Thursday, November 4, 2010

What Bernanke Doesn't Understand

The United States Constitution was designed to create a government of checks and balances. Even during the Civil War, Lincoln could not ignore the powers vested on Congress and the Supreme Court. Which is why it is at least curious that we have come to vest quasi-dictatorial powers in the office of the chairman of the Federal Reserve.

Like his predecessor, Bernanke seems to be able to ad-lib extreme and profound policy initiatives with the sole backing of his "I know better" reserved for the most powerful dictators in History. Dictators, by the way, the American system has worked hard to avoid. Even Roosevelt in the midst of the Great Depression, had to deliberate, negotiate and even back down before the Supreme Court. Since the Federal Reserve was not contemplated in the Constitution, there is no mechanism to keep them in check, force them to debate, and even reconsider their actions. The confirmation process, as we have seen, is opaque enough to be out of the reach of most Americans. Yet, this individual (the other members just seem to go along for the ride) wields more economic power than the President of the United States.

As the Greeks described long ago, efficiency is the main advantage of a good dictator. The main disadvantage is that is hard to tell the dictator when he is wrong. For all the trust we seem to place in his wisdom, Bernanke has shown in the past not only a dangerous lack of understanding of the complex global financial system (see "The sub-prime crisis is small and well contained," or "American financial institutions are strong and well capitalized," among others), but also a willful disregard for the consequences of his actions. After all, is there anyone on this planet who still disputes that the Greenspan policies created the housing bubble? The most dangerous leader is the one who does not seem to acknowledge the past and learn from his mistakes.

Unfortunately, for us, Bernanke is a prisoner of his academic record. As most know, the studied the Great Depression and the Japanese debacle long ago. Back then, he decided what the problem was and what the solution should have been. As far as he is concerned, Japan could have avoided the two lost decades after their real estate bubble burst by throwing money from a helicopter. Never mind what History says about the aftermath of bubbles, or how high the relative value of Japanese land was in 1990, or the effects of an older population in a country without immigration, or any of the dozens of factors that have influenced the Japanese economy. Bernanke wrote a paper saying the monetary-hammer was the tool and, to him, every crisis looks like a monetary-nail.

Today, our esteemed professor has and OpEd in the Washington Post explaining HIS decision from yesterday. If you want to save time allow me to paraphrase, "core-inflation is too low, unemployment is too high and I do not know what else to do." That's it.

Sure, there is some academic language about lower rates encouraging consumption and investment which is dutifully parroted by our media, but who are we kidding? Does anyone really think that driving the 10 year bond from 2.80% to 2.50% will spur even one project? Would you buy your neighbor's house as an investment just because mortgage rates go from 4% to 3.5%? Would you buy it if the rate was zero?

As anyone following our economy knows, companies and individuals have been borrowing money at record low rates for a while. Those who haven't probably cannot because of lack of income, collateral or future earning streams, not because rates are too high.

What Bernanke conveniently ignores are the risks of his policies. No, I am not talking about hyperinflation, the destruction of the US dollar or other medium to long term calamities that may indeed result from his actions. My contention is that we are creating obvious problems right here and now.

Like Greenspan, Bernanke has very particular views about inflation. Not only does he choose to ignore important service components like health care which are underrepresented in the indices, but he explicitly ignores food and energy, two of the three most important items in a poor family's budget (the third being housing). Not only is much of our oil imported, but all commodities, even if locally produced are priced in dollars in the global market. In addition, for the past 10 years or so, commodities have become an active asset class for global investors/speculators. If QE results in a lower dollar, we will in all likelihood see higher commodity prices. Yet Bernanke will insist that there is no inflation, which will encourage even more speculative flows into commodities creating vicious circle that will heavily impact on the American poor. Talk about helping the little guy.

A policy of lower rates in a deleveraging economy neither spurs growth nor encourages employment. Hard as it is for Bernanke to understand, context matters and influences the economy's sensitivity to interest rates. Lower rates, instead, are nothing but a subsidy to those willing to take on leverage (banks and speculators) from those owning the capital (savers and retirees). As we know, money is fungible. Thus, the is no reason why the banks and speculators will all of a sudden rediscover productive projects at home because rates are 0.50% lower. Instead, they will continue to pump money into commodities, projects abroad and maybe stocks. Unless you own some of these, I fail to see how that benefits the average American.

I suppose it is what we can expect for forgetting the principles that made this country great and bestowing to much unchecked power in one individual, even one with a PhD.