The case for keeping Bernanke

By Nicholas Wapshott
May 31, 2013

Whisper it abroad: The U.S. economy is on the mend. Most recent indicators suggest that, five years after the start of the Great Recession, the “L-shaped” recovery is finally heading north. The stock market is booming, and home prices are on the upswing. The rising price of houses makes people feel richer, and consumer confidence is on the mend. Private borrowing is up, and consumers are starting to spend again.

Growth is not great, about 2.5 percent to the end of the year, when the postwar average is 3.2 percent, but it is steady and appears to be self-sustaining. And this despite the 1.5 percent reduction on what growth would be were it not for the clumsy sequester’s fiscal drag. The general outlook is bright, if not sunny. As Winston Churchill said after the Battle of Alamein, “This is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”

Why whisper this good news? Because the idea that we have achieved recovery suggests to some it is time for the Federal Reserve to change tack. Monetary policy is the only instrument the administration has left. Hampered by a hostile House of Representatives, President Barack Obama’s “jobs bill” to stimulate the economy is long forgotten. Even he doesn’t mention it anymore.

But the Fed has a medium-term strategy that means keeping interest rates low so long as unemployment remains stubbornly high. It therefore plans to continue pumping money into the economy through quantitative easing at the rate of $85 billion a month to the horizon. The last meeting of the Fed’s board maintained a steady-as-she-goes policy, with the usual suspect  in the minority anxious about the inflationary implications of quantitative easing.

There is no inflationary pressure, nor is there likely to be. The austerity policies of the European Union, the only rival to America in terms of size and sophistication of economy, have pushed the euro bloc into recession and are keeping the euro weak. The same is true of Britain, where austerity has led to a near-triple-dip recession and sterling is trading lower. America’s old trade rivals the Japanese are on a QE binge, and the yen is sinking fast. As the world’s biggest economy is still growing, there has been a flight to the dollar that has pushed up the exchange rate and kept domestic inflation down.

Month by month we can expect more pressure on Fed Chairman Ben Bernanke to put his foot on the brake, reduce or stop altogether the QE program and allow interest rates to rise. There are endless siren voices urging him to alter course now. Like health insurance adjusters who patrol hospital wards looking for malingerers, the argument is: If the economy is on the mend, why do we need to keep taking the cure?

It is such a relief to have finally escaped from the worst recession in 80 years that it is natural to want to get back to “normal,” even though we know that since the traumas of 2008-09 nothing will ever be quite the same. The same temptation to return to the old ways lured Franklin Roosevelt to prematurely abandon his New Deal stimulus measures in 1937. The result was “the Roosevelt Recession,” a wrong turn in the history of the New Deal that both progressives and conservatives prefer to forget because of the unnecessary pain caused by braking too soon.

In brief: In 1937 Felix Frankfurter  persuaded FDR, whom John Maynard Keynes rightly pointed out knew little to nothing about economics, that blue skies were ahead and it was time to adopt what today we would call austerity measures. In 13 hellish months, unemployment leapt from 14.3 percent to 19 percent and output collapsed by 37 percent. America only resumed its sputtering recovery after Congress in early 1938 passed a bill to boost government spending.

The key today to maintaining our steady growth and avoid sliding back into recession is not the new chairman of the president’s Council of Economic Advisers, Jason Furman, whose elevation signals more of the same. It is who the president picks to succeed Bernanke, who is expected to step down after two terms as Fed chairman in January.

Bernanke was born to be Fed chairman in the middle of a financial crisis. He literally wrote the book about the Great Depression and used the lessons learned from his studies to avoid repeating the mistakes made 80 years ago that caused our great-grandparents such protracted misery. There was no better time for someone with a profound knowledge of the history of economic thought to be in charge of the Fed than when the financial slump broke over our heads in 2008.

Bernanke was a keen student, too, of Milton Friedman, whose research with Anna Schwartz led to him blame the Fed’s over-tight monetary policies in the Twenties for provoking and then exacerbating the Great Depression. On Friedman’s 90th birthday, Bernanke offered an extraordinary mea culpa on the Fed’s behalf. “Regarding the Great Depression,” he said, “you’re right, [the Federal Reserve] did it. We’re very sorry. But thanks to you, we won’t do it again.”

Much to the discomfort of conservatives devoted to the memory of Friedman, Bernanke was as good as his word. His policy of quantitative easing has been a textbook monetary response to a flailing economy. His departure will spark a feisty nomination battle that puts monetary policy at the heart of the Senate’s business. Even if the president were to name to the post Paul Volcker, the Democrat appointed Fed chairman by Jimmy Carter who licked inflation under Ronald Reagan, the sound-money proponents would say he was too soft a touch.

There are a number of good candidates the president could pick who would follow Bernanke’s lead in ensuring there is no premature return to a curb on borrowing through high interest rates. Their general views on when to tighten the money supply and their commitment to putting joblessness ahead of inflation as a priority are similar. Currently the Fed Chairman Stakes puts former Clinton Treasury secretary and Harvard President Larry Summers a nose ahead of former Treasury Secretary Tim Geithner and Federal Reserve Vice-Chair Janet Yellen. Any of the three would be a good fit. But each is sure to attract a protracted and bitter nomination battle that would be worth avoiding with the mid-term elections not far off. The GOP leadership is behaving more like a protest movement than a party of government and its Tea Party supporters will brook no compromise. After the stiletto-ing of Susan Rice, some may feel it is time to take another hostage.

There is, however, a bolder selection that would avoid the need for a nomination scrap altogether and would ensure perfect continuity: having Bernanke stay at his post. There are no term limits to oblige the Fed chairman to stand down. Bernanke let it be known “through friends” he wanted to depart the stage in the run-up to the presidential election when Mitt Romney, like every other Republican presidential hopeful, appeased his donors by pledging that his first act on entering the White House would be to fire Bernanke. Bernanke’s comment at the time the rumors started swirling was hardly a plea to be allowed his freedom. “I am very focused on my work,” he said. “I don’t have any decision or any information to give you on my personal plans.”

