by Doug Noland at The Credit Bubble Bulletin
Dr. Bernanke has referred to understanding the forces behind the Great Depression as the “Holy Grail of Economics.” I believe understanding the ongoing Bubble period offers the best opportunity to discover the “Grail.” When the Washington establishment believed THE Bubble had burst back in 2000/2001, the leading academic espousing inflationism was beckoned to Washington to provide cover for the Fed’s experimental post-tech Bubble reflationary measures. He first served as a member of the Board of Governors of the Federal Reserve System (2002), before being appointed chairman of the President’s Council of Economic Advisors (2005). From the day Ben Bernanke burst onto the scene in 2002, I’ve taken strong exception with his economic doctrine and analysis.
I have yet to read his new memoir. However, I listened attentively this week as he blanketed the airwaves. As I’ve done on occasion for going on 13 years now, I highlight some of Bernanke's thinking (and provide brief comments).
CNBC’s Steve Liesman: “His new book, ‘The Courage to Act – A memoir of a Crisis and Its Aftermath,’ details what he calls ‘the darkest days of the financial crisis when’ he quote ‘stared into the abyss and the behind the scenes struggle to enact innovative policies that he believed saved the economy’… Are you surprised and are you disappointed that after six years of zero percent interest rates – a four and one-half trillion dollar balance sheet – that this economy still struggles with 2% growth?”
Bernanke: “The low growth is coming not from the recession, per se. We’ve come back quite a bit. Unemployment is down to 5%. So we’ve come pretty close to full employment. The slow growth is coming from slow productivity growth. Output per worker has not been growing quickly, and why that’s happening is not totally understood. I don’t think it has much to do with monetary policy. It has to do with the waves of intervention. We saw slowing of productivity growth even before the crisis. So I think that’s part of it. But clearly one of the issues is that we’ve been relying too much on the Fed. The Fed has been the only game in town. It’s been doing most of the policy heavy lifting for the last few years. We need to see more action from other policymakers.”
(Noland: Experimental ultra-loose monetary policies and activist market intervention – along with attendant serial financial Bubbles – over the past twenty years have had a profound impact on the underlying economic structure. These Bubble periods have witnessed profound economic maladjustment that is certainly a major factor behind poor productivity and growth dynamics).
Liesman: “But when you think about six years of zero percent, wouldn’t you have expected that at some point in time that there would have been this pop – that we wouldn’t be doing what we did, for example, in the first quarter 0.6% growth, and concerns almost every quarter that we’re going back into recession.”
Bernanke: “Well, in a slow growth low real return economy – not just in the U.S. but everywhere. And compare the United States with Europe, compare us with Japan and other industrial countries – we’ve been making more progress. I’m not saying things are great. I don’t mean to say that at all. But monetary policy can only do basically two things: It can keep inflation low and stable and it can help the economy come back from recession. And both of those things are happening. More growth has got to come from productivity; it's got to come from capital investment. Those things need some help from other policymakers.”
(Noland: At this point, the entire global economy has been badly impaired by years of flawed monetary management, recurring boom and busts and unprecedented distortions and imbalances. Inflationary monetary policy can inflate asset prices and widen the divergence between inflated markets and deflating economic prospects. Moreover, inflationary monetary policies are especially destabilizing after an extended period where financial returns outperform real economy returns.)
CNBC’s Becky Quick: “Is that a suggestion that this is kind of the new normal. It’s going to be very difficult to fix this.”
Bernanke: “If you look around the world it’s not just the United States. Real interest rates are low everyplace. And we’ve got what I used to call ‘the global savings glut.’ There’s a lot of savings looking for return. There’s not that much in terms of really high return investments available. I think that’s not Fed policy. I think that’s just where the world is right now.”
CNBC’s Joe Kernen: “It could be QE over there too, though.”
Bernanke: “Well, if it were true – if there were lots of high return investments available then you’d be seeing more capital investment than you’re seeing. So I don’t think it can be QE, no.”
(Noland: Having argued against the “global savings glut” thesis throughout the mortgage finance Bubble period, its reemergence is beyond annoying. The paramount issue was never some mythological surplus of “savings,” but instead excessive expansion of Credit, “money” and leveraged speculation.)
