Ben Bernanke: Sweet and Sour Emergencies
Dan Denning discusses Senator Jim Bunning’s reasons for voting against Ben Bernanke for Fed Chairman — and then refutes Bernanke’s opinions on energy and the housing market.
Jim Bunning wasn’t one of them, at least not that I can recall. Bunning is a Republican Senator from Kentucky today. Back then, he was either a first-term or second-term member of the House of Representatives. Just another face in the crowd, or for me, in “the book.”
“The book” was actually a little red book whose pages were filled with the names and faces of all -437 members of the House. . Your average Congressperson looks just like your average dentist, insurance salesman, or hairdresser. Without the book, you’d never know that the man who looks just like your local auto dealer is, was in fact, a distinguished member of the House taking bribes from your local auto dealer.
We used “the book” to memorize the faces and match them with names. With that useful skill, we could take phone messages from the cloakroom and deliver them to members on the floor of the House, busy making laws. The messages were what you’d expect, or example: “Call your office,” or “Your wife is looking for you.” We never saw the important ones, if there were any.
Bunning pitched a no hitter in both leagues. But he also pitched that rarest of baseball feats, the perfect game. In fact, I’m willing to bet is one of the rarest accomplishments in sports. In 130 years of Major League Baseball, there have been only 17 perfect games. That amounts to one perfect game for every 15,000 games played.
Bunning pitched his on June 21, 1964, for the Philadelphia Phillies against the New York Mets. He was 32 years old and threw just 90 pitches over two hours and 19 minutes.
Ben Bernanke: Black Swans, Baseball, Fertilizer, and Exceeding Fundamentals
Perfect games are the black swans of baseball. It’s a rare event that you can’t predict. Yet you know it happens with a small degree of statistical regularity. In baseball, it takes a combination of luck and a pitcher with really nasty stuff to pitch a perfect game. Jim Bunning had nasty stuff. He still does. Just ask Ben Bernanke.
Bunning is the only member of the Senate Banking Committee who voted “nay” on the nomination of Ben Bernanke to be the chairman of the Federal Reserve. Bernanke was recommended by the committee anyway. His nomination will easily be confirmed by the full Senate. But Bunning’s rejection of Helicopter Ben is worth a second look.
In a statement issue explaining his vote, Bunning wrote:
“When I met with Dr. Bernanke when he was a nominee to the Board of Governors of the Federal Reserve, he promised me that he would not be a rubber stamp for Chairman Greenspan but an independent voice who would stand up to the chairman when he believed he was wrong. Sadly, Dr. Bernanke never once cast a dissenting vote. The chairman of the Federal Reserve must be an independent voice. Dr. Bernanke had the chance to prove he was an independent voice, he failed to do so. The position of Federal Reserve chairman is probably the most important economic choice the president has to make. He has chosen poorly.”
It’s true that Bernanke did spend time as the Chairman of the White House Council of Economic Advisors. It’s true this raises questions about his independence from the executive branch. And it’s true that Bernanke moved in lock step with Alan Greenspan on the Fed’s rate cutting and raising decisions.
But there must be other reasons Senator Bunning voted no. It turns out there are. A lot of them. Bunning submitted written questions to Bernanke during the confirmation process in front of the Banking Committee. Bernanke answered, in written form. You can find the complete list of questions and answers here:
There are two aspects of the future Chairman’s remarks I want to skewer into today’s Whiskey. The first is Bernanke’s all-too-common belief that the current energy, ahem, crisis, is strictly economic and that it will be regulated by market forces, not geopolitical ones. The second aspect is housing. And even though new home sales were up 13% in September to a record annual pace, anyone reading Ben Bernanke’s words realizes the Fed is a lot more worried about a bust than a bigger bubble.
Let’s take the simplest question first.
“Q.3. What is currently the most significant threat our economic expansion?
“A.3.[Bernanke] Energy prices have risen steeply in the past three years, and although the economy has accommodated these rises remarkably well thus far, continuing increases in the price of energy would pose difficult challenges for households and businesses. The proximate cause of the energy price increases is a rapidly growing global demand for energy, coupled with insufficient investment in new energy supplies to meet this growth. In the long run, high prices will curb energy demand and call forth new energy supplies. In the near term, however, energy price increases have the potential to spill over into general inflation, sap consumer spending power, and damp overall activity. A further jump in energy prices or a more pronounced reaction to those increases in prices that have already occurred could test the strength of the expansion. With respect to inflation, the Fed, thus far, has been largely successful in limiting the effects of higher energy prices on the broader rate of price inflation. But further energy price increases would also pose upside risks to the outlook for inflation.”
