Why the Fed is Compelled to Lie to Congress
I had an interesting conversation yesterday about Ben Bernanke's testimony with a person upset over the obvious understatements, spin, and happy talk -- even as the Fed Chair quite soberly discussed the US slowdown.
If the Fed were to come clean about the present circumstances, it would cause a market panic. That's why we get this very gradual shift in assessments, all designed to be somewhat reassuring as it slowly feeds measured dollops of reality into the marketplace.
Yesterday's dovish congressional testimony from Bernanke (and in Vice Chair Don Kohn's speech the day prior) will be continued today. It is, as it has always been and always will be.
Why? Imagine if the Fed Chair told the unvarnished truth: The Dow would see a 1,000 point intra-day drop, and that won't help the Fed steer the ship.
Imagine if the Fed fessed up to what we know to be true, and what we suspect the future might bring:
Opening statement of the FOMC Chair, Senate Testimony
February 27, 2008:Senators, we find ourselves in a very challenging situation.
Following the dot com implosion, my predecessor at the Fed slashed rates to a generational low of 1%; the FOMC then kept rates at 1% for over a year.
While that re-inflated the economy, it also set off a shock wave of inflation unseen since the 1970s. Houses doubled in price, Oil is up 5 fold, food stuffs have tripled, and the dollar has collapsed. Gold is at multi-decade highs.
As always happens, these price increases in hard assets attracted speculators, and that made the situation -- especially in housing -- much more complex. Even worse, the housing speculation contributed to a debacle, while these other assets are actually accelerating in price.
Further, as was the political fashion, deregulation and a lack of interest in the oversight role of the banking system allowed an unprecedented expansion of credit, including to the least credit worthy consumers. Additionally, derivative selling -- at is heart, an unregulated form of insurance -- expanded from a few billion dollars to $46 trillion dollars.
The credit crunch is unprecedented, far worse than the S&L collapse and Long Term Capital Management -- combined.
All of these factors have combined to create our present situation. Inflation remains very elevated and worse, quite sticky. Growth continues to slide towards zero -- and possibly beyond.
Like many others, our forecasts in these areas have been wrong. We expected the slowing economy to moderate inflation, and so far, that has not happened. Demand for commodities from China and India is keeping prices elevated. The weakening dollar -- now at levels last seen in the 1960s -- is forcing all dollar denominated commodities higher. I don't necessarily believe in "Peak Oil," but the fact that the Saudis are one of the world's biggest investors in alternative energy research might tell you something.
The last time a slowing economy failed to moderate prices was the 1970s. Even as the economy slid into recession, we had major spikes in the prices of energy, food, clothing.
What is particularly worrisome to me is that as we have slashed interest rates 225 basis points, consumer loans -- mortgages and revolving credit -- have actually moved higher.
Gentleman, this is a major problem. And our internal, non-public projections forecast it is only going to get worse for the next 4 quarters . . .
Now you understand why the Fed fibs. If they told the full and unvarnished truth, it would be beyond fugly.
>
Sources:
Semiannual Monetary Policy Report
to the Congress by Chairman Ben S. Bernanke
Before the Committee on Financial Services, U.S. House of Representatives
Federal Reserve, February 27, 2008
http://www.federalreserve.gov/newsevents/testimony/bernanke20080227a.htm
The U.S. Economy and Monetary Policy
Vice Chairman Donald L. Kohn at the University of North Carolina at Wilmington, Cameron School of Business' Business Week Program, Wilmington, North Carolina
Federal Reserve, February 26, 2008
http://www.federalreserve.gov/newsevents/speech/kohn20080226a.htm
Thursday, February 28, 2008 | 07:32 AM | Permalink
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» BizLinks | 2.29.08 from Loren Steffy
Texas retail gasoline prices approach record high Dollar's Dive Deepens as Oil Soars ($) Why Surprises Still Lurk After Enron Renewable tax credits likely to run out, leaving investment at home hanging Why The Fed is Compelled to Lie... [Read More]
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Praise to the Onion for finally putting my second-favorite picture caption teaser on a t-shirt. Somehow my favorite just won't fit... *** Praise to Barry at The Big Picture for his explanation of why Bernanke must lie his ass off [Read More]
Tracked on Feb 29, 2008 5:18:19 PM
Comments
"And ye shall know the truth, and the truth shall make you free."
Posted by: Shane | Feb 28, 2008 7:48:43 AM
"... we carry an unprecedented burden of debt both public and private and our collaterals are devaluating fast (house and soon equities)..."
Posted by: Stop Loss | Feb 28, 2008 7:52:03 AM
Ditto all the pundits, (mostly self-interested company excutives), that CNBC has on...
Posted by: JustinTheSkeptic | Feb 28, 2008 7:55:38 AM
Why do you need the Fed when you have Roubini's congressional testimony (PDF warning).
