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Bernanke & the Markets

Let's cut Ben Bernanke a break: the present situation wasn't of his making; he merely inherited a bad economic set up. Slowing growth, rising inflation, high energy costs, a real estate dependent economy, and the longstanding problem of excess liquidity -- none of these rest at the feet of the present Fed Chair. In reality, they are the result of what Tim Iacono charitably describes as The Mess That Greenspan Made.

Further, some of the critics are exempting Greenspan and blasting helicopter Ben. Kentucky Sen. Jim Bunning (R), has called Bernanke an "amateur" and "blasted the former Princeton University professor for unnerving markets with his anti-inflation rhetoric." Bunning said Bernanke's "been in a cocoon of academia and is not ready for prime time."

Its funny to hear these criticisms, which ignore history. First, every new Fed chair is an amateur for a while. Even the most qualified economist/politician is unprepared for what may very well be the most powerful position in the world. What can prep you for that? That's why market historians know of the New Fed Chair Curse. No black magic involved, just a painful honeymoon period of adjustment.

Second, consider the opposite: imagine if the Fed allowed inflation to get away from them? If the cruelest tax were allowed to run rampant, the exact same critics would be all over Bernanke. That's why the Fed tends to overtighten: Its the lesser of two evils.

Soft landings are a matter of luck, not policy. Its why they are so rare

Even Paul Volcker, the cigar chomping Fed chair who brought runaway inflation to heel in the late 1970s and 80s, noted that Bernanke faces a tougher task than he did. That's a hell of an admission from a man I perceive as the greatest inflation fighting Fed Chair in history. He not only took away the punch bowl, but bitch-slapped the high priced escorts at the party and kicked the drunks out into the street onto their asses.

Now that's what I call an inflation fighter.

But if you want to understand the true problem facing Bernanke, its the liquidity problem. Greenspan treated every issue as if the only possible repsonse was to increase liquidity. Thats like a dentist giving a kid candy every time they complained of a toothe ache.

Have a look at this liquidity chart for a better understanding of how weer got into the present situation:

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Liquidity Driven Banking Policy 
click for larger chart

Source:  Ritholtz Research & Analytics

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Makes the picture a whole lot clearer . . .

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UPDATE July 19, 2006 11:42pm

The request goes up for what this looks in actual U.S. money supply growth;

 

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Money Supply 1900-2000
clik for larger graph

Thanks to Smithers & Co. for the graphic

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Note the surge from 1995 to 2005 -- that's Greenspan territory . . .

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Sources:
Bernanke: The wimp or the ogre?
Can the Fed chairman keep the inflation-wary bond market and rate-conscious lawmakers satisfied?
Reuters, July 16 2006: 10:11 PM EDT
http://money.cnn.com/2006/07/16/news/economy/fed_bernanke.reut/index.htm

Volcker Says Bernanke Faces Tougher Task Than When He Ran Fed
Matthew Benjamin
Bloomberg, July 14, 2006
http://www.bloomberg.com/apps/news?pid=20601103&sid=alVyNBz4VsvM

Wednesday, July 19, 2006 | 09:40 AM | Permalink | Comments (48) | TrackBack (3)
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Comments

Barry,

Granted all your points about Ben inheriting the problems but, in the same spirit of letting the data/analysis speak for themselves, what alternatives policy strategies would you have suggested for the potentially disruptive crisis facing Greenspan and the Fed ?

In each of those case the Fed didn't create the underlying problem but had to deal with the conquences. For example post the 2000 crash there's a very good argument in economic history that we faced a major economic retrenchment, ala Depression. Or at best a lost decade ala Japan.

While on the upside inflation has terrible consequences (btw - if you want the full diagnosis up & down Keynes, "Essays in Persuasion" are brilliant reading. Worth it for the discussions of currency speculation alone.)

The Fed cannot change the structural characteristics and trends of the underlying economy - it can only try to manage them in reasonable bounds around the trend.