Bernanke’s assumption here is that high energy prices will come down for two reasons. First, when a thing gets more expensive, people use less of it, because they can’t afford it. The high price leads to falling demand. Second, the high price attracts additional competitors, who bring new supply on the market, thus bringing the price down.
Both of those are fine in theory. You’ll find them in any respectable economics textbook.
But oil is not just any commodity. Why? There is no simple, effective, abundant, and cheap alternative to using oil in today’s economy. We will not have a nation full of hydrogen cars and stations this time next year.
Or take another, less assuming example: agriculture. It was petroleum- and natural gas-based fertilizers, among other technologies, that led to the “Green Revolution” of the 1960s and 1970s. Without oil-based fertilizers leading to a huge increase in crop yields around the world, it would be impossible for the earth to support its current population. As Jim Kunstler writes in “The Long Emergency,” “Ninety-five percent of the nitrogenous fertilizers used in America are made out of natural gas, and so it has become indispensable to U.S. agriculture.”
“A world of 6.4 billion people, on the way to 9 billion or more, needs more protein than the planet’s croplands can generate from biologically provided nitrogen. Our species has become as physically dependent on industrially produced nitrogen fertilizer as it is on soil, sunshine, and water,” writes Stan Cox, a scientist at the Land Institute in Salina, Kansas.
“Vaclav Smil, distinguished professor at the University of Manitoba and author of the 2004 book Enriching the Earth: Fritz Harber, Carl Bosch and the Transformation of World Food Production, has demonstrated the global food system’s startling degree of dependence in nitrogen fertilization. Using simple math, the kind you can do in your head if there’s no calculator handy-Smil showed that 40 percent of the protein in human bodies, planet-wide, would not exist without the application of synthetic nitrogen to crops during most of the 20th century.”
“That means that without the use of industrially produced nitrogen fertilizer, about 2.5 billion people out of today’s world population of 6.2 billion simply could never have existed.”
Just two additional points on this issue of food and natural gas before we move back to future Chairman Bernanke’s energy worries. Energy is clearly worry, but so too is the worry that natural gas shortages in America could lead to soy bean shortages in China, which could lead to pressure of China’s massive poultry industry, which could lead to bird flu and the death of us all, or at least most of us.
Ben Bernanke: Protein
First, let’s talk about protein.
“Proteins are made up of smaller units called amino acids. There are about 20 different amino acids, eight of which must be present in the diet. These are the essential amino acids. Unlike animal proteins, plant proteins may not contain all the essential amino acids in the necessary proportions.” Thus says the Vegetarian Society at www.vegsoc.org.
The vegetarians continue, “Protein quality is usually defined according to the amino acid pattern of egg protein, which is regarded as the ideal. As such, it is not surprising that animal proteins, such as meat, milk and cheese tend to be of a higher protein quality than plant proteins. This is why plant proteins are sometimes referred to as low quality proteins. Many plant proteins are low in one of the essential amino acids. For instance, grains tend to be short of lysine whilst pulses are short of methionine.”
I am not a nutritionist, or a doctor, or a dietician. But I am curious about things. It’s clear human beings need protein. We can get it from plants or we can get in from animals Most of us get it from both.
China, lately, has been getting an awful lot of protein from soybeans, many of which are grown in North and South America. You might say, as Jim Kunstler implies, that China’s rise, strictly in terms of increased protein consumption, would have been possible without the oil boom of the 20th century. No natural gas, no soybeans. No soybeans, no extra protein boost for factory workers working longer hours. Think I’m making this up? Check out the chart below from the United States Department of Agriculture.
This char, by the way, is one of the reasons I recommended soybean and fertilizer producer Bunge (BG) in the pages of the The Bull Hunter and Strategic investment. The world needs more calories as much as it needs more oil.
