Alasdair Macleod – 5 January 2010
The Financial Times yesterday (4 January 2010) reported a speech Ben Bernanke made to the American Economic Association, and I quote: “Ben Bernanke has called for reform of financial regulation, arguing on Sunday that it was lapses in regulatory oversight rather than loose monetary policy that stoked the US housing bubble.”
No, it is not all fools day, but it might as well be. His contention that money was leant irresponsibly is undoubtedly true, but this irresponsible lending is easy to explain in the context of inflationary credit. It is simply a reflection of human behavior when there is too much credit in the economy. In 1999-2000 free credit led to the dot-com bubble; in 1973 it was commercial property in the UK; in 1928-1929 it was the US stock market; in 2006-2007 it was residential property in America. You really don’t have to be an economist to understand that the primary cause of irrational exuberance in markets is excess credit. The point has even been conceded by the mighty Greenspan.
We should worry that this obvious link between cause and effect is understood by everyone except Ben Bernanke and his fellow central bankers. They seem to have their noses so close to the grindstone of monetary policy that they miss the blindingly obvious. Furthermore, Bernanke’s speech was delivered to the American Economic Association, a forum attended presumably by economists, who were either too polite or too ignorant to laugh him off the stage.
We have new evidence, if it were needed, that those at the top in America have no clue how to deal with the very serious issues facing the economy. I shall summarise the consequential points briefly.
There has been continual expansion of credit in America ever since the Fed was founded, but importantly, this has accelerated substantially over the last ten years, and particularly since the dot-com collapse. The inflationary consequences have been greater than economists generally recognise, because inflation has been hidden by the continuing tendency for real prices of consumer goods to fall. These prices have benefited from transfer of production to low-cost centres, such as south-east Asia as well as from increased global competition.
None of these real price benefits are recognised in inflation targeting. The same mistake has been made in every business cycle since 1922. There is therefore no guarantee that there is a better hand on the tiller today, contrary to the puff that Bernanke is the world’s leading expert on the causes of the Great Depression.
Bernanke underestimates the economic distortions that result from excess credit creation. This confirms that he will deliver dollars by helicopter if we sink into a slump, and almost certainly be slow to turn off the tap in a recovery. The consequences are very inflationary at the price level.
It’s the same as offering unlimited drink as a cure to an alcoholic, but then if Bernanke doesn’t know what he is doing, we can visualise it happening.
By incorrectly blaming financial regulators for what is actually a failure of monetary policy, yet more regulation in an over-regulated sector will be encouraged. Inevitably this will increase restrictions and make it more expensive to offer financial services, reducing competition and further encouraging the contraction in bank lending. This result is the opposite to that which is intended.
By stating that the Fed is blameless in its management of monetary policy over an issue where it is most certainly not, the risk-premium for holding dollars is bound to rise. We already see the Sovereign Wealth Funds as net sellers, and now even Bill Gross at PIMCO is dumping Treasuries and corporate bonds. This is potentially the most serious and tangible consequence of Bernanke’s professed ignorance because the government will incur far higher borrowing costs as a result.
Assuming those present at the American Economic Association meeting considered themselves to be economically literate, it would be interesting to know if they agreed, disagreed or didn’t know whether the problem is a) poor regulation or b) lack of control over money supply.
I don’t suppose many of them gasped and stretched their eyes.