Dr. Bernanke Gets a Phone Call

Discussion in 'Economics' started by bond_trad3r, Nov 14, 2010.

  1. Zhou Xiaochuan is the Governor of the People’s Bank of China. Imagine that the following phone call were to take place.

    Zhou: Hello. Dr. Bernanke?

    Bernanke: Yes.

    Zhou: I wanted to let you know about the decision that our board has taken, after consulting with the Premier and the Politburo’s Standing Committee. We hope you are sitting down.

    Bernanke: I get it. A little Oriental humor.

    Zhou: You could say that.

    Bernanke: What can I do for you?

    Zhou: You can abandon your plan to purchase $600 billion of Treasury bonds.

    Bernanke: The Federal Open Market Committee voted ten to 1 for this policy. I cannot change it now.

    Zhou: We think it is an unwise policy. It will lower the value of the dollar. Americans will then buy fewer goods from China.

    Bernanke: That is not how we see it. We think the policy is required to put Americans back to work. They will buy more goods from China and everywhere else when they are once again working.

    Zhou: You will increase the supply of dollars, which will lower the dollar’s price internationally. Imported goods will cost Americans more. An increased supply of dollars will mean a lower price for dollars. It’s supply and demand.

    Bernanke: That is the old economics. That is the logic of Adam Smith and Milton Friedman and those kooks from Vienna. We are committed to the new economics.

    Zhou: Who teaches it? Where?

    Bernanke: I taught it for years at Princeton.

    Zhou: Where Paul Krugman also teaches?

    Bernanke: Yes.

    Zhou: We see it differently here. We prefer the older economics.

    Bernanke: Adam Smith’s economics?

    Zhou: No, even older.

    Bernanke: Mercantilism?

    Zhou: That is what you call it. We call it the export-driven Asian miracle.

    Bernanke: But mercantilist governments wanted to hoard gold. Your nation does not hoard gold. Your bank holds U.S. Treasury debt.

    Zhou: That is the purpose of my call.

    Bernanke: Gold?

    Zhou: No. U.S. Treasury debt.

    Bernanke: What about it?

    Zhou: There is too much of it.

    Bernanke: You sound like Ron Paul.

    Zhou: Ah, yes. Congressman Paul. I understand that he is likely to be the next chairman of the Monetary Policy Subcommittee. You and he should have some interesting discussions.

    Bernanke: I prefer to talk about Treasury debt.

    Zhou: We have determined that an increase of $600 billion in your purchases of Treasury debt will lower the rate of interest on the debt.

    Bernanke: That is our thought, too.

    Zhou: We hold almost $1 trillion in Treasury debt.

    Bernanke: You ought to buy more.

    Zhou: We will be losing money on our holdings if rates fall.

    Bernanke: You ought to buy more.

    Zhou: The value of the dollar will fall. That will lower the value of our holdings.

    Bernanke: Nevertheless, you ought to buy more.

    Zhou: We have decided to own less.

    Bernanke: How much less?

    Zhou: $600 billion less.


    Zhou: Dr. Bernanke?


    Zhou: Are you still there?

    Bernanke: I am still here.

    Zhou: We have decided that every time the Federal Reserve purchases its monthly total of $75 billion, we will sell $75 billion.

    Bernanke: Are you serious?

    Zhou: You sound like Nancy Pelosi.

    Bernanke: But that would raise interest rates on Treasury debt.

    Zhou: That is our conclusion, too. But remember: we own lots of Treasury debt. We could use a better rate of return.

    Bernanke: But higher rates might cause a recession in the United States.

    Zhou: That is our conclusion, too.

    Bernanke: But that will mean fewer imports from China.

    Zhou: We think it will mean more bankrupt manufacturing facilities in the United States. Then Americans will come back to our manufacturers.

    Bernanke: But this could cause unemployment in China if you are wrong.

    Zhou: We are willing to risk that.

    Bernanke: That is a big risk on your part.

    Zhou: No bigger than the risk on your part by inflating the monetary base by 30%. That could raise prices in the United States.

    Bernanke: We don’t think so.

    Zhou: Why not?

    Bernanke: Because our bankers are so frightened of recession in 2011 that they are not lending. They just turn the money over to the FED.

    Zhou: Then you do not expect inflation?