The USDA reports that, with my emphasis added:
“China’s soybean imports for 2004/05 are revised higher at 24 MMT, up 800,000 tons from the July estimate. For the first 9 months (October-June), China’s soybean imports from the world totaled 18.3 MMT, exceeding last year’s total annual imports of 16.9 MMT. Strong import demand for soybeans is attributed to rising use of soybean meal as a protein source for swine, poultry, and aquaculture production….China’s 2004/05 protein meal consumption (converted to soybean meal equivalent) is estimated at 37 MMT. This reflects an annual growth rate of 13 percent, compared to 11 percent based on the July estimate. Strong protein meal demand is also reflected in China’s fish meal imports. China’s 2005/06 protein meal consumption is forecast at 40 MMT, up nearly 8 percent from the 2004/05 estimate as sustained economic growth should generate greater demand for protein meal in animal production. China’s 2005/06 soybean imports are forecast at 27 MMT.
Assuming that the soybeans are there to import, this is good news for soybean producers and exporters, the biggest of whom are in the United States and Latin America. The chart below from the USDA shows just how large China’s appetite for soybeans (and the protein they provide) is.
But notice the text I highlighted. It’s all well and good for China to get its protein from soybeans and other plants. But soybean meal (along with fishmeal) is in strong demand for China’s huge poultry, swine, and aquaculture industries.
I know you’ve heard a lot about hoof-and-mouth disease and bird flu lately. So let us take a moment to focus on pigs. In it’s latest report on world pork, poultry, and beef markets, the USDA has this to say about pork and China:
Accounting for 76 percent of the major producers’ increase forecast in 2006, China will drive pork production for those countries 3 percent higher in 2006 to just over 95 million tons. China will continue to dominate as the world leader with nearly 51 million tons of pork production…
Pork production continues to benefit from its role as a substitute for animal protein when trade in beef and poultry declines due to disease-related bans. Growth in pork production and consumption in some regions is due to substitution.
Despite various obstacles, China’s swine production has benefited from efficiency gains due to improved breeds and feed. This is reflected by increased imports of breeding swine. Increasing percentages of sow stocks compared to total inventory will translate into continued strong swine production in 2005 and 2006. Investment in hog slaughter and pork processing has also risen. Increased foreign investment through joint ventures will continue to boost efficiency and production.
I hope the USDA is right, of course. It would be good for China to have a larger swine breeding industry and the ability to feed itself. Even Chuck Schumer couldn’t say no to that. But Chinese consumption AND production of pork ought to concern history students at least a little bit.
Though it is debated, it is also widely accepted that the 1918 Spanish Flu originated in pigs, not birds. It was brought to Europe by GIs from Kansas, not by birds from China. But like all other pandemics, the key mutation in the virus was the one that allowed to be transmitted between human beings rather than between an animal (in this case pigs) to a human.
Of course, there was a mini-hysteria in 1978 about another swine flu pandemic. That never played out. Yet it’s not just China we have to worry about (although I’ll have more on China in a moment.) There was this gem earlier this week from UPI about the unique ability of pigs to act as genetic mixing bowls for all sorts of viruses:
Nov. 28, 2005 (UPI delivered by Newstex) — A federally funded study suggests U.S. farmers, veterinarians and meat processors have a markedly high risk of infection from flu viruses spread by pigs. Scientists conducting the study, funded in part by the National Institute of Allergy and Infectious Diseases, said the fact pigs can be infected by swine viruses, bird viruses and human flu viruses means they act as virtual virus “mixing bowls.” “The worry is if a pig were to become simultaneously infected with both a human and an avian influenza virus, genes from these viruses could reassemble into a new virus that could be transmitted to, and cause disease in, people,” said NIAID Director Anthony Fauci. The U.S. swine industry has shifted during the last 60 years from small herds on primarily family farms to large herds maintained in large, confined facilities. The crowded conditions make swine flu infections among pigs a year-round occurrence, rather than the seasonal event they once were. The study appears this week at the Web site of the journal Clinical Infectious Diseases.
You must understand, it’s not that I want these things to happen. But like black swans, LTCMs, and Jim Bunning’s perfect game, rare things do happen. It just so happens with the earth’s ecology they tend to happen when you crowd teeming masses of humanity in with the animals they slaughter and kill for protein. Those conditions exist all over the world, of course. But they are most pronounced in Asia and especially China.
