continue into the near future.

The purpose of the Fed is to protect the big banks. Bernanke can handle 10% unemployment so long as the big banks are happy. When the banks get in trouble, then he will be forced expand. I think this arises from his complete failure to understand the business cycle. His ideas about the Great Depression are not reassuring.

The mainstream likes to make Bernanke out to be a great sage on the subject of the Great Depression, and that is the case here. I guess the logic is something along the lines of: if Bernanke believes something about the Great Depression, it must be true. It’s Bernanke, he’s smart and he studied the Great Depression, how could he be wrong? (hmm…) Well, I have a big chip on my shoulder about this. This is one of the most baleful ideas in the realm of economic inquiry. Bernanke is totally wrong on this issue.

Bernanke’s thesis is that the Great Depression was caused by the Fed’s contraction of the money supply and the failure to inflate. The Fed did not reduce the monetary base after the crash. After a period of keeping it flat, they expanded the monetary base slightly in 1932 then dramatically from 1933 onward.

The money supply did collapse, but only because so many banks went bankrupt. This came to an end in 1934 when the FDIC was created. From here on the money supply rose. The Great Depression did not end until after World War II. Bernanke’s theory is not supported by evidence.

(This chart was taken from here.)

With Bernanke running things, we are probably doomed. I believe his policies will eventually cause mass inflation, and nations where the economy is structured towards servicing American consumption will be forced to inflate as well. Canada sells the Americans $350 billion dollars worth of goods each year. Mark Carney thinks a strong Canadian dollar is bad for Canada’s economy.