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Generational Dynamics Web Log for 17-Feb-06
New Fed Chairman Ben Bernanke gives predictable upbeat testimony to Congress

Web Log - February, 2006

New Fed Chairman Ben Bernanke gives predictable upbeat testimony to Congress

Pundits are smiling today, happy that they can understand "plain-speaking" Bernanke.

One pundit, a chief economist interviewed by the BBC on Wednesday, said that "Bernanke has exploded the 'Greenspan myth.'" According to the pundit, Greenspan defined the myth himself by saying, "If I speak plainly then I run the risk of inciting a financial panic. So it's in everyone's interest that no one understand a word that I say." The pundit added that Bernanke gave exactly the same message that Greenspan used to give, but in clear English, and the markets didn't panic.

The problem is that Bernanke gave quite a different message than Greenspan used to give. Bernanke gave his standard "What? Me worry?" speech, and Greenspan, in the last year or two, was giving speeches quite a bit of alarm, as I've described frequently on this web site, and summarized in my essay, "Ben S. Bernanke: The man without agony."

In his testimony to Congress on Wednesday, Bernanke said that the economy was performing "impressively," adding that the "economy achieved these gains despite some significant obstacles. Energy prices rose substantially yet again, in response to increasing global demand, hurricane-related disruptions to production, and concerns about the adequacy and reliability of supply."

Inflationary worries

Bernanke's major focus were his worries about inflation, and that's a generational issue. Bernanke was born in 1952 and hasn't seen any serious national economic problems except inflation in the 1970s. Since that's the only problem he's ever seen, that's all he thinks he has to worry about.

In his testimony, he expressed a fear of increased inflation, thanks to two problems. One problem is "higher energy prices." The other problem is that, "with aggregate demand exhibiting considerable momentum, output could overshoot its sustainable path, leading ultimately ... to further upward pressure on inflation." I really have to laugh. This second reason is totally meaningless fluff, but he couldn't think of any other reasons besides high energy problems.

Consumer price index (CPI) from 1870 to present, with an exponential growth trend line. The CPI is 185 in 2003, and 2010 has a trend value of 129.

Consumer price index (CPI) from 1870 to present, with an exponential growth trend line. The CPI is 185 in 2003, and 2010 has a trend value of 129.

From the point of view of Generational Dynamics, we've been saying for three years that we're in a long term deflationary period, and that prices will be falling by 30% in the next few years. This assessment is based on the adjoining graph of CPI from 1870 to the present, along with an exponential growth trend. What most people don't seem to understand is that almost all growth trend values must maintain the long term trend; this is the law of "Mean Reversion," that we've discussed before. Since the CPI is well above the trend line today, it has to start falling soon, and stay below the trend line long enough to balance things out.

So the kind of inflationary pressures that Bernanke is talking about simply don't exist. Remember that we've had near-zero interest rates for most of the last five years, and that oil prices have doubled. Those are huge stimuli, and they should have pushed inflation up above 10%, where it was in the 1970s with far less stimulus. Instead, inflation has remained very close to zero. In Wednesday's testimony, Bernanke himself predicted that inflation should be 2% for all of 2006, basing his prediction on the fact that he implies that the Fed is going to continue raising interest rates. Unfortunately Bernanke, who was an Economics Professor at Princeton, apparently can't grasp something as simple as the cyclical nature of inflation, based on generational changes, and that the Fed really has very little influence over the inflation rate, except temporarily.

Bernanke's testimony does give a hint of why inflation has stayed so low:

"The relatively benign performance of core inflation despite the steep increases in energy prices can be attributed to several factors. Over the past few decades, the U.S. economy has become significantly less energy intensive. Also, rapid advances in productivity as well as increases in nominal wages and salaries that, on balance, have been moderate have restrained unit labor costs in recent years."

Whether the U.S. is significantly less energy intensive is arguable, but his point about labor costs is an interesting one. Why have labor costs remained low?

