Dr. Bernanke's Frankenstein Monster.

September 27, 2011

In the novel Frankenstein, Mary Shelley tells the story of a scientist who endeavors to give life to an artificial Prometheus. Having cobbled his monster together, Frankenstein delivers a life-giving jolt of electrical stimulus to the creature.
Only after bringing his creature to life does the Dr. Frankenstein realize the error in his ways. And he rues the day that he gave life to his monstrosity.
The lessons? 1) Be careful what you wish for. 2) It is usually better to let nature run its course.
Yet, since mid-2008, Dr. Ben Bernanke has done anything but.
The Fed has boosted the monetary base by 207%, having carried out two rounds of quantitative easing, creating $1.6 trillion in excess reserves.
Instead of lending these funds, banks have held onto them, realizing that these programs are temporary. They prefer to not have to shrink their balance sheets and call in the loans once the Fed reverses the easing programs.
Throw in higher liquidity requirements, tighter controls, less profitability on lower interest rates, and one begins to see why how the banks have largely been removed from the lending process.
Conversely, many consumers are too traumatized or lacking in sufficient credit and liquidity, to engage in the lending process anyways. Rates have been at record lows for almost a year, yet loan demand has not increased.
Quantitative Easing I and II. Zero percent interest rates. And last week he yet again attempted to breathe life into the U.S. economy by enacting Operation Twist, a less aggressive form of quantitative easing meant to lower long-term interest rates and so force mortgage rates downward.
Yet, the fact remains that the monster is simply to chock full of bad debt. And no amount of Fed tinkering will change that fact. As Frankenstein's monster rose on wobbly legs and took his first steps, so this monster will not simply rise and walk. An unwinding of this size will take time.
Still, given Dr. Bernanke's tireless efforts, his monster lies dormant.
Businesses refuse to spend their copious cash reserves. The environment is too uncertain. Regulatory overhauls have hamstrung confidence. Government stimulus has muddied the water.
And so equities, gold and precious metals, Treasuries, corporate bonds commodities all trade within narrow ranges, pushed to and fro each time word escapes that Dr. Bernanke has yet another lever to pull.
And given all of the dynamics currently at work, we can only speculate on what may come next. Our thoughts?
-Greece will likely default... bad for equities and European debt.
-Germany and France may eventually face the choice of bailing out their own banks, or bailing out the Eurozone. They will choose their own banks... bad for Spain, Italy and Portugal. Bad for the Eurozone.
-U.S. corporations will likely use the low interest rate environment to issue additional bonds. Some of those funds will be used to buy back stock, and buy other companies... good for equities.
-Investor and consumer sentiment is tanking. The contrarians in us realize that, at some point, this is good for level-headed investors.
Meanwhile, Dr. Bernanke and his minions will continue their experiments. Prodding. Jolting. Stimulating. At some point, we will all be forced to contend with their unnatural creation.
The doctor will not stop until his creature stands and walks on its own accord. Until the very citizens he intended to help are forced to take their pitchforks in hand and forcefully contend with his abomination. Stay tuned.

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