Posted by: Walker | Feb 28, 2008 8:09:33 AM
You don't really mean that. If the Fed were to write such things, this blog would not need to exist. There goes the web site upgrade and the swimming pools full of green filthy cash. People come here for their daily dose of pessimism. You would have to become 'Barry the Happy Guy ' in order to differentiate yourself. That shoe doesn't fit.
Or maybe you would have to analyze whether or not is a coincidence that oil prices rose at the same time as the credit bubble. You know, using supply and demand theory.
Granted, oil is a terrible investment as a commodity at this moment. Why? If Speculators are actually driving demand and price at the margin, and if supply is artificially being held low by OPEC at the margin, and if demand at the consumer level is actually falling a tad, then oil prices at this moment are only the reflection of a world wide circle jerk.
Only an idiot would put huge money into contracts for a commodity that is being priced using substantially artificial supply and demand. It's one thing to use peak oil theory as a justification for supply constrictions. It's totally different if consumer demand is falling and OPEC is responding by openly stating that supply is being withheld.
Rising prices, in the form of speculative demand by idiotic oil traders, is the next bubble waiting to pop. All it will take is one cheater to bust the cartel for a few months.
Posted by: cinefoz | Feb 28, 2008 8:12:38 AM
Unless the Fed knows something about Govt. statistics that we don't, shouldn't the market be informing the Fed and not the other way around?
If the Fed is having to lie to the market then the market has become nothing more than a discarded totem marking the spot where free-market capitalism used to reside.
Posted by: PropAg | Feb 28, 2008 8:14:04 AM
And after the 1,000 point intra-day drop the market would close flat because the people who control the big money know all this already and they realize that the sky won't fall in the end.
Posted by: Vermont Trader.. | Feb 28, 2008 8:25:13 AM
I don't know why this is a surprise to anyone. I've read often here and elsewhere about behavior and perceptions and their effect on the market and the economy. Inflationary expectations are a feedback loop that increase inflation. Bernanke's utterances are part and parcel of the conundrum he faces. You can only really depend on his actions for information. I think you want the banker to be relatively calm and let folks like Walker (too bad he has resigned) try to talk some sense into the idiots spending money like drunken sailors.
Posted by: Gary | Feb 28, 2008 8:28:50 AM
I suspect Natural Gas is another idiot magnet at this time. It's abundant, easy to get, and cheap to recover. a $2 increase over a few weeks, to me, looks like newby gas investors are about to get an unexpected buzz cut.
Don't tell me there is a credit crunch. The dumb money has moved from real estate to oil and gas. By dumb, I mean these people are working at the sub half-wit level. Instead of taking candy from strangers as babies, they are buying energy contract from their new friends ... smiling commodity sales people who are just enthralled to hang on their every word and who promise to make them rich beyond avarice.
I suspect many of these idiots are just buying and selling contracts among themselves, thinking that the profits are real, and not an objective measure of stupid. I wonder if any are named Ponzi?
Posted by: cinefoz | Feb 28, 2008 8:30:19 AM
The problem comes when they start believing their own happy talk, and don't do what they should be doing - Working towards recovery. But since they're still stating they can prevent, they have to focus on prevention, rather than recovery. Not facing reality has its advantages, but so does facing it.
Posted by: Finblogger | Feb 28, 2008 8:34:52 AM
Lie? Who needs to lie when a member of congress thought Bernanke was Paulson. They are clueless, save Ron Paul. Some of the CONgress still believe we are on the Gold Standard. We always get the government we deserve.
Posted by: SPECTRE of Deflation | Feb 28, 2008 8:36:59 AM
It appears that bullshit has reached a permanent high plateau.
Posted by: Winston Munn | Feb 28, 2008 8:38:58 AM
Hi Barry, I do not disagree with a single word of your analysis. You do not however mention any political reasons for the market being proped up. In Greenspan's book he clearly expresses concern about social security, medicare and new populist programs. This combined with tax increases on the ultra wealthy and the lust for power is plenty of justification for the republicans and their supporters to manipulate the market.
Posted by: David Price | Feb 28, 2008 8:40:08 AM
cinefoz, you have it all wrong we come here to get our daily dose of reality. Just wait, my friend; would you like to lay a thousand on what the economy is going to look like a year from now? Your clueless.
Posted by: JustinTheSkeptic | Feb 28, 2008 9:12:35 AM
I don't see the inflation bit the same way. I think inflation IS their ultimate goal.
"We Americans have enjoyed the party while it lasted and now the time has come to deflate the debt and inflation is the way to go. To generate inflation where we want it, we had 2 choices. We could create it internally or we could simply let the dollar drop making imports more expensive and letting foreginers taking the hits on our debt.
We chose the second option for many reasons. Firstly, it would make it easier to blame foreigners for our wies and increase protectionist policies. Secondly, it would make our exports more attractive and that would stimulate many of our exporting industries. Thirdly, it would slow down imports but that doesn't really matter anymore because US households are maxed out.
And lastly, when we say we are keeping our eyes wide open for inflation, we really mean hyperinflation."
Posted by: D. | Feb 28, 2008 9:13:46 AM
Rutters
Washington D.C.