    Bernanke: Only a little. Maybe 2% to 3%.

    Zhou: You sound like Milton Friedman.

    Bernanke: Around here, we say, "Better 2% inflation than 9.6% unemployment."

    Zhou: We think it is better for us not to hold onto Treasury debt that cannot be paid off.

    Bernanke. Don’t worry. We owe it to ourselves.

    Zhou: On the contrary, you owe it to us.

    Bernanke: It’s only a figure of speech.

    Zhou: We can figure. We are going to be left holding the bag, as you say. All we have is a pile of IOUs.

    Bernanke: They’re as good as gold.

    Zhou: Since they pay zero interest, we think gold is better.

    Bernanke: It’s only a figure of speech.

    Zhou: We can figure. Gold is over $1,350 an ounce. The dollar has been falling. We think the older mercantilism was right. We want to own more gold.

    Bernanke: You can’t eat gold!

    Zhou: We can’t eat T-bonds, either.

    Bernanke: But if you sell dollars, their price will fall.

    Zhou: Why?

    Bernanke: It’s supply and demand.

    Zhou: Gotcha!

    Bernanke: You speak English very well.

    Zhou: You see, I was educated in your country at UCRA.

    Bernanke: Really?

    Zhou: Not really. But I love those old Richard Loo World War II movies. He made a great Japanese officer.

    Bernanke: But if you sell Treasury debt, that could start a fire sale. Central banks all over the world might start selling T-bonds.

    Zhou: That is a possibility.

    Bernanke: But that would make your holdings worth even less.

    Zhou: That is true. So, if Japan starts selling, we will dump all of our holdings in one shot. We might as well get out before the rush.

    Bernanke: But that could crash the dollar!

    Zhou: That is a possibility.

    Bernanke: You’re bluffing!

    Zhou: That is a possibility.

    Bernanke: But this is not the way that central banks operate.

    Zhou: How do they operate?

    Bernanke: They inflate.

    Zhou: Always?

    Bernanke: Of course always. That is the only policy tool we have.

    Zhou: You could deflate.

    Bernanke: Are you serious?

    Zhou: You really have Nancy Pelosi down pat.

    Bernanke: There is no way we can deflate.

    Zhou: What about your exit strategy? That is deflation.

    Bernanke: In theory, yes. But we don’t intend to execute it.

    Zhou: That is not what you told Congress. You told Congress you have an exit strategy. Several, in fact.

    Bernanke: We do have them. We just don’t intend to implement them.

    Zhou: Do you think you can fool Congress?

    Bernanke: Are you serious? Congress doesn’t know horse apples from apple butter.

    Zhou: You mistake Barney Frank for Ron Paul. You will now have to deal with Ron Paul.


    Zhou: Hello.


    Zhou: Are you still there?

    Bernanke: Yes, I’m still here.

    Zhou: We are not asking you to deflate. We are asking you not to inflate.

    Bernanke: But we must inflate.

    Zhou: Why?

    Bernanke: Because we have 9.6% unemployment.

    Zhou: What has that got to do with your decision to inflate?

    Bernanke: We must lower interest rates.

    Zhou: For Treasury bonds.

    Bernanke: Yes.

    Zhou: What does that have to do with unemployment?

    Bernanke: When mid-term rates are lower, businesses will start new projects and hire people.

    Zhou: Mid-maturity T-bond interest rates are the lowest ever since what you call the Great Depression and what we call the old normal.

    Bernanke: You can never have low enough T-bond rates.

    Zhou: But, as Treasury bond investors, we don’t like low rates. We like high rates. We hold lots of T-bonds. If we get very low rates, we might as well own gold.

    Bernanke: But you will like all that increased demand for made-in-China goods when all those unemployed Americans go back to work.

    Zhou: But rates are lower than they have been in 80 years. You still have 9.6% unemployment.

    Bernanke: But if the 10-year T-bond rate goes from 2.6% to 1%, American businessmen will hire millions of workers.

    Zhou: Do you have evidence for this in one of those dozen Federal Reserve bank monthly bulletins? Or maybe in the Federal Reserve Bulletin?

    Bernanke: Not really. But it’s the thought that counts.