In the absence of any pressing personal reason for stepping aside, it would make perfect sense if Bernanke were to see out the job he began. The Great Recession is not yet licked. He has not completed the task history dealt him. He is every bit as good as the person who would succeed him. Now is a good time for the president to invite him onto the golf course, or have a beer in the executive mansion garden, or do whatever it takes to keep Bernanke in place.

Nicholas Wapshott is the author of Keynes Hayek: The Clash That Defined Modern Economics. Read extracts here.

PHOTO: Federal Reserve Board Chairman Ben Bernanke testifies before the Joint Economic Committee in Washington May 22, 2013.   REUTERS/Gary Cameron

11 comments

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Your argument that Bernanke should be retained as fed chairman is totally vacuous.

NONE of the purported data — pssst, it’s “good news”, but don’t tell anyone, that the US economy is in recovery — is even remotely accurate.

The real truth is that Bernanke, and his predecessor Greenspan, were instrumental in causing the US economy to crash in the first place through grossly negligent handling of the fed’s duties.

I think back now on Greenspan’s famous or now infamous remark about the market’s “irrational exhuberance”. In hindsight I think what he really meant was that he (and by extension Bernanke) didn’t have a clue as to the fact that the US economy was in the midst of the greatest speculative bubble in history, one that would make the run-up to the crash of 1929 look like a child’s balloon before it burst into the Great Depression.

Bernanke was appointed solely on the basis of his statements that no nation need go through another Great Depression as long as it was willing to print money until the economy recovered.

Well, fellow lab rats, Bernanke has obviously failed again to understand Economics 101.

(1) Never allow the federal reserve rate to remain at or near zero for extended periods of time or the economy is guaranteed to crash from excess liquidity.

(2) NEVER, NEVER, NEVER PRINT MONEY TO SOLVE ECONOMIC PROBLEMS, WHICH ARE REALLY A REFLECTION OF SEVERE UNDERLYING STRUCTURAL ISSUES THAT CONGRESS ALONE IS CAPABLE OF ADDRESSING. In other words, the Fed CANNOT perform the job that Congress has been elected to do, since it will only make matters worse. THAT is a major reason why this economy will NEVER recover, and Congress is more than happy to allow Bernanke to do their work for them.

Although it would take a book to detail the true state of the US economy it goes something like this.

– As a result of Bernanke’s QE program the Fed’s balance sheet is somewhere around 3-4 TRILLION dollars in debt. For those not familiar with accounting lingo, this is like running up a MASSIVE credit card bill with absolutely no way to pay it off.

Why is this important?

(1) It is this accrued debt on their balance sheet that is being used to finance the market excess we see today, and which at some point MUST be paid off.

(2) THIS ACCRUED DEBT IS WHY BERNANKE INSISTS THERE IS NO INFLATION. The fed is keeping the debt from flowing through to the real economy, which makes it seem as though there is no inflation, but the American people at some point will have to pay for this accrued inflation, PLUS take the hit when the fed begins to raise interest rates — a “double whammy” that will likely cause the US economy to crash into another Great Depression.

There are many who would doubt what I am saying, but it is EXACTLY how the Chinese government managed to maintain double-digit GDP without inflation for decades. Now, however, the Chinese government MUST pass through all that accrued inflation to its people and they have MASSIVE problems controlling their inflation at a more normal GDP of 7-8%.

DUH!

Bernanke is using the “Chinese Method” to defer inflation to another time, when we can more easily deal with it. But there is a fatal flaw in his reasoning.

That fatal flaw is this: Bernanke’s argument that we can grow out of deflation simply by printing money is ridiculous on the face of it. He is saying he has invented the economic equivalent of a “perpetual motion machine”, which no one would believe because is has been proven to be a scientific impossibility. Yet, the saying that there is a fool born every minute is apparently true, since many well-educated believe in Bernanke “perpetual money machine”!!! It is a scam and a ponzi scheme that relies on ever increasing numbers of fools to rush in that the markets have now become a “crowded trade”. THIS phenomenon is one of the final pieces of evidence of a totally unstable market just before it crashes.

THAT is the truth about the US economy. Thanks ENTIRELY to Bernanke, it has become a “Tale of Two Economies”.

(1) Let’s call one economy the “WALL STREET” economy, in honor of those in the wealthy class who appointed Bernanke, knowing he would do their bidding — not directly of course, but like petulant little children having a tantrum and causing the markets to crash whenever they didn’t get their way with the US government and Bernanke, which has now been going on for nearly five years with NO SIGN OF REAL ECONOMIC IMPROVEMENT.

HOWEVER, THE MARKET, USING THE DOW AS A PROXY, IS NOW MORE THAN 1,000 POINTS HIGHER THAN WHEN IT CRASHED AT 14,OOO IN 2008.

Is this good news? NO!

Not even for those wealthy in the markets who are supposedly benefitting from the increase in stock prices over the past 5 years, since ALL OF IT IS BASED ON A SPECULATIVE BUBBLE. (i.e. funny money, Monopoly money, and not worth the paper their stock or bonds are printed on, or the electronic version, if you prefer.)

Is this massive increase in market prices due to market fundamentals? NO!

IT IS DUE SOLELY TO MASSIVE AMOUNTS OF “FREE MONEY” BEING PUMPED INTO THE WALL STREET ECONOMY FROM THE GOVERNMENT (ala Bernanke), WHICH FORMS THE REAL “BASIS” OF OUR ECONOMY — “WEALTHY WELFARE”!

(2) That’s right folks! Let’s call it for what it really is — “WEALTHY WELFARE” — because the other economy, let’s call it “MAIN STREET” is suffering from the “Great Recession”.

