Rather than regurgitate the usual economic analysis of the Fed's policies, let's hazard a psychoanalysis of the Fed. Given the primacy of psychological factors in human behavior, it is astonishing how little attention is paid to the psychology of the Fed's statements and policies.

Zero Hedge offered just such a psychological insight (with a deliciously Freudian twist) with this question: Does the Fed need to re-instill some discipline in order to regain its omnipotence? Why (For The Fed) It Is All In The Foreplay

Exactly. Subservience is a slippery slope, and if the Fed "caves in" to market demands for a massive QE campaign, then where is the Fed's vaunted autonomy? It's gone. So what happens in a few months when the market is once again in danger of rolling over? Will the Fed cave in again and issue more QE? If it doesn't, the market reaction will be violently negative, and the Fed will get blamed for the catastrophic decline.

You see the positive feedback loop of Fed subservience: the longer the Fed puts off regaining autonomy, the more disruptive their refusal to obey the market will be.

The more they appear to meekly comply to the demands of the market, the greater the pressure will be on them to continue giving the market what it now needs to continue rising: QE.

The only psychologically wise choice is to nip Fed subservience to the market in the bud before it becomes even more destabilizing.

ZH's reference to Fed omnipotence raises a critical question: what happens to the Fed's power to manage market behavior with mere words if they launch QE3 and it fails to move the market? Jawboning, promises and threats are the primary tools of "perception management," and Bernanke has masterfully manipulated perceptions with promises of future QE "should the need arise" for the past 15 months.

If he unleashes a tsunami of "free money" (QE3) and the market spikes up and promptly rolls over into a decline, then his power will be destroyed in three ways:

1. The promise/threat of more QE has been eviscerated; jawboning has lost its power and will only make the Fed chairman look silly and irrelevant.

2. QE itself will be revealed as the victim of diminishing returns: everyone will understand that QE4 will be a failure.

3. The Fed's omnipotence will be revealed as illusory.

Imagine the addictive rush of being globally relevant. Now imagine losing that power. The Fed only remains relevant, domestically and globally, as long as QE and its other "unconventional" (and now utterly conventional) policies exert a powerful magic on the market and economy. If these policies are perceived as failures, the Fed's relevance vanishes--along with the addictive rush experienced by its leaders.

The Fed has foolishly backed itself into a corner. In essence, what Chairman Bernanke and the other easy-money "doves" on the Board have said is this: "We have the power to move the market and economy. We will use this immense power when we feel the need to."

Now the stock market is calling their bluff: "Oh, so you have this great power, huh? Well, you better use it right now, or I'm going to throw a fit and collapse!"

By constantly talking up the success and power of his policies, Bernanke has backed the Fed into a corner: either it proves its power is as potent as it has constantly promised, or the power of the promises will fade.

Bernanke has also backed the Fed into a corner by essentially promising that the Fed can bail out the market and the economy while gridlocked Washington burns trillions. What Bernanke has said: "Our policies have worked, and will continue to work magic."

What he should have said: "We have done all we can. The Fed cannot solve fiscal problems or structural problems in the economy. That is up to the President and Congress, the elected leaders of the nation."

Having foolishly made grandiose claims of supernatural powers, Bernanke now has to deliver on those grandiose claims or be stripped of power.

Some have suggested that Bernanke is frustrated by Washington's gridlock and inaction on the "fiscal cliff," but he himself has played the enabler of Washington's denial and addiction to borrowed trillions.

If Bernanke shoots his QE wad here with the stock market at multi-year highs, what will he do for an encore when the market falters? Once again Bernanke has created a positive feedback loop: the more QE he pushes into the market at its highs, the more vulnerable the market is to steep declines when the QE runs out.

If he promises a steady drip of QE cocaine, what happens when the market declines anyway? Announcing any QE at market tops leaves fewer "surprises" available at market bottoms. Bernanke will have expended his high-power ammo and be facing the rampaging Bear with a dull Swiss Army knife he picked up in Davos.

Is Bernanke a stud or a wimp? Most of us never get close to the sort of power Bernanke wields, and so we must explore the psychology of those who revel in power, regardless of their public persona of calm modesty.

People with power want to retain their power. Having backed himself into the corner in two ways, Bernanke is extremely vulnerable politically. If he launches a massive, sustained QE, he will rightly be perceived as acting solely to get President Obama re-elected. (Wouldn't the Democrats accuse him of that were the sitting president Republican? Of course they would, loudly and vehemently.)

If he launches QE and the market declines because QE has already been priced in, he will be perceived as a failed Fed chair and will eventually be asked to step down, i.e. fired. That's not the legacy he desires, but he has backed himself into a corner: having over-promised, he can only under-deliver.

Does Ben Bernanke want to be perceived as a wimp who caves into the market's every demand? Once again, he has backed himself into a corner by touting the stock market's rise as evidence that his policies have succeeded. Having tied his policies to the market, he now faces the possibility that a market decline will be rightly viewed as a failure of his policies and leadership.

Having taken credit for the market's spectacular rise, he will now be held responsible for its decline. Bernanke has made all the classic errors of the grandiose ego: over-claiming credit and over-promising on the effectiveness of his "magic."

Admitting the Fed is not all-powerful would have diminished his perceived power, but it would have increased his real power because he would be viewed as a truth-teller. But in claiming a magic and power he does not have, he has set up the classic pitfall of promising what cannot be delivered.

Diminishing returns and unrealistic expectations make a volatile pairing. Having raised expectations to the stratosphere even as the real-world returns on his policies have been diminishing, Bernanke now faces an explosive gap between what he has promised and what can actually be delivered.

There is one last irony in Bernanke's constant promotion of his powers to unleash QE. Having talked up the market for years with his promises/threats of QE, the market has priced in ever higher doses of QE, in effect bidding expectations of QE's effectiveness to the sky.

Bernanke has lost the power to surprise the market. Having raised expectations to the sky, he must deliver something beyond the stratosphere to surprise the market. But he doesn't have anything capable of matching the absurd expectations he's inflated, never mind exceed them.

The only surprise left is a negative one. Chairman Bernanke and his fellow doves will soon realize the consequences of over-promising and under-delivering. It works better the other way around, but now it's too late.

New video: Gordon Long and I discuss "Marginal Return":

Read the Introduction (2,600 words) and Chapter One (7,600 words) for free.

We are like passengers on the Titanic ten minutes after its fatal encounter with the iceberg: though our financial system seems unsinkable, its reliance on debt and financialization has already doomed it.

We cannot know when the Central State and financial system will destabilize, we only know they will destabilize. We cannot know which of the State’s fast-rising debts and obligations will be renounced; we only know they will be renounced in one fashion or another.

The process of the unsustainable collapsing and a new, more sustainable model emerging is called revolution.

Rather than being powerless, we hold the fundamental building blocks of power. We need neither permission nor political change to liberate ourselves. A powerless individual becomes powerful when he renounces the lies and complicity that enable the doomed Status Quo’s dominance.

If this recession strikes you as different from previous downturns, you might be interested in my book An Unconventional Guide to Investing in Troubled Times (print edition) or Kindle ebook format. You can read the ebook on any computer, smart phone, iPad, etc. Click here for links to Kindle apps and Chapter One. The solution in one word: Localism.


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