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Generational Dynamics Web Log for 15-Jan-2009
As his Great Historic Experiment collapses, Ben Bernanke scrambles to save his reputation

Web Log - January, 2009

As his Great Historic Experiment collapses, Ben Bernanke scrambles to save his reputation

Who "lost" the economy? The finger-pointing is getting intense.

"This moment of anticipation is like the calm that settles after all hopes have died."

That's what Hannah Arendt wrote in a different context, and that's the atmosphere among investors today.

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The same sense of desperation pervades discussions, after a year when one bailout after another has failed. The political sniping over the fiscal stimulus plan is increasing -- as people realize that no plan actually exists. The discussions are sounding more and more like kindergarten kids in a candy store, with different kids fighting over the tastiest morsels of candy. The impression is that the fiscal stimulus plan appears to be descending into chaos.

I heard Massachusetts ultra-liberal Barney Frank on the news yesterday deliver a long partisan harangue that the reason for all our problems is that the Bush administration didn't spend the TARP bailout money correctly. He, of course, knows the correct way to spend bailout money, and he's going to make sure that it works this time. We'll be looking forward to enjoying the benefits of his expertise.

The failure of a year of bailouts is also a failure of Fed Chairman Ben Bernanke, considered by many to be the world's greatest expert on the Great Depression. Bernanke developed his theories starting while he was on his grandmother's knee as a child. By the time he reached the position of Chairman of the Princeton University Economics Department, he had "proven" that the 1929 stock market crash war nothing, a mere piffle, and that the Great Depression was caused by an accounting error by the Fed.

He also "proved" that deflation was impossible with a fiat currency like the American dollar, since you can always print more dollars. He held onto this belief well into the 2000s, even after a deflationary spiral struck Japan and proved his theory wrong. For all I know, he still believes it today.

On Tuesday, he fought back. He gave a speech at the London School of Economics to defend his policy, and to claim that his ideas were still needed:

"The Federal Reserve will do its part to promote economic recovery, but other policy measures will be needed as well. The incoming Administration and the Congress are currently discussing a substantial fiscal package that, if enacted, could provide a significant boost to economic activity. In my view, however, fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system. History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively."

However, as is usually the case when discussing Bernanke's speeches, all you can do is shake your head in utter disbelief in what he's saying because it's such nonsense.

Here's a paragraph from Tuesday's speech:

"One important tool is policy communication. Even if the overnight rate is close to zero, the Committee should be able to influence longer-term interest rates by informing the public's expectations about the future course of monetary policy. To illustrate, in its statement after its December meeting, the Committee expressed the view that economic conditions are likely to warrant an unusually low federal funds rate for some time. To the extent that such statements cause the public to lengthen the horizon over which they expect short-term rates to be held at very low levels, they will exert downward pressure on longer-term rates, stimulating aggregate demand. It is important, however, that statements of this sort be expressed in conditional fashion--that is, that they link policy expectations to the evolving economic outlook. If the public were to perceive a statement about future policy to be unconditional, then long-term rates might fail to respond in the desired fashion should the economic outlook change materially."

What is he thinking? This is so bizarre that I can barely believe I'm reading it. He actually still thinks that he can give a speech or issue a policy statement, and that's all that's needed to move markets. I was already criticizing Bernanke for this in 2004, after a speech he gave claiming that it was his clever rhetoric and policy statements that were keeping inflation and long-term interest rates under control.

Now, four years later, he's making the same kind of claim. He says that his policy statements "they exert downward pressure on longer-term rates, stimulating aggregate demand."

You know, as I've written in the past, former Fed Chairman Alan Greenspan's speeches all made sense and contained real content, whether you agreed with him or not. I commented on all of Greenspan's speeches in 2004-2005, and they were amazing, intelligent speeches. Actually, they didn't seem so at the time, but they do retrospectively, when compared to almost any speech on economics since then. A good example are statements by economics Nobel Price winner Joseph Stiglitz, which verged on total absurdity.

So now we have this silly speech by Bernanke. And did you see the last sentence above? "If the public were to perceive a statement about future policy to be unconditional, then long-term rates might fail to respond in the desired fashion should the economic outlook change materially."

I find this absolutely amazing. He actually believes that the Fed's credibility depends on whether he says "will happen" or "might happen" in policy statements. Could it really be possible that he doesn't understand that long-term rates are low because the credit bubble is collapsing, leading to a deflationary spiral? Does he still believe that deflation is impossible?

