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Feature
Not-So-Gentle-Ben
Obama’s risky Bernanke gamble.
Last December in these pages we concluded that George W. Bush’s economic legacy will be remembered in history as a failure, in no small part because of the collapse of the dollar and the tripling in gold prices over the course of his presidency. We wish that Barack Obama had paid attention to that column because by reappointing Ben Bernanke as Fed chairman, he has endorsed one of the two people in Washington who were architects of that Bush weak dollar policy (with Alan Greenspan being the other). So much for change you can believe in.
Mr. Bernanke fashions himself as the man who last fall saved America from another Great Depression and “saved capitalism” by helping design the bailouts, stimulus plans, and the gigantic surge in the money supply to try to flood the economy with liquidity and consumer spending power. The Washington tale being repeated like a mantra is that things would have been so much worse without the Bernanke monetary stimulus on steroids. It is hard to see how this “savior” tag can be accurate, given that the unemployment rate in the United States has doubled on his watch, with 7.5 million more Americans now without jobs, and the combined debt of the Fed and the federal government has leapt upward by at least $3 trillion over the past 18 months.
One key measure of the Fed’s performance is how the financial markets perform during a chairman’s tenure. Using this barometer, Bernanke has been an unquestionable failure. After all, the great crash that began in earnest in September 2008 and liquidated $11 trillion of wealth happened on Bernanke’s watch. This was a classic credit bubble over-inflated by an overly easy money policy that the Fed began around 2003 under Mr. Greenspan and dutifully continued without reservation under Bernanke. During 2003–2007, when the federal funds rate was held at a preposterously low 1 percent, inflation ran at roughly 3 percent, meaning that the Fed was subsidizing banks to make loans—essentially paying them to do so. We now know that this flood of money went into mortgages that never should have been made and catastrophically overinflated the housing bubble. The Wall Street Journal editorial page had been warning of this for month after month but was regarded as the skunk at the housewarming party.
The dollar has been in a steady state of decline during the Bernanke tenure as well. The flood of money, combined with Obama’s trillion-dollar deficits, has moved America away from the Reagan-Volcker-Greenspan-Clinton maxim of keeping the dollar “as good as gold.”
We are told that Mr. Bernanke is a student of the Depression and knows how to steer us clear of the mistakes of the late 1920s and the 1930s. But it was FDR’s strategy circa 1934 to devalue the greenback versus gold. The price of gold rose from $20.67 an ounce to $35 an ounce in that year. So even as the unemployment rate ranged from 14 to 20 percent, the inflation rate came in at 7 percent—a double dose of economic cyanide.
Which brings us to our central complaint about Mr. Bernanke’s monetary philosophy. He is a true believer in the idea of the Phillips Curve—i.e., that there is an inverse relationship between unemployment and inflation. When one goes up, the other comes down. It’s an idea that gained currency in the 1960s and then wrecked the economy in the 1970s when it helped generate the great inflation. In a famous 1980 column for Newsweek, Paul Samuelson, Nobel laureate and author of the Economics 101 textbook that taught a generation of students about, well, economics, observed that to reduce the 1970s inflation we would need “five to 10 years of austerity, in which the unemployment rate rises toward an 8 to 9 percent average and real output inches upward at barely 1 or 2 percent per year.”
To Samuelson and most establishment economists of that bygone era, economic growth was the cause of inflation. This lunacy was accepted by almost all economists, except, thank God, for one who earned his degree at Eureka College. Reaganomics buried for good the faulty Phillips Curve—one would have thought. After all, from 1983 to 2000 the U.S. economy grew more or less without interruption (a minor recession in the early ’90s the exception), with falling inflation the rule. Gold is arguably the best indicator of inflationary pressures, and after hitting a high of $875 in 1980, by 2000 an ounce of the yellow metal was trading in the $300 range. As economist Arthur Laffer has explained it a thousand times: when an economy produces more apples, the price of apples falls, it doesn’t rise. Mr. Laffer has history on his side. Since 1950 inflation and unemployment rates have generally moved in tandem, not in opposite directions. Growth is anti-inflationary, but Bernanke seems not to believe this.
In a July 2005 op-ed for the Wall Street Journal just a few months prior to his Fed nomination, Bernanke asserted that there is a “highest level of employment that can be sustained without creating inflationary pressure.” And more recently, in another piece for the Journal, Bernanke reaffirmed his Phillips Curve bona fides with his suggestion that once “recovery takes hold,” there could be “an inflation problem down the road.” This is right out of the Samuelson 1970s textbook. Yikes.
It gets worse. When the economy was flat on its back in the first half of this year, the Bernanke Fed opined that economic weakness will tame any pricing pressures. In Bernanke’s model, unused labor and capacity is inflation’s cure in much the same way Samuelson felt economic sluggishness would break inflation’s back nearly 30 years ago.
