What's Bad for Bernanke Is Worse for You
Bad day for stocks, Monday. A bad day. Not a terrible day. Not a crash day. Just a bad day.
The Dow fell 140 points. This was baaaad…because it shows that the stock market does not really buy Bernanke’s storyline.
You’ll recall that when we left off last week, Ben Bernanke assured the world that while the recovery was not exactly what he had hoped for, he nevertheless had the situation in hand. He said he had the tools necessary to fix the problem and would do whatever was required.
The initial reaction was positive. The Dow rose more than 160 points on Friday. Some analysts thought the market’s downward trend had been broken. But it needed follow-through on Monday. Instead, the market fell.
The fact is, there is no recovery…and no recovery is possible…and investors are beginning to realize it.
Then what is going on? A “Great Recession,” say some analysts. A “depression,” say others.
There is a good article in The Financial Times that helps understand what is really going on. It’s by Ken Rogoff and Carmen Reinhart; you’ve heard of them before, dear reader. They are the ones who researched dozens of episodes of financial crisis and sovereign default throughout history.
Today, they write in the FT about what happens after a financial crisis. Well, what do you think? Do you think you get a “recovery”? Do things go back to normal? Is the recession over quickly and painlessly?
Not at all. Instead, there is rarely anything you would recognize as a “recovery.” Things do not go back to normal because they weren’t normal before the crisis. Crises are caused by abnormal conditions — usually too much credit, too much debt, too much spending and too much speculating. Then, when the bubble blows up, it typically takes a long time for the economy to get back on its feet.
Over the following ten years, unemployment usually stays higher than it was before the crisis.
Growth rates are usually lower.
And ten years after a blow-up in real estate house prices are still usually BELOW where they were when the crisis hit.
But what if the feds really get on the ball and try to turn things around? Then, watch out!
We read an article on dying yesterday. Here’s a question for you, dear reader. Would you rather live in a recessionary economy or die in a booming one? We’ll take the recession. Probably most people would. Heck, make it a depression.
There are a lot of illnesses for which there are no cures. Still, people will spend a fortune…and endure unspeakable treatments…in the hopes that they will be the one in a thousand who survives.
So too are people ready to believe that Dr. Bernanke can cure what ails the US economy. We don’t think so. Because we don’t think the economy is “sick.” We think it is healthy…and finally correcting the mistakes of the Bubble Epoque.
Leading economists and the feds have believed, for example, that there was some problem of “liquidity” that was temporarily blocking the flow of cash and credit. They believed the problem could be solved by making more money available. That was why the Fed bought an extra $1.4 trillion of the banking sector’s suspicious “assets.” They wanted to make sure the banks had money to lend.
Well, now the banks have plenty of cash. Businesses too have record holdings of cash. Even households are rebuilding their cash accounts.
But who’s borrowing? Who’s spending? Who’s buying new houses, for example? (New house sales are currently taking place at the slowest rate ever measured.)
CNN: “Credit if finally available, but no one wants it.”
Why don’t people borrow?
Because it’s not a liquidity problem. It’s a debt problem. A solvency problem. And it won’t go away by making more cash and credit available. Instead, all those bad decisions, bad loans, and bad investments have to be cleaned up. And that takes time. And while the economy is de-leveraging, people are becoming more cautious…more risk-averse…more modest in their expectations.
What do Rogoff and Reinhart say about governments’ efforts to fix these problems? What does history show?
They say the feds often make the situation worse.
Not only do governments typically pour bad money after good, they also disrupt the process of correction. Insolvent banks are kept alive. Big businesses that ought to go broke and be sold off are instead propped up…the lights are kept on by government subsidies, preventing new competitors from occupying the space. Consumers and investors keep waiting for the promised “recovery”…for the cure…for the fix. Instead of quickly adjusting to the new circumstances, they delay…they hesitate…they postpone unpleasant changes.
They might quickly sell a house at a loss, for example. They could then go on with their lives. But when they hear the feds tell them they have a new program in the works…or a new stimulus bill in Congress…or new action by the Fed…what are they supposed to think?
“Maybe I should wait and see if this new effort does the trick…” they say to themselves. “I’ll feel like a real fool if I sell now and then the feds get a new bull market going.” “Maybe I should wait before accepting a job at a lower salary; it says in the paper that the economy should recover by summer…”
The economic setbacks of the 19th century were sharp, but fairly short, affairs. The contribution of modern economics has been to stretch them out and make them worse.
September 1, 2010