Are jobs actually increasing? NO!
Are the job numbers from the government even remotely close to telling the truth about this economy? NO! They are nothing more than figments of some bureaucrat’s fevered imagination, BUT sanctioned nevertheless by the powers that be to keep the masses ignorant of the true state of affairs of this nation. The truth is probably that, in the the best case scenario, we are no better of than the EU with 12% average unemployment (as of yesterday), and in the the worst case scenario, probably triple our supposed 6-7% unemployment now.

Why? Because NONE of the data collection methods used by the federal government accurately state the true unemployment because they are statistically invalid. We are using statistical methods that belong back in the Great Depression, and haven’t been improved since.

The “bottom line” is simply this: WITHOUT MAIN STREET JOBS, THE US ECONOMY WILL CRASH INTO ANOTHER GREAT DEPRESSION.

THAT IS THE UGLY TRUTH THAT MR. WAPSHOTT WOULD KEEP FROM YOU, SOLELY TO KEEP “WEALTHY WELFARE” GOING.

THE EVEN UGLIER TRUTH IS THERE ISN’T EVEN REMOTELY ENOUGH MONOPOLY MONEY TO KEEP THE MARKETS SATISFIED MUCH LONGER, NO MATTER HOW LONG THE “WEALTHY WELFARE” IS CONTINUED.

WE, AS A NATION, IN BOTH ECONOMIES NEED TO ACKNOWLEDGE THAT BERNANKE’S GRAND EXPERIMENT HAS FAILED MISERABLY AND THAT IT WILL ONLY BRING MORE ECONOMIC PAIN THE LONGER IT IS ALLOWED TO CONTINUE.

Posted by EconCassandra | Report as abusive

Mr. Wapshott,

Perhaps you might be more successful in writing fiction than economic analysis.

Try, just for a change, to actually research a subject before presenting your personal opinions as facts.

Here, for your edification, is simply ONE of many articles I have read that contradict your “fantasy world view”.

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Bubbles Inflating Faster Than GDP
May 14, 2013 posted by Michael Pento

Three reasons why an economy soaked in debt grows only bubbles.

Global central banks have clearly demonstrated the ability to re-inflate stock and real estate bubbles. Global stock markets are roaring ahead of their economies and real estate prices are quickly rebounding from their recent collapse. However, rock-bottom interest rates and massive money printing have yet to show an aptitude for creating sustainable GDP growth.

There has been a lot of talk about a rebound in the equity and real estate markets helped along by the Fed’s free money. That much is for sure the truth; but the evidence of a viable and sustainable recovery built on free-market forces just isn’t there.

For example, the percentage of consumers who own their own home continued to fall during the first quarter of 2013, dropping to a national level that hasn’t been seen since the fall of 1995. The Census Bureau reported that the nation’s homeownership rate slipped to 65% in Q1 2013, a decline from 65.4% posted in the last quarter of 2012. The rate of home ownership now stands at a 17-year low!

But if the housing market was gaining ground on stable footing then why aren’t first-time home buyers and owner occupiers participating? Instead, it has been hedge funds and speculators that are sopping up all the foreclosures. One has to wonder if these “investors” will hold onto their rental properties if the economy tanks once again and home prices take another steep drop.

In addition, the labor market isn’t rebounding as the Fed had hoped and projected it would. Last month’s NFP (National Financial Partners Corp.) report showed that, despite $85 billion per month of Quantitative Easing, 9,000 goods-producing jobs were lost. And even though you hear the mainstream media talk about resurgence in the manufacturing sector, there were zero manufacturing jobs created in April. What’s even worse is that aggregate hours worked fell by 0.4% in April over March. Therefore, despite the fact that the Labor Department says that 165,000 net new jobs were created, the actual total number of labor hours worked was in decline.

There is a reason why the Fed and other central banks have been unable to achieve a healthy and viable economy even after five years of trying to manufacture one from a printing press. The truth is an economy soaked in debt just doesn’t grow because it is always marked by at least one, if not all three, of the following growth-killing conditions: high interest rates, rampant inflation and onerous tax rates.

Any country with outstanding debt equal to or greater than its GDP is forced into sucking an exorbitant amount of capital out of the private sector due to burdensome rollovers and interest payments on that debt. In addition, rising tax rates act as a disincentive to increase productivity, and whatever money is taken from the private sector is always redeployed in an inefficient, GDP-destroying manner. Rising interest costs also discourage borrowing and lead to capital shortages. And finally, inflation destroys the purchasing power of the middle class by eroding the value of the currency and leaving consumers with an inability to make discretionary purchases.

But central bankers don’t acknowledge this truth and are instead seeking to increase their efforts in pursuit of ever-increasing money supply growth. Of course we are all familiar with the counterfeiting undertakings of the Fed and Bank of Japan. Now Australia’s central bank is joining the crowd of inflation lovers and has cut its key interest rate by 25 basis points on May 7, to a record low of 2.75%.

Investors need to be aware that if a central bank wants to set an inflation target it will be achieved. European Central Bank President Mario Draghi said recently that the ECB was “technically ready” to shift the deposit rate into negative territory, meaning it would start charging lenders for holding their money with the central bank. A bank cannot accept a negative return on its assets. Therefore, if Draghi follows through on his threat, expect money supply growth and inflation to kick into high gear over in the eurozone.

The bottom line is that central bankers are totally inept at creating economic growth but extremely proficient at building asset bubbles. Inflation targets will be met and exceeded as they deploy their new “tools” of charging interest on excess reserves and buying up the stock market. They are in the process of rebuilding the equity and housing bubbles and have already created a massive bubble in the sovereign debt of Europe, America and Japan. Once this bubble breaks (like every other bubble has done in the past) expect economic chaos in unprecedented fashion.

Mr. Michael Pento is the President of Pento Portfolio Strategies and serves as Senior Market Analyst for Baltimore-based research firm Agora Financial.