As the Washington Post’s Annys Shin has described it, economists at the Fed feel that “a tepid recovery will keep inflation in check.” Further evidence of the Fed’s thinking comes from a recent press release from the Fed’s Federal Open Market Committee, which noted that due to “increasing economic slack here and abroad, the Committee expects that inflation will remain subdued.”
The problem with the Fed’s thinking is that just as strong economic growth cannot cause inflation, flagging economic health can in no way cause deflation. Putting people out of work reduces demand, true, but it also reduces supply, which works to increase prices.
A related myth the Bernanke Fed has embraced is that savings are bad and that consumption is good for the economy. Saving in no way detracts from demand. Money saved is merely lent out to others, some with near-term demands. If a household increases its savings, that money then becomes a pool of capital available for businesses to borrow to build factories, hire more workers, invest in computers—all of which are forms of “demand.” Savings help reduce the price of borrowing and are a solution to the credit freeze, not a contributor to it.
Mr. Bernanke seems to believe that money creation is the long-term solution to all economic problems. And while printing money may sound good in theory, it’s easy to see why what Bernanke presumed as a cure may wind up being quite hazardous. Money is not wealth, but a lubricant that enables the exchange of wealth. And just as a car engine can be ruined by being flooded with oil, so can an economy suffer from having too much money pumped into it. Bernanke essentially put the cart before the horse in assuming that the printing of undefined money—and lots of it—would take the place of actual productivity.
Sound money types have correctly blanched at all the unwarranted money creation, and have pointedly asked Bernanke how he intends to remove all the dollars that his Fed pumped into the system. In testimony and in print, Bernanke has said that he can reduce the quantity of money now in U.S. banks through interest paid on dollars returned to the Fed.
No doubt this would in the near-term reduce money quantities in our banks, but only in the near-term. That is so because the dollar is the world’s currency. For evidence we need only remind ourselves that two-thirds of all dollars are overseas. If and when dollar shortages reveal themselves stateside, the shortfall is made up with inflows of dollars from foreign locales.
About the Author
Stephen Moore is a member of the Wall Street Journal editorial board.
Letter to the Editor View all comments (26) | Leave a comment
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Alan Brooks| 10.18.09 @ 9:39PM
We can rest assured that since no one ever goes broke under-estimating taste, the economy will do just fine.
Alan Brooks| 10.18.09 @ 11:10PM
'risky gamble' is redundant.
All gambles are risky.
Pingback| 10.29.09 @ 7:17AM
The American Spectator : Not-So-Gentle-Ben « Ring Gold links to this page. Here’s an excerpt:
Ryan| 10.29.09 @ 9:20AM
Several things that the article is right and wrong about:
1. Economists persist in leaving out one critical statement. It was NOT low interest rates that were the problem. It was low interest rates WITHOUT STANDARDS FOR LENDING. The matter KEEPS not being spoken about. If banks had actually lent the money to people who could afford to pay it back, we either wouldn't be in the current mess or it would be greatly abated. The low interest rates were a BOON to both individuals and businesses, but people got greedy on all sides.
2. Gold prices are NOT related to inflation, they are related to FEAR. People are running back to putting their faith in useless, pretty rocks because they're afraid of what may or may not happen. Yes, the dollar is getting far too undervalued (I'm not an opponent of a weak dollar from time to time - it's actually good for the economy occasionally - but it's getting too low with no near-term solution for strengthening it).
3. The article is right about saving. How many banks would be in decent positions today if there was less of a borrow-and-spend mentality? Not just that, how many wealthy people and businesses with offshore accounts would have that money back home if there were lower tax rates?
L. Ross| 10.29.09 @ 11:41AM
I have a small dispute with your first point, Ryan.
While I certainly agree that relaxed lending standards totally mucked up the housing market, keeping interest rates too low too long were at least as big a problem regarding housing. Couple this with very creative financing and no down payment requirements, and it quickly becomes obvious that the system is ripe for a meltdown.
Low interest rates and no down payment meant that peoples ability to purchase more expensive housing increased dramatically, therefore the price of housing increased dramatically. The value of the house (lot price, materials, labor, permits) didn't increase any, just the price.
Ryan| 10.29.09 @ 11:53AM
That was EXACTLY the point that I made. It was the lending STANDARDS that were at fault, not the lending rates. Banks and other lending institutions did not show the proper restraint.
Of course, some blame can be thrown at the CRA and Freddie and Fannie as well, as they made the path clear for lowering standards.
Todd| 10.29.09 @ 3:58PM
So you think having prolonged lending rates from the Fed well under the rate of inflation is okay? It is all interrelated Ryan, all part of the recklessness that comes with easy money in an foolish attempt to "stimulate" the market. The hangover after the party if you will.