Liesman: "So would you weigh in on what Stan Fischer spoke about just last Friday, which is this notion of - should monetary policy be used to create or to worry about financial instability, in the sense that you would raise rates now in order to ward off some of the excesses that Joe was talking about?”
Bernanke: “Well, it should be a last resort because you have to raise rates an awful lot, for example, to have the kinds of effects Joe was concerned about. And we don’t even know very much about what the linkages are. I mean, arguably, if the economy is really weak because you raised rates too soon that could cause financial problems as well. So the right thing to do first is do everything you can on the regulatory, supervisory, macroprudential front. And then, if nothing else works, then you can think about monetary policy. But it's really self-defeating to use the wrong monetary policy…”
(Noland: It’s the same failed asymmetrical policy approach – only much grander – that led to serious market Bubble distortions for more than 20 years now. The Fed slashed rates and added massive liquidity during the 2008/09 financial crisis. And during 2013 and 2014, the Fed added $1.6 TN of additional liquidity in a non-crisis backdrop. The Fed has gone so far as to assure the markets that it will “push back against a tightening of financial conditions” – i.e. a “risk off” market backdrop. On the other side of the equation, the Fed supposedly has macroprudential tools it is to employ to ward off financial excess that risks financial instability. Essentially, the markets fully anticipate the use of “whatever it takes” QE in the event of faltering markets. On the other hand, macroprudential to counter market excess has zero market credibility.)
Bernanke: “Well, you can't. You can't. But it wasn't - I think that misrepresents what we saw and what we didn't see. We knew house prices were really high. We knew that subprime mortgages were a problem. What we didn't see was the extent to which the financial system was endangered and driven into panic by that problem. Subprime mortgages were a relatively small asset class. But what happened was that they created distrust by investors in all different kinds of securitized assets - and caused a panic that caused money being drawn out of all different kinds of assets. And that panic is what really created the crisis. So it wasn't the fact we didn't know house prices were high. We knew house prices were high. But what was the problem was the weakness in the financial system itself. And there, the first line of defense has got to be more capital, tougher oversight. Those sorts of things to make the system more resilient to whatever shock comes along.”
(Noland: Subprime was definitely not the fundamental issue. Instead, mortgage finance Bubble excesses had seen almost a doubling of mortgage Credit in six years. Bubble distortions had created historic mispricing throughout the Credit market, certainly including Trillions of MBS, ABS, agency securities and corporate debt. A Credit boom had inflated asset prices, perceived wealth, spending, corporate profits and incomes. Over years the Bubble had become deeply systemic. Inevitable risk aversion and a tightening of financial conditions at the Periphery – subprime – unleashed contagion that would ensure a bursting of the Bubble at the Core (home to Trillions of mispriced securities and derivatives). Market panic, deleveraging and an abrupt collapse in Credit growth almost led to system collapse.)
Quick: “We had one market watcher who joined us earlier this morning, Mark Grant. And he suggested that the Fed should sell down or let run off some of its balance sheet - a trillion dollars. Let that run off before they raise interest rates. What do you think about an idea like that?”
Bernanke: “Well, Joe had an earlier comment about how are we going to get out of $4 trillion, that kind of thing. That's actually not a big issue. You know, when the time comes, the Fed is just going to let the balance sheet run off. And that's pretty straightforward. I don't think that's going to create any particular problems. But I think that the concern is that they have less knowledge about how that would work; how that would affect the markets than they do about how short term interest rates would. And so the plan - and the Fed has been very clear about this, is to begin by raising short-term interest rates, which they can absolutely do, even if the balance sheet is still $4 trillion. And then, if the economy is still making forward progress then they can stop reinvesting and the balance sheet will passively run off over time.”
(Noland: Shrinking the Fed’s balance sheet is a big issue. When the Fed articulated it’s so-called “exit strategy” back in 2011, I titled a CBB “No Exit.” The Fed’s balance sheet has more than doubled since 2011. I believe the odds that the Fed again doubles its holdings are significantly greater than those that it will shrink its balance sheet in half.)
Bloomberg’s David Westin: “Monetary policy versus regulatory functions for the Fed, and you talk – page 92 I know it is – you talk about the fact that monetary [policy] wasn’t really the approach that needed to be taken when it came to the bubble in mortgages. And you say in a 2002 speech, ‘financial regulation supervision should be the first line of defense against asset price bubbles and other risks to financial stability.’ Has that been corrected now? There was a regulatory fail, wasn’t there that led to this?”