—————

http://www.prudentbear.com/2013/05/bubbl es-inflating-faster-than-gdp.html#.UaoTl 5ymhVI

Posted by EconCassandra | Report as abusive

I can easily — and you can duplicate just as easily — what is wrong with this economy using the DOW’s own numbers.

(1) Go to this link and “zoom” to “5y” to isolate the period we are discussing.

http://www.google.com /finance?q=INDEXDJX:.DJI

Notice the period shown is June 6, 2008 to May 30, 2013, which is slightly longer than the period we need, but it establishes what is wrong with using conventional analysis.

If you place your cursor on the trend line, it will give you the data for any day during that period.

If you place your cursor at the beginning of the 5 year period, it will give you the DOW price of 12,638 for the closing price on May 30, 2008.

The total change shown for the period is +2,477, with a percentage change of 19.6%, which means even the DOW is using the wrong percentage change to accurately measure the change during that period.

They are, in fact, using the “Arithmetic Mean”, when they should be using the CAGR (i.e. Compound Annual Growth Rate) instead.

“Compounded Annual Growth rate (CAGR) is a business and investing specific term for the smoothed annualized gain of an investment over a given time period.”

What investors really need to know is the annual rate of change of the stocks represented by the markets, not the total change, which tells you absolutely nothing.

(2) Now look at the data for March 6, 2009, which is the “low point” reached before the DOW began its climb to yesterday’s “relative high point” of 15,116 at close.

You should see the DOW low was at 6,627 before stabilizing and beginning its QE-driven rise since then.

Using CAGR to compute the average rate of change per year for the period, which is roughly 4 years, yields a CAGR of 9.6% average increase in the DOW per year.

(15116-6627)^.25 = %

Since, according to the fed and government sources, there is no inflation and GDP is growing somewhere in the 2.0-2.5% range per year, I would argue that there is a gross discrepancy between the market rate of growth and that of the US economy over the same period.

What could cause such a discrepancy?

The ONLY reason that makes sense is the Bernanke QE programs which are the main driver of the markets by inflationary means, while the real ecoomy of main street is languishing.

I would argue that Bernanke, his “novel” approach to economics, is literally destroying this nation for two reasons that should be obvious to anyone who can do simple math.

(1) He is creating an inflationary bubble by printing money — supposedly to counter unemployment — but is actually creating another bubble of inflated “assets” instead.

(2) Obviiously , his QE is NOT reaching main street, where the jobs need to be created, but are simply being used by banks, international corporatins, and their investors to fund “free money” investments in other countries where their returns are far beyond what this nation could possibly offer.

THAT IS WHY THE STOCK MARKETS ARE RISING AND THE US ECONOMY IS COLLAPSING AT THE SAME TIME.

BERNANKE’S “THEORY” OF PRINTING MONEY UNTIL THE ECONOMY RESPONDS HAS A FATAL FLAW.

THAT FATAL FLAW IS THAT INVESTORS WILL NOT INVEST ANYWHERE EXCEPT AT A PLACE THEY CAN GET THE BEST RETURNS.

THE REAL UNDERLYING PROBLEM IS THAT BERNANKE HAS PLACED NO RESTRICTIONS WHATSOEVER ON WHAT INVESTORS DO WITH THE FREE MONEY, THEREFORE IT IS NOT, AND NEVER WILL BE, INVESTED IN THIS COUNTRY NO MATTER HOW LONG THE QE PROGRAM IS CONTINUED.

—————–

THIS IS THE SAME REASON US COMPANIES WILL NOT INVEST THEIR HUGE SURPLUSES OF CASH IN THE US UNTIL ECONOMIC CONDITIONS BECOME FAVORABLE FOR THEM TO DO SO, WHICH MEANS THEY WILL NOT INVEST UNTIL THEIR CORPORATE TAXES ARE MUCH LOWER THAN AT PRESENT.

——————-

THIS IS THE SAME REASON THAT MULTINATIONAL CORPORATIONS REFUSED TO BRING THEIR PROFITS HOME TO BE TAXED AT THE PRESENT RATES.

IT IS WHY THEY WANT TO CUT A DEAL WITH THE GOVERNMENT TO ALLOW A “TAX HOLIDAY”.

THE SIMPLE ISSUE WITH THE BILLIONS OF TAXES HELD ABROAD IS THAT THE STOCKHOLDERS ARE DESPERATE TO USE THESE PROFITS FOR CAPITAL INVESTMENT.

BUT THESE PROFITS WILL NOT BE INVESTED IN THE US, AS THE PREVIOUS “TAX HOLIDAY” HAS SHOWN.

INSTEAD, THEY WILL BE INVESTED OVERSEAS WHERE THEIR CAPITAL INVESTMENTS WILL BRING GREATER PROFITS.

—————

THIS IS EXACTLY THE SAME PROBLEM, FOR EXACTLY THE SAME REASONS, CURRENTLY BEING EXPERIENCED BY THE EU, SINCE THEIR CENTRAL BANK BEGAN IMPLEMENTING THE “BERNANKE PLAN” FOR “RECOVERY”, WHICH WILL NEVER WORK AS IT IS STRUCTURED.

INVESTORS WILL NEVER WILLINGLY INVEST IN THEIR OWN COUNTRIES WHICH ARE IN TROUBLE UNLESS THEY ARE FORCED TO DO SO.

—————

YES, IT REALLY IS THAT SIMPLE!

DUH!!!!

————–

Since I have not aware of any similar analysis being made public anywhere, consider this to be notice that I alone reserve the legal “copyright” to this economic interpretation of what is wrong with the global economy.

Under no circumstances shall my ideas presented here or previously be used for any reason whatsoever without my specific written permission.

————————

Posted by EconCassandra | Report as abusive

One of the more obvious questions is why would the DOW choose to use an arithmetic mean to measure yearly change is beyond my comprehension, since it imparts no useful value on the annual change in the DOW market whatsover.