Feb 28, 2008
In order to address a slumping consumer sentiment rating, Congress today passed legislation to mail 300,000,000 copies of Bobby McFerrin's "Don't Worry - Be Happy" in CD format to every U.S. household, along with a yellow stick-on smiley face.
Heated debate raged between the Republicans, who supported using Alfred E. Newman and his famous slogan, "What, me worry?", and Democrats, who supported McFerrin. In the end, a compromise was reached to add smiley faces to the McFerrin song.
President Bush is expected to sign the new bill.
Posted by: Winston Munn | Feb 28, 2008 9:18:18 AM
I forgot an important part:
The reason why we, the Fed, chose option 2 is because Government will do a great job at creating inflation internally.
Posted by: D. | Feb 28, 2008 9:18:27 AM
"at is hearty, an unregulated form of insurance"...hearty?
Arrrggghhhh that's pirate talk!!! Pirate Ben! Captain Ben?
*frantically looking for spot to post picture of Captain Jack Blacknanke*
Posted by: viamede | Feb 28, 2008 9:18:31 AM
so basically the economy asks the fed if it is fat. afraid the economy will get depressed and eat more, the fed says no.
Posted by: tim | Feb 28, 2008 9:21:05 AM
PTC: preaching to the choir here.
we all know it--but if you say it in public, you get treated like Peter Schiff. While is style is suspect, his message was and has been right on. Not only bad for economy to say it, bad for business and if you are negative you get dissed.
Ben Stein and others say outrageous things and get away with it. How many guests are perma bulls and thats ok, but even being a temp bear makes you a whacko, forget being a LT bear (vs perma bear).
The people do not want to hear bad news and they get what they want. The minority, who put in the effort to understand IT, gets it.
Posted by: Hal | Feb 28, 2008 9:23:42 AM
The economy is a secondary concern for the Fed at this point. The immediate problem is the banking system, which is dancing with insolvency due to all of the mortgage-related junk on bank balance sheets.
You guys can talk about inflation and the economy til you're blue in the face, it isn't going to change the Fed's perspective or actions one iota. They are dealing with a crisis that has far worse implications for the economy than monetary policy.
Posted by: E | Feb 28, 2008 9:32:52 AM
cine . . .
actually your dumb investors are the smart ones . . . wait till regular J6P start putting commodity funds in their stock portfolios.
You're just pissed off b/c the lower interest rates of the fed won't take the stock market up to 13000. All that excess money is going to commodities. As they say don't fight the fed. Ride the commodities bull!
Posted by: Shane | Feb 28, 2008 9:36:09 AM
Karl K,
Your assertion that Fed's reckless rate cutting (and pumping money growth in the process) and central banks in general have nothing to do with commodity inflation is only partially correct. Some of it was demand related. However, look at commodities after the Fed started easing and tell me that the 30%+ rise in the CRB, for example happening starting in August, 07 was just coincidental. Fed is easing and the money created is not going into the real economy (or stocks) yet. They are creating commodity inflation and lots of it.
Posted by: zao | Feb 28, 2008 9:44:27 AM
David Price,
How is it that those who tear-down social programs as being a drag on the economy and the country - typically preaching the mantra of 'personal responsibility', never look to the other side of the equation?
There used to be a conservative concept known as husbandry (there also used to be a quaint and admirable traits called 'patriotism' and 'selflessness' - but I'll leave those for another post). Husbandry is something that farmers (a very conservative, yet not obscenely wealthy, group of people) understand well, because if they don't, they starve.
Without husbandry, yields go down, resources are depleted, and eventually, core assets lose all of their ability to produce income.
Husbandry is what stops farmers from killing the milk cow because they'd rather have a steak tonight than cream for their coffee and milk for their cereal for the foreseeable future.
The huge and growing disparity between the highest and next-highest (and lower) income brackets is an indicator of the state of husbandry of the economy by business nowadays.
Social security, medicare and new populist programs are examples of society's previous and current attempts to guarantee that the economy - as well as the populace - will be properly husbanded (and, in being so treated, will continue to serve a mutually beneficial function in a healthy enterprise).
The conservative notion of the husbandry of one's own economic system has been replaced by the ultra-liberal notion of entitlement to wealth, even if obtaining that wealth means destroying the underlying system. The rich don't want to pay taxes? High taxes will look like a good value when the working class (the cow) is no longer there to provide the cream they (the 'conservative' business class) took for granted.
The 'free market' crowd and those believing that 'the market' is inherently more competent than the government have foolishly thrown the concept of husbandry onto the rubbish heap as so much bunk. (it didn't help that the cow was such a willing participant in its own demise - but I guess that's the nature of cows).
We are paying the price for that foolishness.
Nice barn.
Where's your cow?
Posted by: Marcus Aurelius | Feb 28, 2008 9:46:03 AM
OT:
Check out the short squeeze action in NFLX....
I am.....;-)
Ciao
MS
Posted by: michael schumcaher | Feb 28, 2008 9:52:47 AM