Bernanke: “Yes, absolutely.” …“So I think the critique of the Fed prior to the crisis – I think a lot of it was focused on monetary policy. People who have looked at it carefully, generally agree that monetary policy was not the main reason for the housing bubble. But one way the Fed was responsible was with other regulators that didn’t do enough to prevent the bad mortgage lending. And there’s a lot of reasons for that. One reasons was that there was this very strong political support for subprime lending because it was creating home ownership so broadly. So I thought that was the main…”
(Noland: I have “looked at it” quite carefully. Monetary policy was indeed the main reason for the mortgage finance Bubble. There is no way mortgage Credit – especially risky loans – would have continued expanding rapidly for years had the marketplace not been convinced that the Fed would aggressively backstop marketplace liquidity and ensure there were no financial crises or severe recessions. The Greenspan/Bernanke puts were instrumental in what became essentially insatiable market appetite for high-yielding MBS, ABS, CDOs and other derivatives.)
Fox’s Maria Bartiromo: “What do you say to those critics now, so many years later who everybody now can judge you, and they judged you from the moment we sort of got to dry land, what do you say to them who say, ‘look, we shouldn’t be bailing out anybody, you guys bailed out everybody, and that’s not the way the Constitution should go, that’s not democracy – that’s not Capitalism?’”
Ben Bernanke: “Well sure. Somebody once said that 'Capitalism without bankruptcy is like Christianity without hell,' basically. You need to have market discipline and all that. But in the middle of the most intense financial crisis in the history of the United States – maybe the history of the world – we had to do whatever we could to keep the system from falling apart. And that’s what we did. And, if anything, the effects of the financial panic on the U.S. economy were even bigger than I thought. And I was very much concerned about that. Now, once the crisis was over, absolutely, everything we could do to make sure it didn’t happen again. To make sure banks are sufficiently well capitalized. That they’re not going to be too big to fail. All those things are really important. But in the middle of a crisis you can’t do that.”
(Noland: I argued at the time of the crisis that, of course, policymakers would not allow the system to collapse. But I also warned against actions that carried a serious risk of inflating an especially dangerous Bubble at the heart of “money” and Credit. By no later than 2011, the Fed needed to have taken steps to nudge the financial markets back in the realm of “market discipline and all that.” Rather, it did the exact opposite. Pushing experimental central banking to “open-ended” QE in 2012 was a monumental mistake. Further delaying “normalization” and telegraphing a willingness to “push back against a tightening of financial conditions” in 2013 only compounded the error. Bank capital is not at this point a leading issue – not with tens of Trillions of securities mispriced these days on a global basis.)
Fox’s Greta Van Susteren: “Was this a fun job being chairman of the Federal Reserve?”
Bernanke: “Well, it was an interesting job, that’s for sure. As an economist, I sure learned a lot. But I didn’t really bargain for having history’s greatest financial crisis and deep recession to deal with. No.”
(Noland: “History’s greatest financial crisis” is a stretch – expedient used to rationalize what I believe history will eventually judge as disastrous inflationary policies. Besides, he should have been prepared. Dr. Bernanke, after all, was the Fed governor espousing “helicopter money” and the “government printing press.” The proponent of such radical monetary management should have been on guard for what evolved into relatively conspicuous financial and economic excess. The crisis was predictable.)
Van Susteren “Were there nights in 2008 where you couldn’t even sleep? Were we on the cliff?”
Bernanke: “Absolutely. We are on the cliff and I was in my office on that red sofa trying to stay awake and be on the conference calls. It was a very, very tough time. Particularly in about September and October of 2008.”
The Wall Street Journal’s Jon Hilsenrath: “I want to talk to you a little bit about inflation. You’ve said before, all the way back to your earlier writings on Japan, that a central bank can create inflation if it has the will to do so. Inflation in the United States has been running below the Fed’s 2% target for more than three years now. How do you explain that and has the Fed not done enough to create the inflation that it’s supposed to create?”