Ryan| 10.29.09 @ 4:55PM
Letting the rate float would probably be better. That being said, it WAS probably a mistake to let it go so long, but it's hard to tell what would have happened had lending standards not been so loose. It doesn't come back to the rate itself, but to the standards attached to those rates. Everything is so interconnected, that it's well-nigh impossible to predict anything when everything is coming up roses.
We don't know what it would have caused, but we DO know that the core problem was people borrowing too much money. It doesn't matter what the rate is - when people and businesses can't repay en masse, it's a problem.
Another problem was the market continually thinking in terms of short-term growth rather than long-term maintenance.
JohnD| 10.29.09 @ 9:28AM
The new 3rd Quarter GDP data was released today, and they are being touted as showing growth. Yes, 3.5% growth quarter to quarter, however, 3rd Real GDP Q 2009 is down 2.3% year to year (from 3rd Q 2008).
However, if you look behind the numbers, the “good news” on GDP is being fueled largely by a weak dollar and unsustainable deficit spending by the U.S. Government: Some highlights:
“Real personal consumption expenditures increased 3.4 percent in the third quarter. . . The third-quarter increase largely reflected motor vehicle purchases under the Consumer Assistance to Recycle and Save Act of 2009 (popularly called, “Cash for Clunkers” Program).”
“Real exports of goods and services increased 14.7 percent in the third quarter” (Reflection of the weak dollar)
“Real federal government consumption expenditures and gross investment increased 7.9 percent” ($1.4 trillion FY 2009 deficit)
Bad news for consumers:
“Current-dollar personal income decreased $15.5 billion (0.5 percent) in the third quarter”
“Personal current taxes increased $4.8 billion in the third quarter”
“Disposable personal income decreased $20.4 billion (0.7 percent)”
Bob Miller| 10.29.09 @ 11:13AM
Above all, Bernanke has to outmaneuver George Soros and his associates and facilitators. One of the latter is the President.
A Fan| 10.29.09 @ 12:04PM
Too much money can no doubt be a prolem. Just look at the 0-1 Yankees. Go Phillies!
Lullaby's, Legends and Lies| 10.30.09 @ 2:38AM
It's tied up now "Fan" at 1-1. Let's Go Yankees!!
LiveFreeOrDie| 10.29.09 @ 3:55PM
END THE FED
Pingback| 10.30.09 @ 10:34PM
massage birmingham | Massage Beauty Wisdom links to this page. Here’s an excerpt:
Jake Peachey| 10.30.09 @ 11:37PM
"Money is not wealth, but a lubricant that enables the exchange of wealth."
First let's get some definitions straight so we don't talk past each other:
Value is an attribute that exists only in the imagination of the mind.
Assets are things to which participants in the marketplace ascribe value when trading.
Wealth is the term used for the accumulation and quantity of assets.
In the real world practice of modern economy, money is actually the premier asset. When there is a bankruptcy, everybody with a stake in it wants the money ----not the real assets of tangibility except for the purpose of converting it to money. Even the burglar recognizes money as the premium asset. If he takes things of high-value, it is for the purpose of converting them to money at the risk of disposing them. Try making transactions with gold at Wal-Mart or sending gold by wire for a global current transaction.
Value (which exists only in the imagination of the mind) defines assets. Assets do not defined value because science has yet to discover properties peculiar to value in tangible things, and you can't qualify value because of which assets it is ascribed to. It just is what it is.
The fools gold for practitioners of economic thought has been pursuit of an objective base for economics in emulation of the hard sciences. Habits of thought as taught by our educational system, in emulation of the hard sciences become fixed parameters. This pursuit of "objectivity" installs limiting barriers of thought that causes severe reductionism and simplification of the chaotic open system nature of human behavior and relationships, which includes economics.
There is nothing objective about the perception of value that exists only in the imagination of the mind. It is only upon this unstable, slippery, bottomless swamp of value can the enquery of economics be built. No matter how deep you dig in this swamp of value you never come to a solid bedrock to build an objective theoretical structure. Economic theorist will then invent an objective base.
Judy Shelton in a WSJ opinion had this revelatory axiom, "and gold is real money." That was her way of saying certain assets have inherent value ----the objective starting point for her theory of finance.
And then the pursuit of objectivity with complex statistical models from historical data. However, statistical correlations are always in a state of change because perception of value is forever in a state of flux --- which is handy because you can find a correlation for every argument you want to make. There are a few successful traders using the quantitive approach, but that's only because there are always alert to changes of value correlations and quickly make changes. They recognize the short life of a working correlation. The debacle of Long Term Capital and the recent instruments of debt derivatives (risk defined by historical data) epitomizes the problem.
The real test of validity with the objective/quantitative approach is not how well you can argue with them, but whether you can make money with such objective models. If you can't--- your theory doesn't relate to the real world.
Toronto | 3.12.10 @ 1:07AM
Ben seems to be playing it safe.
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