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Ben Bernanke’s Bond Bunk

Posted by
December 8, 2010
in Blog

“Here’s the problem in the main: Bernanke’s only tool to “tighten” monetary policy means selling bonds into the market and taking in cash from the system. But what happens if he holds bonds that have all gone down in value? He gets screwed, that’s what. In an extreme case, the Fed could go “bankrupt.” Bernanke will avoid this, of course, and he can … but only by not soaking up that liquidity; that is, by allowing the cash he printed to remain in the system while the rotting bonds he bought are “absorbed” by the Fed.

The market knows this. It also knows that the duration of his holdings has gone up — a lot — and that he cannot pull enough liquidity via short-term roll-off to matter. Despite his claim of being “100% confident,” he cannot tighten policy — not now, and not for many years.

The market thus sees risk — that if the economy improves you get inflation, and lots of it, as Bernanke can’t do anything about it. If the economy doesn’t improve, then the only way for the government to continue spending like crazy (which it clearly is going to do) is to continue to devalue the currency, which means interest rates go up too as commodities will continue to skyrocket (priced in dollars) — and this will destroy the tax base upon which government funding rests from the bottom up.” Read more

Ben Bernanke’s Bond Bunk 
Karl Denninger 
Seeking Alpha, December 8, 2010. 

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