Bernanke: “Well, a more accurate statement about creating inflation would be that ‘so long as fiscal policy is at least reasonably cooperative.’ And throughout this past few years, fiscal policy has been either restrictive or at best neutral. So that has been a bit of a drag on that side. The Fed’s doing what it can to get inflation back up to target. But there are a number of things going on: First of all, is the fact that the recovery has been relatively slow and so slack has been absorbed at a reasonably good pace, but probably there’s still a bit of slack left. And secondly, we’ve been hit with what I guess you can call reverse supply shocks. In the seventies we were worried about big increases in oil prices. Now we’re seeing declines in oil prices and a strengthening of the dollar. Those things are depressing near-term inflation. It’s only a longer-term issue if they lead to inflation expectations beginning to move down. And I think there is some uncertainty about that as well. So, between remaining slack and global influences like commodity prices, I think that explains where we are. But getting inflation back up to 2% is a critical thing to accomplish. It’s really at the center of the debate of what the Fed should be doing going forward.”
(Noland: The world would be a much safer place if central bankers accepted the reality that they do not control the nature of inflationary effects. And this would not change if monetary and fiscal polices were orchestrated in tandem by a single central committee.)
Hilsenrath: “You describe in the book how you came to Washington a Republican and left public office an Independent. What changed in the process?”
Bernanke: “I didn’t really change. The political environment changed. I’ve always been moderate in my inclinations. As an economist I was very market oriented, so that put me more on the Republican side. But I was very unhappy with the big increase in partisanship in Washington – the inability to get things done and the increasing influence of the far right and far left in the debates, which was in my view, it’s fine to bring in different points of view, but if it means you can never get anything done – that you're basically going to be focused on shutting down the government –those kinds of things. I thought that was very counterproductive. And so in particular, I was unhappy with both extremes, but on the right – the populist Republican perspective was very anti-Fed and very opposed to what we had done. Obviously, it would be a little inconsistent for me to support the view that went against what we had done…”
(Noland: This is another one of those instances where the monetary administrators somehow remain oblivious to the profound effects of their inflationary monetary mismanagement. As I’ve argued over the years (paraphrasing the late Dr. Kurt Richebacher), the only cure for Bubbles is to not let them inflate. Bubbles, after all, are mechanisms of wealth redistribution and destruction. A burst major Bubble will leave in its wake tremendous social and political tension. These serial booms and busts have inflicted terrible damage upon our great country – economically, socially, politically and geopolitically. Indeed, inflationism is the leading cause of our troublingly divided country – as well as an increasingly fractious world. It was an issue near and dear to the hearts of our nation’s Founding Fathers. And this type of experimental inflationary monetary policy should never have been decided by a small group of unelected officials. One cannot overstate the ramifications and consequences of printing Trillions of dollars and grossly manipulating the financial markets.)
Hilsenrath: “Wasn’t the global savings glut a precursor to the housing bubble?”
Bernanke: “My thinking about this now is that the global savings glut probably kept rates a bit lower than they otherwise would have been. But my thinking about this is a little more complicated now. I think that the sequence of causation was more like this: There was this huge global savings glut – and there was this huge demand for liquid, safe assets. There were not enough Treasuries to go around. And so Wall Street very creatively began to create these supposedly safe assets, which were in fact the AAA tranches of securitized securities that inside included lots of different kinds of credits, including subprime mortgages, for example. And I would argue that the securitized credits were in fact one of the sources of the crisis – I think everyone would agree with that actually. But one of the reasons they were created in the first place in such large amounts, was it was Wall Street responding to the global demand for safe assets. And I think that was one of the mechanisms which the savings glut generated the risky situation that ultimately led to the crisis.”
(Noland: Actually, Wall Street was responding to what was at the time insatiable demand for perceived high-yielding safe – “money-like” assets. I invoked “Moneyness of Credit” throughout the Bubble period. Importantly, however, Dr. Bernanke’s thinking is flawed as to cause and effect. Global liquidity excesses were the consequence of rampant U.S. mortgage Credit growth and speculative leveraging, with attendant trade deficits and financial outflows inundating the world with dollar balances. Much of this dollar liquidity was then recycled back into the U.S. Credit system through the purchase of mortgage-related securities - MBS, ABS, GSE, CDOs and other derivatives. It was a historic episode of self-reinforcing Credit excess and market mispricing that were certainly discernable in real time.)
Hilsenrath: “Should we be worrying about the risk of another bubble given everything you’ve just described?”