Granted, an arithmetic mean will tell you the total change over the 4 year period, but there is no reasonable way to determine the average change per year.

For example, using the aritmetic mean applied by the DOW, the total rate of change over the past 4 years is 128%, which is meaningless.

(15116-6627)/6627 = 128%.

Simply diving 128% by 4 will not yield the correct yearly average, but a “bogus” average of 32% per year.

The correct method to use, as I said above, is the CAGR, which will accurately measure the average change per year.

Once you accurately compare the CAGR over the past 4 years:

(15116-66270)^.25 = 9.6%

it shouldn’t take rocket science to figure out there is a massive discrepancy between the value of the present DOW price and the real economy with no inflation and 2.0-2.5% growth.

Something is seriously wrong.

That something has to be Bernanke’s QE program.

There is nothing else to account for it.

—————–

It would also argue strongly that the present rate of growth of 9.6% per year is NOT POSSIBLE going into the future.

For example, using even the real CAGR growth rate of 9.6% would argue — assuming no change in the Bernanke QE marke strategy — means that during the next 4 year period, the DOW should increase in the following DOW pattern:

(2014) = 16,567
(2015) = 18,157
(2016) = 19,900
(2017) = 21,810

DOES THIS RATE OF GROWTH, EVEN AT THE REDUCED REAL RATE OF GROWTH PER YEAR, MAKE ANY SENSE?

Thus, the longer we continue “Wealthy Welfare” as it is presently structured.

DUH!

I rest my cast against continuation of the Bernanke QE program, since it would destroy, not only this nation, but the global economy as well.

Posted by EconCassandra | Report as abusive

Well, once again I am truly amazed by the “underwhelming” response to this article.

It says a lot about the present state of the American people.

Apparently, you people only care about “hot button” issues — gun control, abortion, gay rights, etc. — ALL of which are totally meaningless issues without a viable economy.

Clearly, you deserve what is about to happen to you.

Posted by EconCassandra | Report as abusive

The reason money printing used to work is because the other countries would not follow suit and thus the printer’s currency supply would increase and exchange rate weaken making exports cheaper and thus boosting production. Money printing no longer works because everyone is doing it. The article fails to consider this and thus it falls flat. The real issues are irresponsible behavior by the banks and governments in printing money through fractional lending. Bernanke is the captain of the titanic and debating the merits of the captain is meaningless once the lower decks are flooded.

Posted by BidnisMan | Report as abusive

Will the Crash Be This Year or Next Year?
June 3, 2013 posted by Martin Hutchinson

At some point, this gigantic ziggurat of global malinvestment must collapse.

The stock markets of the world spiral up to infinity with only an occasional hiccup and the U.S. housing market is well into bubble mode again, pumped up by cheap money. Only gold and silver languish, hard assets that have gone out of fashion because of the lack of inflation. At some time this bubble must burst, bringing devastation to global financial markets. The crucial question to investors seeking to maximize gains and protect their few remaining assets is: will the burst come this year, or is it more likely to be delayed into 2014 or even 2015.

Make no mistake, there will be a crash. Interest rates have been negative in real terms for five years. That has made it attractive to leverage and has caused asset prices to spiral towards infinity. It has also disguised the extent of stock market overvaluation by inflating reported earnings, as the cost of balance sheet debt diminishes below zero in real terms.

To use the Austrian economic term, the malinvestment of 2003-07, caused by the previous bout of ultra-low interest rates, has not really been washed out. In housing, all kinds of schemes have been used to prevent the expected foreclosures, while innumerable funds have bought up the inventory of foreclosed housing, intending to use it to satisfy a rental demand that has not been proved to be there (much of the overstock being in outer suburbs, while rental demand is strongest in inner suburbs and gentrifying inner cities).

More important, the wave of leveraged buyouts carried out in 2006-07, which were expected to present a huge economic obstacle in 2011-12 as 5-year debt required refinancing, have simply been rolled over. There is thus a huge amount of “water” in valuations, both from good assets whose prices have been chased too far and, more important, from bad assets that have minimal value in a free market but have been propped up by funny money.

Trees don’t grow to the sky, straight lines do not continue to infinity and bubbles do not inflate indefinitely. At some point, this gigantic ziggurat of global malinvestment must collapse. The question is: when and how?

Since the beginning of this year I have held the view that we were due for a major market breakdown in 2014, probably in the second half of 2014. Monetary policy seemed likely to remain ultra-easy until the end of this year, the “Abenomics” experiment in Japan would take at least 12-18 months to work through, we were a long way from the top of the business cycle, and while stock markets were already close to all-time highs it seemed to me they had a lot further to go. Then there was gold; I found it difficult to believe that the cycle could end without a major spike in gold prices, and the experience of 1978-80 suggested pretty strongly such a spike should take at least 12 -18 months.

There are now a number of signs that the bubble may burst sooner than this. For a start, many economic commentators from the right of the political spectrum, who in 2012 were duly forthright about replacing Ben Bernanke at the earliest possible opportunity, have now reversed themselves and embraced Bernankeism, claiming that quantitative easing is the only thing keeping the economy going.

Most of these commentators had been dire in their warnings in November and December about the dangers of the “fiscal cliff” that would have closed 80% of the current budget deficit; that suggests they are closet Keynesians who have not properly shaken off their leftist training in college economics courses. Now that there is nothing politically to be gained (they think) from denouncing Bernanke, they have stopped doing so, since their Keynesianism leads them to believe the economy is about to collapse under the weight of the modest January tax increases and the even more modest March sequester.

In reality the “fiscal cliff” would have represented a return to sound economic policy. Had it been put into effect in toto, the budget deficit would have been reduced to $200 billion or so, taking it out of the picture and eliminating the possibility of a near-term U.S. default. Naturally, there would have been a mild recession in the first half of 2013 because of all the tax increases, but that recession would have stopped the continual inflation of asset prices, while Bernanke would have found his current $1 trillion per annum QE very difficult to pursue, since he would have been financing five times the U.S. budget deficit.

