Ben Bernanke recently announced that the Federal Reserve would hold short-term interest rates near zero.
Listening to Ben Bernanke announcing the Fed’s decision to buy mortgage-backed bonds until hell freezes over, I’m reminded of a British cartoon character called Billy Bunter. Bunter was a portly schoolboy who made a point of gobbling up as many candies and bon bons as he could get his hands on. He didn’t have a beard, like Ben Bernanke does, but he was constantly being abused and berated by his peers, just as the current Chairman of the Fed is today.
The Fed’s plan to buy up vast quantities of bonds in order to juice the economy sounds a lot like a plan hatched by Bunter to save the British candy industry by trying to eat all of its products. On the face of it, the plan looks reasonable: if Bunter gobbles up all the candies and jujubes on the shelves of the local candy stores, the shopkeepers will have to buy more. That demand will drive manufacturers to make more sweets, which means hiring more people, buying more equipment, developing more real estate, acquiring more raw materials and so on. A beneficial cycle ensues, and the candy industry booms.
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Unfortunately, so does Bunter’s waistline. And losing all of the excess weight that he gains in his heroic endeavors on behalf of the sweet business becomes a serious challenge.
The same goes for the Fed. At some point in the future it will have to sell all the bonds that it bought. Not just the $40 billion in mortgage-backed securities that it will buy each month from Fannie Mae and Freddie Mac, but also the more than $2 trillion in Treasury bonds that it bought in QE1 and QE2. Selling those bonds will be a painful process for our economy – every bit as painful as doing endless laps of the rugby pitch would be for Billy Bunter. The bond sales will drive up interest rates, and therefore the cost of borrowing for consumers and companies. It will also increase the debt of the federal government, which right now isn’t paying interest on all that Treasury debt bought by the Fed, because the Fed rebates interest payments back to the Treasury. The public won’t be so generous.
Right now the Fed is basking in the applause of the stock market, just as Bunter would be welcomed enthusiastically by the owners of the local sweet shops. But after the binge comes the diet. One reason the US economy is struggling is because consumers are working to shed the debt acquired before the financial crisis. When the Fed goes on its regime, that struggle could become a torment.
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Paddy Hirsch is the Senior Producer of Personal Finance at the public radio program Marketplace. He’s also the author of Man vs Markets, Economics Explained, Plain and Simple, a tongue-in-cheek guide to the workings of Wall Street.