Ben Bernanke gave a speech today to the Austin Chamber of Commerce (why doesn’t my chamber get speakers like this?) and he reprised part of his famous helicopter speech of a few years ago. The helicopter reference is actually from Milton Friedman who said you could always create inflation by dropping dollars from a helicopter. The interesting thing is the context in which Bernanke used the helicopter reference in his speech from 2002:

Each of the policy options I have discussed so far involves the Fed’s acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman’s famous “helicopter drop” of money.18

Of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.

Bernanke’s preferred method of avoiding deflation and depression then is a tax cut financed by printing money. More recently he endorsed a spending stimulus which appears to be the second option according to his speech. Notice too that the Fed is apparently well into the outlined program. The Treasury is purchasing private assets and the Fed is purchasing agency debt which will have the same effect as buying Treasury debt.

In today’s speech, Bernanke said that if necessary the Fed could purchase long term Treasury bonds to reduce long term interest rates. That set off a major rally in the Treasury market (via Bloomberg):

The decline in yield for the 30-year Treasury was its biggest, and the drop in yield for the 10-year note was its second-biggest, since Nov. 20. That’s when the Fed announced it would buy $100 billion in debt issued by the government- sponsored enterprises, Fannie Mae and Freddie Mac, and $500 billion in mortgage-backed securities issued by the companies.

Investors have flocked to Treasuries, pushing their return in November to 5.4 percent, the biggest monthly gain since 1981, Merrill Lynch & Co. index data show.

It probably had something to do with stocks falling too. The only game in town right now is the Treasury market and the returns there are attracting ever more money. In fact, it seems to me that there is significant risk in the Treasury market right now. What if Bernanke doesn’t buy Treasuries? What if the economy starts to recover? There is a lot of room to fall if the economic disaster everyone is expecting doesn’t come to pass. Some are calling the Treasury market the new bubble:

Demand for Treasuries has reached the “bubble” phase seen among technology stocks in 2000 and real estate six years later, according to David Rosenberg, chief North American economist at Merrill Lynch & Co.

“The 10-year note yield is now firmly below the 3 percent threshold and this next leg down in yield will undoubtedly represent the classic mania-turn-to-bubble phase that quite plausibly sees an overshoot to or even through the April 1954 lows of 2.3 percent,” New York-based Rosenberg said in a research note today before Bernanke’s speech.

At some point, money will start to come out of the Treasury market in search of higher returns. I don’t know when that will happen but when it does, somebody is going to lose a lot of money.

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