Yet this is not all bad news for investors. Here in Australia and next door in New Zealand exporters are champing at the bit. Australia has the largest reserves of natural gas in the AsiaPacific reason, with 90 trillion cubic feet in the ground. With natural gas only 17% of domestic energy use, this makes Australia a natural gas exporter to China and Japan.
Liquid natural gas appears to have a bright future here as well, at least as long as the gas lasts. Australia is the world’s sixth largest LNG exporter. And when it comes to beef, lamb, and dairy products, New Zealand is sure to benefit from the bi-lateral trade deal it hopes to seal with China in 2006.
You may remember the Chinese National Offshore Oil Corporation (CNOOC). CNOOC’s money, all $18.5 billion of it, was no good at UNOCAL or in the U.S. Senate. But it may be good enough to secure China $21 billion in Australian LNG. The gas would be shipped from Australia’s Greater Gorgon field of the coast of Western Australia to China’s LNG terminal in Guangdong (or perhaps any of it’s three other LNG terminals slated to come on line in the next three years.)
Yet even if this deal doesn’t go through-Chevron, which owns 50% of the Gorgon filed singed a deal with Japan’s Chubu electric last week to begin exporting 1.5 million tones of Gorgon LNG to Japan for the next twenty-five years-there are others already in place and surely others that will come along. As long as the gas lasts, that is.
Ben Bernanke: The Chairman’s Cryptic Warning?
You might recall the market’s strange reaction to Alan Greenspan’s decision on June 10th, 2003 to sit down in front of the House subcommittee on Energy and Commerce and give a speech about natural gas. After all, you’d think managing the nations money supply and interest rates would be job enough for the Chairman. But he’s a talented man. And back then he was a worried man. Here are the Chairman’s closing remarks from that day. The emphasis added is mine:
the long-term equilibrium price for natural gas in the United States has risen persistently during the past six years from approximately $2 per million Btu to more than $4.50. The perceived tightening of long-term demand-supply balances is beginning to price some industrial demand out of the market. It is not clear whether these losses are temporary, pending a fall in price, or permanent.
If North American natural gas markets are to function with the flexibility exhibited by oil, unlimited access to the vast world reserves of gas is required. Markets need to be able to effectively adjust to unexpected shortfalls in domestic supply. Access to world natural gas supplies will require a major expansion of LNG terminal import capacity. Without the flexibility such facilities will impart, imbalances in supply and demand must inevitably engender price volatility.
As the technology of LNG liquefaction and shipping has improved, and as safety considerations have lessened, a major expansion of U.S. import capability appears to be under way. These movements bode well for widespread natural gas availability in North America in the years ahead.
“Perceived tightening,” driving “industrial demand” out of the market. Was Greenspan concerned then, among other things, about what the loss of domestic gas production and high gas prices would do to American agriculture? Was he further concerned that a drop-off in American crop yields would have a domino effect across the world, especially China-where poultry, beef, and swine herds get much of their protein from soybeans? Or was he just worried, like any good politician would be, that rising gas prices and a cold winter spell a political disaster for northeast politicians-not to mention real suffering for Americans who have no idea just how thin our nation’s gas tether is.
Ben Bernanke: Should Bernanke be worried about these things too?
Alan Greenspan gives a speech on natural gas and all but proclaims that future American demand for natural gas can only be met through LNG. The Canadians, he pointed out earlier in the speech, don’t have any extra gas to send our way. We’re already consuming 85% of it.
Perhaps Greenspan wouldn’t have gone on to tie in the results of falling industrial demand for gas to what happens in the world’s food markets, or in China. But that is what we’re here for at Whiskey & Gunpowder.
And before I move on to Mr. Bernanke’s other fears, let me put a fine point on the dangerous combination of high natural gas prices resulting from peak gas production, a fall off in global fertilizer production and crop yields, coupled with a newly created demand for protein in China-a nation which had a worse week geopolitically than even George Bush could have imagined.
What I’m getting at is one of two possibilities: a massive famine in China, sparking even more political violence and collapse of the communist government. Or, in the attempt to avoid a massive famine, the outbreak of either swine, avian, or some new and even deadlier flu the world hasn’t seen yet.