Posted by: DBLWYO | Jul 19, 2006 10:04:45 AM

The interest-rate mechanism currently used to control domestic inflation of a reserve currency is wrong-headed. If the Federal Reserve decides that there is too much dollar liquidity in the world, it can directly absorb it in a number of ways other than the indirect mechanism of managing interest rates. Using more direct methods, such as buying or selling bonds, while targeting the aforementioned market-based prices, would have the desired effect on both domestic inflation and exchange rates, while also diminishing market volatility.

In contrast, the indirect impact of raising interest rates is twofold: It reduces the supply of dollar liquidity, but at the same time diminishes the global demand for dollar liquidity. The paradoxical effect may be higher domestic inflation if the global demand for dollar liquidity drops. If this happens, gold will rise and the dollar will go down, effects that may then show up in higher measured price indices. Misguided by its focus on price indices, the Fed may raise rates again — with similar consequences.

http://article.nationalreview.com/?q=NjNiN2MwOGU4ODM0MmViMGQ4OTA5MWZjOGU0ODE1YzM=

Posted by: jrg | Jul 19, 2006 10:05:41 AM

Barry,

Unlikely as it may be, if the market were to hold up and simply meander into years end, would you reign in your market low price targets or merely push out the target time frames?

Posted by: Michael C. | Jul 19, 2006 10:38:44 AM

The question is, even though he learned not to leak to Mario Bartiromo, is he still whispering to the heads of major banks the day before we all get the news? It sure seems like it...

Posted by: Bob A | Jul 19, 2006 11:02:15 AM

love how everyone takes shots at Greenspan and Bernanke ....... yet , no one has an alternative for any policy move .... i remember how Volcker was vilified , yet without his targeting Money Supply the economy never would've righted itself ..... I guess this is Routine 11 ..... everyone's a critic

Posted by: Marrinner Eccles | Jul 19, 2006 11:18:53 AM

That Cramer over on RM is a real hoot.

Yesterday mid-day he was saying this..."Remember, the only cavalry is the oversold. We aren't there yet. But if this pace keeps up we will be there by Monday for certain." Ohhhh...ok. So it will be Monday when we are oversold. Gotcha.

Today, less than a half day later he says..."But none of those really triggered this [rally]. What triggered it is that every indicator of selling pressure says it just got too hard."

Ohhhh...ok. Anyone who follows this chap around will eventually go bald pulling out their own hair.

Posted by: Michael C. | Jul 19, 2006 11:26:48 AM

Cramer? You can get better information at the monkey house at the zoo.

Posted by: Bob A | Jul 19, 2006 11:31:42 AM

more ideas about what the Fed should be doing re monetary policy - instead of changing interest rates:
"Again, the Fed must abandon its interest-rate targeting. Time is of the essence. This time the Fed should apply tried and proven classical principles by targeting a value for the dollar as reflected by a price for gold. The Fed can reach the target by selling its Treasury bonds to remove dollars from the economy.

The target price should be between $375 and $450 an ounce, which would cause the least price displacement in the economies of the United States and the rest of the world. The precise gold-price target is not as important as the dollar's stability. Lack of a floor under the dollar is what dropped the floor from under stock and bond prices during the stock-market crash of 1987. "

http://www.atimes.com/atimes/Global_Economy/HF21Dj02.html

Posted by: jrg | Jul 19, 2006 11:37:57 AM

After watching some of the testimony I can't help but think that Bunning is a complete fool. He clearly is more interested in propping up asset prices in order to make the "common man" feel more happy-go-lucky about the economy, which translates into votes. This is a cruel bribe in my opinion as most here agree that if the Fed stopped at 4.5% we'd have a hell of a lot more trouble and pain in our future. Attributing market action solely to Bernanke and the FOMC's actions discounts the plethora of other factors influencing markets.

Sarbanes waxing on about OER concerns, as suggested by home builders' letters to the committee, is really humorous. If it's overstating inflation today, I wonder what it was doing 1-3 years ago?

Posted by: Tom D | Jul 19, 2006 11:56:07 AM

Bernanke has impressed me slightly more than I thought he would. I still don't think he is a real inflation fighter though, unfortunately.
The guys who buy and sell on his every word are the real donkeys if you ask me. The Bartiromo incident was bizarre, with an amazing reaction to an off the cuff remark.
Do we want the Fed to speak and if so do we want them to say what is really on their minds or not? Or do we want some kind of sugar coated crap that in reality gets us no where but makes everyone feel better?