Here's a quote from yesterday's Q&A session, when Terry Easton of Human Events said that the "90 year edifice" of Keynesian economics was failing, and asked whether it would be better to following the advice of the Austrian school:

"The question is related to the former one, has to do with the benefits of markets. I think economists are often accused of being market fundamentalists. I think economists have done a better job than anybody in figuring out what markets do well and what they don't do so well with problems of information and other things.

Economists have also pointed out that government interventions are not benign, perfectly executed interventions. They're also executed by individuals with interests, and so on. This is a public policy school. And so the balance between markets and the government is a delicate one.

In particular, those of us who are economists, and I think that accounts for almost everybody in the room, are always amazed by the lack of understanding in the general public about the power of markets. And in particular, the Austrian school emphasized the power of markets to aggregate information and incentives, and to provide outcomes that a top-down government approach can't provide.

So, as an economist, I have a lot of faith in markets. I don't think, for example, I would completely disagree with the view that what's happened in the last year and a half is a crisis of capitalism per se. I mean capitalism has done a lot for growth and living standards for a long time.

But rather, it's a crisis that arises from a particular set of situations and conditions that we have faced in the last couple of years. In particular, as I indicated before, because of the tendency of financial systems to boom and bust, which is a very long standing problem, one that was recognized by virtually every economist who's studied these issues, and because of the effects of that on the economy, there's been a long-standing tendency to find a regulatory balance that reduces the cause of those booms and busts without costing us the benefits of the market forces and innovation and information aggregation and so on. It's a very difficult balance.

I think what we've learned in this case is not necessarily that we need to have a lot more regulation, but we need to think through what went wrong.

When I describe the financial system, I mean private system PLUS the regulatory overlay - that whole complex didn't perform well in this case, and we need to think very hard about how to fix it.

Now, as I tried to say in my speech, we have both short term and long term considerations. I think it's important to try to put out the first. I think it's good avice in general that if there's a fire burning, you try to put it out first, and then you think about the fire code. So you don't try to do it all at once necessarily.

We need to figure out how to solve this problem, how to stop the costs that are being borne, but going forward, we have to look at the fire code, we have to think about what is the right balance of regulation, markets, that will give us a powerful innovative financial system, but one that will be safer to use in some sense."

Within this quote, the particular sentence that I'm reacting to is: "But rather, it's a crisis that arises from a particular set of situations and conditions that we have faced in the last couple of years."

Bernanke has absolutely no grasp as to what's going on. He sees no connection between the 1990s dot-com bubble and the recent credit bubble. He's totally baffled about how we got to where we are today, and ascribes the current crisis to being a random event that began because of random circumstances two years ago, and presumably thinks that the problem can be solved if the Fed issues just the perfect policy statement.

This speech is almost gibberish, a final act of desperation by a man who has been taking one desperate measure after another as Fed chairman to stave off being blamed for the coming disaster.

Perhaps Barney Frank and Barack Obama will end up saving Bernanke's reputation. Normally, a new President has 6-12 months in which to blame any problems that arise on the previous administration, but this is going to be difficult for Obama. Obama and Frank and other Democrats have been smug and arrogant in condemning President Bush as the worst President in history, a man who did everything wrong. And Obama has been extravagant in his claims of "change" on January 21, change that will immediately heal the world.

Now, with this huge bailout and fiscal stimulus package, and with total Democratic party control of the Congress and the White House, it's going to be hard to blame the previous administration for long.

And that should make Ben Bernanke happy, because it'll be hard to blame him either, and people may forget that once upon a time, long, long ago, he was considered the world's leading expert on how to prevent a new Great Depression.

From the point of view of Generational Dynamics, things are going to get much worse, disastrously worse, as investors around the world panic and create the worst financial crisis in history, leading to instability, chaos and war around the world. There's nothing really remarkable about this, since similar things have happened over and over again throughout history. It's about to happen again, and politicians can do nothing about it except to do what they always do -- try to blame someone else.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.

Also, check out the discussion of investment strategies in the You Have The Investing Advantage thread.) (15-Jan-2009) Permanent Link
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Generational Dynamics Web Log for 15-Jan-2009 As his Great Historic Experiment collapses, Ben Bernanke scrambles to save his reputation

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Generational Dynamics Web Log for 15-Jan-2009
As his Great Historic Experiment collapses, Ben Bernanke scrambles to save his reputation