Ben Bernanke: The Technology Fallacy and the Energy Emergency
Now that we’ve taken a very speculative look at what some of the natural consequences could be to rising natural gas prices in a peak oil world-namely a massive global famine/and or pandemic, returning the earth to a pre-peak oil and sustainable carrying capacity-let’s tackle one of the great myths of cornucopian economics, that technology will bail us out.
For this section I’m indebted to James Kunstler’s excellent book, “The Long Emergency.” It belongs on any serious investor’s bed side table, marked up with notes and questions. But let me first remind you of what Dr. Bernanke said regarding the risk of high energy prices. He said, “In the long run, high prices will curb energy demand and call forth new energy supplies.”
There are two major mistakes here in Bernanke’s thinking, and Kunstler nails both of them in his book. First, there are no easy, cheap, and abundant replacements for the things oil brings to modern life. There is no curbing the appetite for food, short of death. In the long run, with no viable replacement for natural gas to feed humanity on its current scale, we will be either freezing or starving.
There are no replacements for oil and gas that allow Asia’s three billion new capitalists to live at the energy density of the average American. Demand will not fall. It will collapse in countries that don’t have the cash to buy depleting resources, or the military force to seize them.
It is one of the great curses of mainstream economists to be obsessed with equilibrium, the idea that supply and demand are always in harmony at just the right price. But to borrow a phrase from economics, there is no diminishing marginal benefit or utility for oil at higher prices. The demand is inelastic.
That is, it either stays the same and grows (more trips to the grocery store, air travel, food imported from all over the world fresh on your shelves daily) or it snaps altogether. The price of oil gets so high that it simply precludes the kind of behavior we’re used to in our oil-abundant economy.
So if high prices fail to discourage energy demand without destroying it altogether (and throwing the world in to a long period of zero or negative growth) then what are the alternatives? Well, for one you have resource wars. Some people think we’re in one already and have been for years. But can’t technology bail us out? In The Long Emergency, Jim Kunstler says no, and then some:
“What is known, therefore, about the geology of oil suggests there are no inexhaustible reserves…and that it is very unlikely that known oil fields or basins can be ‘replenished’ from some mysterious source far deeper beneath the earth’s crust, as some wishful commentators would like to believe. In fact, all credible authorities agree that these special and precious pockets of fossil hydrocarbons will all be gone by the end of the 21st century even if the rate at which we use them doesn’t increase. The complacency over this rather startling fact is due to the presumption that technology and markets will, naturally, rescue us….
The belief that “market economics” will automatically deliver us a replacement for fossil fuels [the ‘new energy supplies Dr. Bernanke alludes to]is a type of magical thinking…
This age old tendency of humans to believe in magical deliverance and wish for happy outcomes has been aggravated by the very technological triumphs that the oil age brought into existence. Technology itself has become a kind of supernatural force, one that has demonstrably delivered all kinds of miracles within the memory of many people now living-everything from airplane travel to moving pictures to heart transplants.
I myself admit to being spoiled by abundant oil and technology. I can travel to Australia and live and work here with relative ease, thanks to the internet. Kunstler continues:
There’s no question technology has prolonged life spans, relieved misery, and made everyday life luxurious for a substantial lucky minority. A hopeful public, including leaders in business and politics, views the growing problem of oil depletion as a very straightforward engineering problem of exactly the same kind that technology and human ingenuity have so successfully solved before, and it therefore seems reasonable that the combination will prevail again. There are, however, several defects in this belief.
It does bother some people, in an almost instinctive way, when you suggest that there are physical limits on what human ingenuity can overcome. It’s natural, if you’re a cow, to want to jump over the moon. That is why we are always encouraged, especially in America, to reach for the stars. If we really believed in fixed limits to our future, we might not get out of bed in the morning. But sometimes this belief in the ability of technology to solve any problem is overdone. Today is one of those times.
We tend to confuse and conflate energy and technology. They go hand in hand but they are not the same thing. The oil endowment was an extraordinary and singular occurrence of geology, allowing us to use the stored energy of millions of years of sunlight. Once it’s gone, it will be gone forever. Technology is just the hardware and programming for running that fuel, but not the fuel itself. And technology is still bound by the laws of physics and thermodynamics, which both say you can’t get something for nothing, and without the petroleum “platform” to work off, we may lack the tools to be beyond the current level of fossil-fuel based technology.
