We can end bank panics forever by limiting the ability of lenders to create money out of thin air.
Last week, voting 70-30, the Senate confirmed Federal Reserve Chairman Ben Bernanke for another four year term. So now what will he do?
Phase one of the recovery is certainly complete. Since September 2008, the Fed has bought mortgage-backed securities and Treasurys, and increased the monetary base to $2 trillion from $850 billion. The flood of dollars has bank profits booming.
Sadly, banks still have all those underwater mortgage-backed securities and derivatives, but Mr. Bernanke is assuming they will just earn their way out of this problem. Banks also are not lending enough to get the job-creation engine rolling again—though sooner or later they will, at which point inflationary pressures will build tremendously. So every currency trader, bond buyer and man on the Street wants to know one thing: "What's the exit strategy, Ben?" Raise interest rates, shrink the money supply and risk cratering the economy, or keep rolling along and risk a collapsing dollar?
My guess? Mr. Bernanke will leave the money out there but restrict banks' ability to create more out of thin air. He'll be called crazy. Crazy like a fox.
The Fed has a once-in-a-millennium opportunity to do away with banking panics. Investors will rejoice, but Wall Street firms are not going to like it one bit.
The Fed has a once-in-a-millennium opportunity to do away with banking panics
Our banking system has changed little since the days of Elizabethan goldsmiths writing more gold receipts (aka banknotes) than they had gold in their vaults. This "fractional reserve banking" system has caused every major panic in this country—I've counted at least 16 of them since 1812.