A tough question Ben Bernanke should answer

With last week's downgrade of the outlook for US debt, it's time the Fed came clean about interest rates and Treasury bond buying.

By InvestorPlace Apr 26, 2011 11:14AM
investorplace logoBy Richard Band, InvestorPlace.com

The clock is ticking on "Bubbles" Bernanke. Come June 30, his latest quantitative easing program (QE2) is scheduled to end. The big question on everyone’s mind is: what happens next?

Surely such big-picture ideas will be discussed tomorrow at the central bank's first-ever press conference. But the bottom line is that the reckless behavior of the Federal Reserve demands closer scrutiny -- and harder questions.

Here is one I want a straight answer to: "Chairman Bernanke, what would you do if, one of these days, the Chinese placed a $100 billion order to sell their U.S. Treasury bonds?"

It's time to figure this out. First, the Fed stuffed its balance sheet with more than $1 trillion of dodgy mortgages purchased with money created out of thin air. Then last November, Bernanke's crew voted to buy another $600 billion of Treasury paper. This massive money printing has undermined global confidence in the dollar's purchasing power. 

Last week, Standard and Poor's announced it was downgrading the outlook for U.S. debt, saying "In 2003-2008, the U.S.'s general (total) government deficit fluctuated between 2% and 5% of GDP. Already noticeably larger than that of most 'AAA' rated sovereigns, it ballooned to more than 11% in 2009 and has yet to recover." China's Foreign Ministry Spokesperson Hong Lei responded, "We hope the US. government will earnestly adopt responsible policy measures to protect the interest of investors."

Let’s face right up to that big issue that S&P has called to our attention: The U.S. government’s spending has gotten wildly out of control, and something really needs to be done about it. S&P says an agreement between the Republican and Democratic Parties in Congress and the White House needs to be reached by 2013. If not, S&P says there’s a 1 in 3 chance that they will have to lower the debt rating of the United States government.

The Fed is sitting on a powder keg. At some point, it will be necessary to restore a semblance of balance between savers and borrowers. When interest rates begin to tick up, the rush to buy anything and everything could turn into a universal urge to sell. The Chinese are already complaining about the meager rewards of Treasuries.

What would happen if they decided to dump just 10% of their $1.15 trillion position in U.S. debt? How is the Fed going to deal with such an outcome?

To read a full list of my 5 tough questions for Bernanke, follow this link.

Richard Band is the editor of Profitable Investing and writes for InvestorPlace.com.



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