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Editorial See other Editorial Articles Title: DR. BERNANKE GETS A PHONE CALL 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. Bernakne: 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. Bernanke: Zhou: Dr. Bernanke? 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. Berrnanke: Zhou: Hello. Bernanke: 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"? Barnanke: 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.
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