    Zhou: I don’t think we are getting anywhere. So, just to remind you. We will sell enough Treasury debt each month to match any net increase in the amount you buy.

    Bernanke: Dollar for dollar?

    Zhou: Dollar for dollar. But, I’ll tell you what. Buy them from us, and we’ll give you a discount for volume purchases.

    Bernanke: You guys never miss a trick, do you?

    Zhou: We’re really not inscrutable. We just offer discounts for volume purchases.

    Bernanke: I will discuss this with the FOMC.

    Zhou: Do that. Shalom!

    Bernanke: That’s my middle name.

    Zhou: You Americans have a saying for everything.

    Bernanke: No. I mean it. That really is my middle name.

    Zhou: If you start buying Treasury debt, you’ll have an honorary middle name over here.

    Bernanke: What’s that?

    Zhou: Paper Tiger.

  2. Another Mises post.
    I stopped reading when Zhou says if rates fall he'll lose on his holdings. If you're actually a bond trader, that's where you should've stopped too.
    Dumber and dumber.
  3. Anyone see the US treasury bill skit on Saturday Night Live last night? Now everyone in the USA is a macro trader...
  4. dhpar


    good post OP.

    with respect to Chinese losing if Ben takes rates down that's very true - in a material sense.

    A. China does not MtM Treasuries on their books and
    B. rolls maturing issues and coupons into new ones (together with trade surplus).

    Therefore every rate reduction reduces their cash flow income - and they are losing dollars (which at the same time are worth less!). This is very important for a bond trader to understand as well as for someone doing monetary policy.

    In fact this is one of the main reasons why Ben is doing it imo, i.e. if Chinese do not play the ball (by devaluing Yuan) US will not pay them on their borrowings and take the dollar down against other currencies while elevating inflation pressures in China and therefore increasing the probability of a Chinese crash. It is an macroeconomic equivalent of war - nothing else.

  5. Nice try.

    Actual quote:

    Zhou: The value of the dollar will fall. That will lower the value of our holdings.

    "our holdings", not the cash flow from what we're going to buy in the future, since obviously the cash flow from present holdings stays the same. I doubt the writer even understood that the cash flows on present holdings wouldn't change.
    As for it lowering the value of present holdings, which is what Zhou actually said, this is an obvious mistake made by people who don't understand how bond pricing works.
  6. dhpar


    i did not try anything.

    if you want to pick up on few words from the OP post so be it - I could not care less. The important is the message - which you did not read because you very busy declaring victory when Zhou did not express himself clearly.
    before making conclusion maybe you should try to think that Zhou was not talking about duration at all but was referring to the currency effect right from the start. if you have experience in fixed income you know that 20bps on 10 year treasury ( (presumed effect of QE) is easily offset by 1.5% USD depreciation...

    now I can call you a dick-head because to prove your point you posted the above (clearly by a mistake too), i.e. Zhou: The value of the dollar will fall. That will lower the value of our holdings. so he was talking about the currency after all. LOL :D

    so now fuck off elite trader
  7. ...except the yuan is fixed to the dollar, has moved all of 3% since they decided to take off the hard peg and go to a creeping one, and the effect of QE is going to be measured in more than just a few bps, or at least that's the intent.
    The Chinese evidently agree, since they've tightened twice very recently. This puts them in a box, since every time they tighten, gold falls, the dollar rises vs the euro, and in the meantime they have to continue to raise the yuan vs the dollar or face a real retaliation far beyond QE from the US.
    At this point we're way over your paygrade and that of the Mises poster. Bernanke is playing chess, you and Mises are playing checkers.
  8. I don't believe I'm familiar with the species of bond whose value goes down when yield goes down.
  9. You mean you stopped reading when business cycle theory went over your head.

    And this from someone who thinks stronger unions are key to economic growth. I really hope some people here are trolls. It's hard to believe such mindless drones exist.
  10. Yes, the guy who hit the panic button at exactly the wrong moment over and over again in 2008. Bobby Fischer must be shaking in his grave. What was that? Some French dude keyed in the wrong amount and we responded with a 75 bps cut? Oh well.

    Bernanke's bullets are gone. He's down to pistol-whipping now. It's so painfully obvious that the rest of the world sees it..and only the brainwashed think Bernkanke has a clue.
    #10     Nov 16, 2010