Bernanke: “I don’t see any obvious major mispricings – nothing that looks like the housing bubble before the crisis, for example. But you shouldn’t trust me. What you should do is make your own judgments about individual asset prices. And what the Fed is doing of course is again monitoring very closely all of these different asset categories and trying both to determine if there is some downside risk and, if the downside risk occurs, what would the implications be for the broader system. One of the things I learned from our experience in the crisis was with respect to the housing bubble, the Fed spent a lot of time debating ‘Is it a bubble – isn’t it a bubble? If it is a bubble how big is it?’ That was the wrong way to think about it I think. The right way to have thought about it I think: ‘We don’t know if it’s a bubble. It might be. If it bursts, what’s the worst that can happen?’ And I think that looking at the worst-case-scenario was the right way to do it and the Fed didn’t do enough of that…”
Hilsenrath: “That implies that, the Fed this time around, if it faces some set of questions about whether there’s a bubble will be potentially more proactive either using regulatory tools or monetary policy to address it. Do you think that’s the case?”
Bernanke: “Based on the experience of the crisis, I think if anyone needed convincing that financial crisis or large speculative bubbles are dangerous I think they should be convinced now. So yes, so the Fed has changed its perspective. Formally speaking, the Fed has switched from being a so-called microprudential regulator that’s focused on a narrow set of institutions and markets – to a macroprudential regulator which means that in addition to looking at individual firms and markets is trying to assess the stability of the overall system. And that’s critical and to the extent there are risks that are apparent – either in terms of the structure of the system or in terms of building mispricings or other problems, the Fed needs to be proactive working with other regulators.”
(Noland: The Fed needs to extricate itself from manipulating the financial markets. It needs to end backstopping market liquidity. It must never again print Trillions of new “money” out of thin air. Because so long as the marketplace perceives that the markets are "too big to fail", there will be speculative excess, major securities markets mispricings and Bubble fragilities. No one – average investor or sophisticated financial operator – has a clue as to the degree Fed policies have distorted asset prices. A credible macroprudential regulator would not promote securities market inflation. And when it comes to courage, history has shown it takes tremendous courage to halt monetary inflation.)
I’ll briefly address the markets. What a week. When I commenced writing the previous week’s CBB - a week ago Friday morning - the Dow was 1,000 points lower. The VIX was 24. It closed this week at 17.08, the low since prior to the August “flash crash.” The Transports gained 4.8% this week. The small cap Russell 2000 surged 4.7%. The Morgan Stanley High Tech Index jumped 4.0%. The HUI index rose 16.3%. Stunning U.S. stock gains were outdone overseas. The German DAX surged 5.7%. Spanish stocks rose an incredible 7.4%. EM equities rallied sharply. Russian stocks jumped 7.2%. Brazilian equities rose 5.2%. Hong Kong’s financial stock index jumped 7.1%. The Shanghai Composite gained 4.3%.
The currencies and commodities were as crazy as stocks. The Brazilian real rallied 4.3% and the Indonesian rupiah surged 8.4%. The Russian ruble rallied 7.3%, the Malaysian ringgit 6.5%, the Colombian peso 5.0%, the South Korean won 3.1%, the Turkish lira 2.7% and the South African rand 2.8%. Big moves were not limited to EM. The Australian dollar surged 4.1% and the New Zealand dollar jumped 4.0%. The Norwegian krone gained 3.5%. The Goldman Sachs Commodities Index surged 5.9%. Crude oil jumped 8.7%. Silver rose 3.8% and copper rallied 2.9%. Wild stuff.
It was a brutal week not only for the bears. Hedging strategies came unglued. Long/short strategies suffered in the chaos. Trend-following momentum strategies were crushed by abrupt reversals in equities, Credit, currencies and commodities. In short, there appeared to be a lot of panic buying and considerable mayhem.
Over recent years, painful short squeezes often provided lift-off for another bull market leg higher. To be sure, once squeezes gain a head of steam, predicting when they’ve run their course tends to be tricky business. But I’m sticking to the view that the global Bubble has burst and contagion has set its sight on the Core. Despite this week’s powerful squeeze, I don’t believe markets have overcome deleveraging/de-risking pressures. I expect wild volatility to continue to weigh on leveraged currency “carry trades.” I would be surprised if the hedge fund community doesn’t suffer year-end outflows. And I certainly don’t think we’ve heard the last of China’s financial and economic woes. Yet in these unstable markets, anything can happen.