To us non-Keynesians the partial fiscal cliff of payroll tax increases and tax bracket increases at the upper end combined with modest but genuine spending cuts have been beneficial. By making Bernanke’s monetary policy more extreme, they have also caused the bubble to inflate faster and may also have brought forward the collapse that must follow it.

There are still a lot of factors leading one to believe the burst will come next year, not this. Home prices are rocketing upwards at 12% a year, with much faster rises in places like San Francisco, but they’re not far enough off the floor yet for speculative fever to cause real problems. Broad money supply is rising at only around 7%, which suggests that even with Bernanke printing like mad, the system remains under control. The Japanese market is still less than half its 1990 level; it’s probably not going to get back that far, but it seems unlikely that any Japanese bubble will burst with the Nikkei below 20,000, the level it attained in 1999-2000. Gold is positively depressed; can we really end this bubble without a gold blowout? The global economy is still far below capacity, with unemployment in the U.S. and Europe still at deep recessionary levels when declining workforce participation is taken into account. Finally, where’s inflation?

Still, there are now some factors suggesting an earlier crisis. Bond interest rates have ticked up quite a long way from their bottom. Most likely, they will tick down again, but a further rise could accelerate the denouement. The crash, when it comes, will find massive losses in the financial system, as did 2008, but this time mostly from interest rate risk rather than credit risk. Then there’s the junk bond market, which is as extended as it was in 2006-07–can it go on getting more extended for another year? Finally, while broad money supply is behaving itself, narrow money supply certainly isn’t; the monetary base has risen at a 50% annual rate this year and shows no sign of slackening off.

There are certainly possible triggers for a 2013 crisis, the most obvious of which are France and Italy. Whereas the markets have to a certain extent priced in Italian risk, one should never underestimate the potential for the Italians to do something utterly foolish and make that risk immeasurably worse. As for France, that risk is not priced in at all, the 10-year OAT French treasury bond yields only 2.06%, less than the U.S. bond of the same maturity.

Finally the U.S. tech sector looks ever more overextended, with $1 billion takeovers taking place at 50 times revenues, not profits, as in Yahoo’s takeover of Tumblr. As with the narrow money supply and the bond markets, it seems impossible that this bubble can continue to inflate for another full year from now.

One’s conclusion must be inconclusive–there are arguments in both directions. But that’s a change from a few months ago, when a crash in 2013 seemed very unlikely indeed. If the crash comes this year, it will most likely be caused by the bond market, will not be accompanied by inflation or a massive gold run-up, and will allow the Obama/Bernanke team to inject a further dose of monetary and fiscal “stimulus”–thereby leading to another round of funny-money non-recovery and malinvestment.

If on the other hand the crash is delayed until the second half of next year, and is accompanied by inflation and/or a massive gold bubble, then it will be far more severe, but its causes will be completely obvious, and monetary and fiscal stimulus will not be available to rescue it, because of inflation and credit worries respectively. In that case, the subsequent recession will be prolonged and severe, but at the end of it we will have restored sound monetary and economic conditions, and will resume economic growth on a balanced basis, with interest rates well above the inflation rate and savings financing investment.

Overall, I think a crash in late 2014 is most likely, and most beneficial. But a 2013 crash cannot entirely be ruled out.

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http://www.prudentbear.com/2013/06/will- crash-be-this-year-or-next-year.html#.Ua yVXJymhVI

Posted by EconCassandra | Report as abusive

Notice in the above article by Martin Hutchinson, a major factor leading to the uncertainty of the timing of the next crash (this year or next), depending on the exact circumstances, he poses this question.

“Gold is positively depressed; can we really end this bubble without a gold blowout? The global economy is still far below capacity, with unemployment in the U.S. and Europe still at deep recessionary levels when declining workforce participation is taken into account.

Finally, where’s inflation?”

As I pointed out in my analysis above, I believe the inflation he is looking for as a sign of imminent economic collapse is sitting on the balance sheets of the central banks, which no one seems to understand.

Thus, the only remaining piece of the puzzle is why is gold in decline?

I have to give that some thought, since the answer does not seem immediately obvious at this point.

Posted by EconCassandra | Report as abusive

Actually, a post in the UK Guardian today by Nouriel Roubini holds the answer to the question “where’s the gold?”. So, the final piece is in place, at least in my analysis, for a market collapse in 2013.

I will continue this analysis below Roubini’s article.

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Gold prices are heading towards $1,000

There are many reasons why the gold bubble is deflating, and why gold prices are likely to move much lower by 2015

Nouriel Roubini
guardian.co.uk, Monday 3 June 2013 05.02 EDT
Jump to comments (13)

Fall in the gold price is likely to continue. Photograph: Petr Josek/REUTERS

The runup in gold prices in recent years – from $800 per ounce in early 2009 to above $1,900 in the autumn of 2011 – had all the features of a bubble. Now, like all asset-price surges that are divorced from the fundamentals of supply and demand, the gold bubble is deflating.

At the peak, gold bugs – a combination of paranoid investors and others with a fear-based political agenda – were happily predicting gold prices going to $2,000, $3,000 and even to $5,000 in a matter of years. But prices have moved mostly downward since then. In April, gold was selling for close to $1,300 per ounce and the price is still hovering below $1,400, an almost 30% drop from the 2011 high.

There are many reasons why the bubble has burst, and why gold prices are likely to move much lower, toward $1,000 by 2015.

First, gold prices tend to spike when there are serious economic, financial and geopolitical risks in the global economy. During the global financial crisis, even the safety of bank deposits and government bonds was in doubt for some investors. If you worry about financial Armageddon, it is indeed metaphorically the time to stock your bunker with guns, ammunition, canned food and gold bars.

