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Ambrose Evans-Pritchard: The troubling side of Ben Bernanke
By Ambrose Evans-Pritchard
The Telegraph, London
Tuesday, August 25, 2009
Ben Bernanke has proved himself a heroic firefighter, saving the world from a calamitous spiral into debt deflation by showering markets with liquidity.
A good thing too. He helped cause the raging fire of 2007-2009 in the first place. As a Princeton professor and then a junior Federal Reserve governor, Mr Bernanke was the intellectual architect of his predecessor Alan Greenspan's policies that so distorted global finance and pushed debt to historic extremes.
Indeed, Bernanke was picked to join the Fed because he provided academic cover for Greenspan's view that asset bubbles do not matter. Greenspan blamed credit excesses on Asia's "saving glut," arguing that reserve accumulation by export nations suppressed global bond yields. That let the Fed off the hook for its own role in driving the US savings rate to zero -- and consumption through the roof -- by holding interest rates below "Wicksell's Natural Rate."
It is this twin nature of Bernanke that raises nagging questions about his reappointment as chairman of the Fed. He has admitted errors: It was wrong to think the sub-prime crisis could be contained. But he has yet to acknowledge that his economic ideology is deeply flawed.
Bill White, former chief economist at the Bank for International Settlements, said the error of the central banking fraternity over past 20 years has been to cut real interest rates ever lower to keep the game going. This has lured the world into a debt trap. The effect is to keep drawing prosperity from the future -- until the future arrives.
"It does the job for a while but moves in interest rates have to be ever more violent to achieve the same effect," White says. "My worry is that we may have reached the point where the policy ceases to work altogether. These imbalances come back to haunt you, and that is where the world now is. People have been induced to bring forward purchases by taking on debt and there has been a massive expansion in corporate investment."
Economists call this critique "intertemporal misallocation". It is a favourite of the Austrian School. It plays almost no role in the "New Keynesian" thinking of Bernanke.
His reflex is to see any fall in demand as an outside shock to be corrected by extra stimulus. What he does not accept is that the adrenal glands of the economic system have been depleted by perpetual credit stimulus, giving the world a form of Addison's Disease.
Bernanke made his name studying the "credit channel" causes of depressions, chiefly drawing on the 1930s. He was quick to see the danger when the financial system had its heart attack on August 20, 2007, the day yields on three-month Treasuries collapsed on flight to safety.
He dusted off his manual for fighting slumps -- his 2002 speech, "Deflation: Making Sure It Doesn't Happen Here" -- and coolly embarked on monetary revolution. Rates were slashed to zero. The Fed stepped into to prop up the banks, commercial paper, mortgage securities, and finally Treasuries. Nothing like this had been tried before. Bernanke did so against fierce resistance from Fed hawks. Only a man so convinced of his mission could have pulled it off.
Given Bernanke's calmness under fire and his grasp of credit mechanics, it makes sense for President Barack Obama to give him a second term. We are not out of danger. The markets might have taken fright at a political appointee.
Yet Bernanke's certainty is troubling. The thrust of his academic writings is that the Depression was a "financial event" that could have been avoided if the Fed had flooded the economy with money (by bond purchases) to prevent a banking crash.
This theory -- half-Friedmanite -- has merit. The Fed made horrible mistakes. But it neglects other causes of the slump: industrial overcapacity created by the 1920s bubble, so like today.
It also led to the Greenspan doctrine that central banks can let stock market and housing booms run their course, stepping in to "clean up afterwards."
Bernanke spelled out the policy bluntly in his 2002 speech. "The US Government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost," he said.
The "no cost" flippancy grates now. Washington says the damage will lift the US federal debt by $9 trillion over the next decade, pushing the total towards 100 percent of GDP. In any case, the Fed cannot use this machinery so easily after all. Foreigners own 40 percent of US Treasury debt and have a partial veto on the policy. Overt attempts to "monetise" US debt will cause the policy to short-circuit. Investors will dump US bonds.
Bernanke's theoretical model is clearly wrong -- since he was blind-sided two years ago -- and must lead him into fresh error. The risk is that he will mismanage the Fed's "exit strategy" by tightening policy too soon on the false assumption that recovery is secure. He knows this was the Fed blunder of 1936-1937 but also seems to think he has basically licked our Great Recession of 2008-2009. Has he really?
As Mark Twain put it: "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so."
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