US Government Policy and Ben Bernanke

The US Gov't is replacing private balance sheets with its own. I am sure that this will soon include pension funds and state/municipal governments. That is fine when we have balance of payments surpluses, but we don't and haven't for about 50 years. The world's economic engine post-WWII was driven by a persistent and growing US current account deficit. Now that that finally seems unsustainable, what happens now? Can we collectively ease off of, and gently devalue, the USD as the world reserve currency or will that too fall off a cliff, as have all other asset markets and currencies of late?

It looks like this can only go in two divergent, but related paths. Each comes with a great deal of pain, but will likely lead to a change in world leadership from the US to someone else at some point in time. It doesn't seem at this point if anyone else is ready to pick up the mantle, which will likely keep this disequilibrium in place for that much longer.

Who knows what the ultimate destination is for the US and world economies but the policy road ahead seems somewhat clear. A book I recently read laid out the Bernanke recipe should the US economy be faced with a possibility of deflation. It was written by Ethan Harris, (presumably former) Chief US Economist for Lehman Brothers. While not that insightful overall, I thought the following list was thought provoking. Take a look at this list and lets review what has or hasn't occurred.

Step 1: push the funds rate to zero (getting there)

Step 2: drive down long-term Treasury interest rates by either promising to keep short rates low for a number of years or commit to make unlimited purchases of Treasury bonds until their interest rate falls. (just announced)

Step 3: push down interest rates on private securities by buying them up as well (announcment of buying Fan and Fred qualifies - wonder whats next?)

Step 4: intervene aggressively in the foreign exchange market to weaken the dollar and raise the price of imports (not yet)

Step 5: Have a coordinated easing of both monetary and fiscal policy, with, for example, a cut in taxes financed by issuing money so there is no increase in government debt ($500B+ stimulus plan likely paid by new money printing)

This list seems to be a cookbook from the Chef Ben Bernanke. Seems like he will do anything to cook up some inflation for us. While the talk now is of deflation, seems like printing up gobs of cash and placing it into the system should ultimately have inflationary effects. And my guess is that this new inflation will not be successfully transmitted into financial assets, due to the longer memories of market participants who may not be as interested in extreme credit growth.