But even in that dire scenario, gold might be a poor investment. Indeed, at the peak of the global financial crisis in 2008 and 2009, gold prices fell sharply a few times. In an extreme credit crunch, leveraged purchases of gold cause forced sales, because any price correction triggers margin calls. As a result, gold can be very volatile – upward and downward – at the peak of a crisis.

Second, gold performs best when there is a risk of high inflation, as its popularity as a store of value increases. But despite very aggressive monetary policy by many central banks – successive rounds of “quantitative easing” have doubled or even tripled the money supply in most advanced economies – global inflation is actually low and falling further.

The reason is simple: while base money is soaring, the velocity of money has collapsed, with banks hoarding the liquidity in the form of excess reserves. Ongoing private and public debt deleveraging has kept global demand growth below that of supply.

Thus, firms have little pricing power owing to excess capacity, while workers’ bargaining power is low owing to high unemployment. Moreover, trade unions continue to weaken, while globalisation has led to cheap production of labor-intensive goods in China and other emerging markets, depressing the wages and job prospects of unskilled workers in advanced economies.

With little wage inflation, high goods inflation is unlikely. If anything, inflation is now falling further globally as commodity prices adjust downward in response to weak global growth. And gold is following the fall in actual and expected inflation.

Third, unlike other assets, gold does not provide any income. Whereas equities have dividends, bonds have coupons, and homes provide rents, gold is solely a play on capital appreciation. Now that the global economy is recovering, other assets – equities or even revived real estate – provide higher returns. Indeed, US and global equities have vastly outperformed gold since the sharp rise in gold prices in early 2009.

Fourth, gold prices rose sharply when real (inflation-adjusted) interest rates became increasingly negative after successive rounds of quantitative easing. The time to buy gold is when the real returns on cash and bonds are negative and falling. But the more positive outlook about the US and the global economy implies that over time the Federal Reserve and other central banks will exit from quantitative easing and zero policy rates, which means that real rates will rise, rather than fall.

Fifth, some argued that highly indebted sovereigns would push investors into gold as government bonds became more risky. But the opposite is happening now. Many of these highly indebted governments have large stocks of gold, which they may decide to dump to reduce their debts. Indeed, a report that Cyprus might sell a small fraction – some €400m – of its gold reserves triggered a 13% fall in gold prices in April. Countries like Italy, which has massive gold reserves (above $130bn), could be similarly tempted, driving down prices further.

Sixth, some extreme political conservatives, especially in the United States, hyped gold in ways that ended up being counterproductive. For this far-right fringe, gold is the only hedge against the risk posed by the government’s conspiracy to expropriate private wealth. These fanatics also believe that a return to the gold standard is inevitable as hyperinflation ensues from central banks’ “debasement” of paper money. But, given the absence of any conspiracy, falling inflation and the inability to use gold as a currency, such arguments cannot be sustained.

A currency serves three functions, providing a means of payment, a unit of account and a store of value. Gold may be a store of value for wealth, but it is not a means of payment. You cannot pay for your groceries with it. Nor is it a unit of account. Prices of goods and services, and of financial assets, are not denominated in gold terms.

So gold remains John Maynard Keynes’s “barbarous relic,” with no intrinsic value and used mainly as a hedge against irrational fear and panic. Yes, all investors should have a very modest share of gold in their portfolios as a hedge against extreme tail risks. But other real assets can provide a similar hedge, and those tail risks – while not eliminated – are certainly lower today than at the peak of the global financial crisis.

While gold prices may temporarily move higher in the next few years, they will be very volatile and will trend lower over time as the global economy mends itself. The gold rush is over.

Copyright: Project Syndicate, 2013.

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http://www.guardian.co.uk/business/econo mics-blog/2013/jun/03/gold-bubble-bursts -nouriel-roubini

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I believe the missing piece is stated by Roubini in this paragraph above, but he is seriously wrong in his interpretation of why gold prices are dropping:

“Second, gold performs best when there is a risk of high inflation, as its popularity as a store of value increases. But despite very aggressive monetary policy by many central banks – successive rounds of “quantitative easing” have doubled or even tripled the money supply in most advanced economies – global inflation is actually low and falling further.”

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TO SUMMARIZE ALL OF MY COMMENTS ABOVE:

ESSENTIALLY, IT IS THE INVESTORS’ PERCEPTION OF NO GLOBAL INFLATION, AS SUMMARIZED BY ROUBINI AND HUTCHINSON, THAT IS TOTALLY INCORRECT.

THIS MISPERCEPTION OF NO INFLATION BY INVESTORS COMPLETELY EXPLAINS WHY GOLD PRICES ARE CURRENTLY DROPPING, AND IS PROOF OF THAT MISPERCEPTION.

THE TRUTH IS THAT THE GLOBAL ECONOMY IS ACTUALLY IN THE MIDST OF THE GREATEST SPECULATIVE BUBBLE IN HISTORY.

BUT, BECAUSE THE INFLATION — THE EARLY WARNING SIGN OF AN IMPENDING MARKET CRASH INVESTORS ARE LOOKING FOR IN VAIN — IS BEING HELD BY THE CENTRAL BANKS ON THEIR BALANCE SHEETS AS “ACCRUED DEBT” (I.E. INFLATION WAITING TO BE RELEASED INTO THE GLOBAL ECONOMY) INVESTORS DO NOT RECOGNIZE IT AS SUCH.

NEVER BEFORE HAS THE GLOBAL ECOMOMY EMBARKED ON SUCH A MASSIVE PROGRAM OF REFLATIONARY EFFORT AS THE BERNANKE-INSPIRED QE PROGRAM, WHICH HAS BECOME WIDELY ACCEPTED AS THE “SOLUTION” TO THE PROBLEMS OF THE GLOBAL ECONOMY.