Posted by: Si | Jul 19, 2006 11:59:13 AM

Si, I'm afraid the votes are in, and we've been heavily in favor of sugar coated crap for quite some time now.

Posted by: Whammer | Jul 19, 2006 12:01:03 PM

Pour some suger on me.

The FED is nothing more than a suger daddy that helps the rich trigger depressions every once inawhile to clean out the herd.

Posted by: Cherry | Jul 19, 2006 12:04:51 PM

Tom D,

Bunning is a retard. Your comment on such is the most accurate and penetrating analysis on this site today. How did he get on that committee?

Posted by: ML | Jul 19, 2006 12:25:07 PM

Yeah, nice one Tom.

Posted by: Si | Jul 19, 2006 12:48:34 PM

Actually that looks like a severe downtrend from 1989 to 1996 and below the long-run trend from 1990 to 2000. How does that establish Greenspan's Fed having provided excessive liquidity ? And how does that reflect Japanese monetary policies with contributed greatly ?

The post-2000 period is clear a blip above trend and if that avoided a major Depression I'm all for it. Look at the Depression periods.

Posted by: DBLWYO | Jul 19, 2006 12:50:50 PM

cue the Columbia U video!!

Posted by: DavidB | Jul 19, 2006 12:52:36 PM

2006 -> Bond Price Inflation

Posted by: sell_the_10_year | Jul 19, 2006 1:12:07 PM

Agree with Tom D. As a baseball player Jim Bunning was something but as a senator he has proven himself virtually useless although, apparently, he can still throw a bean ball; "not ready for prime time" indeed. Bunning came within a hair of losing his last election and Kentucky would have frankly been better off if he had.

If Bernanke can even come close to helping us get out of this credit bubble w/o a major smashup I'd say he'd earned his bones and then some.

Posted by: RW | Jul 19, 2006 1:37:43 PM

>>>Kudos to Cody and Rev
7/19/2006 1:51 PM EDT

I love a good market call as much as the next guy, and two comments yesterday stood out for their level headedness and prescience.<<<

IMHO, this is one of the things that encourages people to call tops and bottoms throughout.

The Rev and Cody made several mis-timed calls and trades during the bleeding but no one commented negatively. On this good call..."Kudos!"

Just sayin'...

Posted by: Michael C. | Jul 19, 2006 2:02:27 PM

So is it time to put some of my 401k cash into one of the reverse ETFs? When the market is up 200, it's a tempting buy. Someone talk me out of it, please.

Posted by: Rusty | Jul 19, 2006 2:02:52 PM

Talk you out of it? Can't you see a suckers rally when it comes son? Especially since Bernanke told half-truths and didn't even get into the juicy parts.

Posted by: Cherry | Jul 19, 2006 2:14:35 PM

Don't do it Rusty!! You're too young, er, too old to die....

Posted by: brion | Jul 19, 2006 2:17:58 PM

I would love some feedback!
If I understand this right, at some point if one ceases to increase liquidity, the result would have to be a general downturn in the economy. Granted it might hit certain segments more than others but lets keep this very broad and general for the moment and assume that many key segments will drop and that it will affect employment nos etc.

First question - Is that a valid assumption?

If it is a valid assumption, then is there a limit to sources of liquidity? As in, should we be able to tell when there is really no more chance of an increase in liquidity. If that is true, then we should be able to predict the market direction?? Maybe not short term but medium term??

Thanks

Posted by: ralph | Jul 19, 2006 2:20:20 PM

Back up the truck Cherry !!!
booyah !!!!!
ha

Posted by: JimC | Jul 19, 2006 2:38:40 PM

JRG: No offense, but please, no links to the National Review if you want to be taken seriously. Cato, I can handle in small doses, but a GOP house organ like Buckley's rag that repeatedly displays mendacity, intellectual dishonesty, and plain ignorance on the topic of economics...umm no.

Hey, how do you boys and girls like this BS rally? +220 on what? I believe I'll take those coal profits now.

Posted by: Alaskan Pete | Jul 19, 2006 3:20:50 PM

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