Labor costs are influenced not by the Fed but by the law of supply and demand. Inflation was high in the 1970s because labor costs were high, because labor was in high demand. Labor was in high demand because the Great Depression of the 1930s had forced almost all businesses into bankruptcy, forcing the creation of news businesses that reached their peak growth in the 1960s and 1970s, causing a high rate of labor demand, causing a high rate of inflation. The Fed had nothing to do with it.

Today, those same businesses are encrusted with bureaucracy. This ties together with the the Katrina report that I discussed a couple of days ago. The sloth that the government showed during Katrina is the same sloth that businesses are exhibiting as well. Millions of jobs have been outsourced to China and India, leaving behind an American work force that places job security above everything else. So businesses "make do" with the people that they have. This increases productivity, as Bernanke mentions, but it also reduces the demand for labor, which keeps labor costs down, which keeps inflation low. Once again the Fed has absolutely nothing to do with all this, although this concept appears to be complete foreign to Professor Bernanke, as well as most analysts, journalists and pundits.

Other confusions

Professor Bernanke repeated some of the silly things in speeches that I've previously commented on on this web site.

He repeated "a hypothesis I offered last year":

"that, in recent years, an excess of desired global saving over the quantity of global investment opportunities that pay historically normal returns has forced down the real interest rate prevailing in global capital markets."

This refers to his claim that America's astronomically high public debt can be blamed on a "global savings glut" in other countries. This is so silly that he should be embarrassed to say it.

Household cash and liabilities, 1945 to present <font size=-2>(Source: Contrary Investor)</font>

Household cash and liabilities, 1945 to present (Source: Contrary Investor)

The adjoining graph shows how public debt has been increasing exponentially since 1945, and really took off in the 1990s, at exactly the same time that the stock market bubble occurred. They both happened at that time, and had the same cause: The risk=averse generation of senior managers that had grown up during the Great Depression all disappeared (retired or died) all at once in the 1990s, and were replaced by the risk-seeking Boomer generation, with no personal memory of the Depression. Once again, this has nothing to do with anything the Fed does, and blaming it on a "global savings glut" in other countries is just a silly conceit.

The man without agony

This brings us back to how plain-spoken he is. He's plain spoken because everything is simple for him. In Bernanke's "What? Me worry?" world, there are no bubbles, and panics are no problem at all, as I described in "Ben S. Bernanke: The man without agony." It's the same for everyone in the Boomer generation -- every problem is always someone else's fault and responsibility.

Alan Greenspan, born in 1926, lived through the Depression and knows how complicated the world really is. He knows that there are more dangers besides inflation, which is why Greenspan's "swan song" Fed speech warned about the stock market and housing bubbles, that "history has not dealt kindly with the aftermath of protracted periods of low risk premiums.”

There's nothing like that kind of stern warning in any of Bernanke's speeches.

The reason that these expert economists, analysts and pundits that always get quoted on tv didn't understand what Greenspan was saying was because either they don't understand macroeconomics or didn't want to listen to what Greenspan was saying. "Plain-spoken" Bernanke will please these experts and pundits because it takes place in his academic world where the only danger is a little inflation. It's a shame the real world isn't like that.

As I've been saying since 2002, Generational Dynamics predicts that America is entering a new 1930s style Great Depression, with a stock market crash to the Dow 3000-4000 range by the 2007 time frame. I certainly have no reason to change this prediction now, especially with public debt and the trade deficit continuing to grow uncontrollably and exponentially, so it may happen a lot sooner than expected. (17-Feb-06) Permanent Link
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Generational Dynamics Web Log for 17-Feb-06 New Fed Chairman Ben Bernanke gives predictable upbeat testimony to Congress

Inflationary worries

Other confusions

The man without agony

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Generational Dynamics Web Log for 17-Feb-06
New Fed Chairman Ben Bernanke gives predictable upbeat testimony to Congress