BUT THIS IS WRONG. THE BERNANKE QE PROGRAM, AS WELL AS THE OTHERS WHO ARE EMBARKING ON THE SAME COURSE, ARE MISTAKEN.

THEIR EFFORTS HAVE WRONGLY PREVENTED THE COLLAPSE OF THE GLOBAL ECONOMY, THEN COMPOUNDED THAT MISTAKE BY ATTEMPTING TO REINFLATE THE GLOBAL ECONOMY TO ITS PREVIOUSLY UNSUSTAINABLE LEVEL, WHICH HAS HAD THE EFFECT OF BUILDING ANOTHER BUBBLE ON TOP OF THE EXISTING BUBBLE THAT WAS NEVER ALLOWED TO COLLAPSE.

THE RESULT OF THIS EFFORT IS ADDING MOE INFLATION ON TOP OF WHAT WAS ALREADY THE GREATEST SPECULATIVE BUBBLE IN HISTORY, SO THAT THE ORIGINAL BUBBLE HAS NOW GROWN TO TRULY EXPONENTIAL PROPORTIONS.

THE PROOF, AS I POINTED OUT ABOVE IS IN MY COMPARISON OF THE DOW AND THE REAL US ECONOMY.

IRONICALLY, THE COLLATERAL DAMAGE OF GROSSLY OVER-INFLATED MARKETS IS BEING SEEN AS A GOOD SIGN, INSTEAD OF A DIRE WARNING OF IMMINENT DISASTER.

INVESTORS DO NOT UNDERSTAND WHAT THIS MEANS, SINCE IT IS AN UNEXPECTED PHENOMENON OF THE BERNANKE QE PROGRAMS THAT HAVE NOW BEEN SPREAD WORLDWIDE.

THE DANGEROUS LEVELS OF INFLATION ARE NOT BEING RECOGNIZED FOR WHAT THEY REALLY ARE. AS A RESULT, BERNANKE’S QE PROGRAM AND ITS ILK ARE NOT BEING TAKEN PROPERLY INTO ACCOUNT WHEN THEY LOOK AT THE GLOBAL RISK FACTORS.

THAT IS WHY, WHEN MARTIN HUTCHINSON ASKS “WHERE’S THE INFLATION?” AND NOURIEL ROUBINI ASKS “WHERE’S THE GOLD?”, THEY ARE BOTH ASKING RELEVANT QUESTIONS THAT WOULD ANSWER THE QUESTION AS TO WHERE IS THE NECESSARY INFLATION THAT WOULD CAUSE THE GLOBAL ECONOMY TO CRASH, BUT NEITHER SEEM TO UNDERSTAND THE ANSWER IS ALREADY THERE IN TERMS OF THE ACCRUED DEBT ON THE CENTRAL BANKS’ BALANCE SHEETS.

IN OTHER WORDS, NEITHER THEY NOR INVESTORS UNDERSTAND THE MISSING PIECE TO THE PUZZLE IS ALREADY IN PLACE.

CENTRAL BANKS ARE HOLDING IT ON THEIR BALANCE SHEETS, WHICH IS SOMETHING THE CENTRAL BANKS NEVER DONE BEFORE.

THIS IS THE RESULT OF PRINTING MONEY IN AN ATTEMPT TO REFLATE THE GLOBAL ECONOMY, BUT IT IS NOT GOING INTO THE REAL ECONOMY AS THEY ARGUE IT IS, WHICH IS THE REASON FOR THE MASSIVE DIFFERENCE BETWEEN THE INFLATED MARKET PRICES — WHICH IS WHERE THE INFLATION IS ACTUALLY VISIBLE, AND IS LOGICALLY THE OTHER SIDE OF THE ACCOUNTING EQUATION — AND THE REAL ECONOMY.

THUS, THE GLOBAL INFLATION IS REAL AND GROWING MASSIVELY AS LONG AS THE GLOBAL QE CONTINUES, IF YOU UNDERSTAND THE DYNAMICS OF WHAT IS HAPPENING DUE TO THE NEVER BEFORE ATTEMPTED QE PROGRAMS, BUT THE INVESTORS DO NOT UNDERSTAND THE HUGE DISCREPANCY BETWEEN THEIR INFLATED EQUITY VALUES AND THE REAL GLOBAL ECONOMY.

THAT IS THE REAL REASON WHY GOLD PRICES ARE LOW AND DROPPING — INVESTOR PERCEPTION THAT NOTHING IS WRONG. WHY? BECAUSE NO ONE BELIEVES THERE IS ANY INFLATION ANYWHERE IN THE GLOBAL ECONOMY, DESPITE OBVIOUS SIGNS OF MISPRICED ASSETS EVERYWHERE WHEN COMPARED TO THE REAL ECONOMY, WHICH IS MOVING RAPIDLY INTO RECESSION.

SO, IF THE INFLATION IS REAL AND GROWING EXPONENTIALLY WITH EACH PASSING DAY OF QE PUMPING MORE LIQUIDITY INTO THE GLOBAL MARKETS, I WOULD ARGUE THE COLLAPSE WILL BE IN 2013.

PROBABLY SOMETIME THIS FALL, WHEN THE STRESSES OF RECESSION CAN NO LONGER BE OFFSET BY THE ILLUSORY EFFECTS OF CENTRAL BANK QE PROGRAMS.

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As before, I want to reiterate that I retain the “copyright” to my ideas expressed here and previously on this subject.

None of these ideas may be used for any reason whatsover without my express permission.

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Posted by EconCassandra | Report as abusive

To those above, the arguments against the author’s position are well stated. Even with the diversity of opinions, there is something to be learned in each of your comments.

Posted by COindependent | Report as abusive

@ Econ Once posted on a blog your hypothesis is part of the public domain, devoid of any copyright or intellectual property protection. Much the same as a doctoral thesis.

Posted by COindependent | Report as abusive