IN the meantime, the rate at which we use oil IS increasing, . This tends to have a destabilizing effect. It forces long-term planners like nation states to confront the possibility that if cooperation doesn’t work, conflict might. So stabilization is urged, as it was this week in Asia. “Stabilizing energy demand and supply among Asian countries is vital if a scramble for resources is to be avoided, analysts from across the region agreed in Tokyo last week.” reports the Singapore Business Times. The story goes on to repeat the facts energy bulls are well aware of: Asian oil consumption will double over the next 20 years.
Environmental groups are worried about the huge amount of water expanding BHP’s Olympic Dam project will take (a legitimate worry.) And other groups are concerned that Australian uranium might not just go into Chinese fuel reactors, but will lead to increased nuclear proliferation and nuclear terrorism.
Perhaps those concerns are valid. But I don’t suspect it will stop BHP from producing uranium or China from buying it. China has already spent over US$6.3 billion this year on acquisition of real assets overseas, especially in Australia. Australia is resource rich. China is cash rich. Business will get done.
Australia may, for now, have natural gas. But it does not have oil. And for oil consumption in Asia to increase, there will have to be strategic cooperation among Asian nations in the pursuit of increasingly scarce resources, not competition. And with no “swing producer” like Saudi Arabia to simply increase production to meet the new demand, the entire market mechanism that allows nations to conduct somewhat rational (or at least non-belligerent) energy policies suddenly fails. While Dr. Bernanke waits for the market to magically fix things, desperate governments across the globe will do some man-made fixing of their own, or at least try.
As Kunstler writes:
“Rising demand among still-growing populations will bid up the [oil] price. The lack of a moderating market mechanism, such as surplus supply, to influence price will, by default, lead to allocation-by-politics…The economic stress among virtually all nations, the rich and the poor, the advanced and the “developing,” will be considerable and is certain to lead to an increasingly desperate competition for diminishing supplies of oil.”
Dr. Bernanke is right to see rising energy prices as a threat to the American economy. But being an economist, he fails to appreciate the political and sociological aspect of rising energy prices. The Chinese won’t be content settling for less oil any more than Americans used to paying less than $2 for a gallon of gas. The market mechanism for peacefully adjusting the demand for oil (by increasing supply) simply doesn’t exist, because the oil doesn’t exist in the abundant and easy-to-reach quantities it used to.
“Further inflation” because of higher energy prices is not just a risk, then, but a near certainty. There is a point, of course, at which oil becomes so expensive that it throws the global economy into a devastating regression to the mean of economic growth, in this case a depression.
It’s not what anyone wants to hear. But until you appreciate the magical powers of cheap oil and low interest rates to grow an economy artificially fast, you cannot appreciate the seriousness and the degree of the slowdown when those interest rates rise and that oil is no longer cheap. Dr. Bernanke is either bluffing or he naively believes that the nation states of the world will play nice in the competition for scarce oil, or that someone will come up with a just-in-time technological solution to the whole very real problem of physical scarcity.
You don’t have to a Malthusian view to recognize that there are some physical limitations on economic growth. You don’t even have to be an economist from Princeton. An economy needs energy every bit as much as it needs capital. And when energy is scarce, it becomes its own kind of capital.
In human terms, a man can do a lot with his hands in the desert, including building shelter and growing things. But he can’t do it without water. And when water is scarce, access to it is a kind of power. It’s a strange accident of history that a place with so few resources like the desert of Arabia should have in abundance the one resource without which the industrial West would not exist.
Maybe when Peak Oil has done its mean regressing work on global growth, the oil in the desert will become less important. Thus, the huge petrodollar profits that fund anti-Western maddrassas all over the world will disappear. And the tribal rivalries of humanity will go back to being more local than global. That’s one aspect of globalization — the clash of civilizations — I could live without.
Ben Bernanke: Helicopter Ben on Housing
The section above on oil and energy and protein and soybeans is long, but I think it’s absolutely crucial that you-as an investor and as someone who wants to live through what Kunstler calls “the long emergency-think about the very real possibility that peak oil is going to change people live. And the extreme end, it will kill a lot of people, which is a radical change to your living condition.
If you’re in a position to prepare, however, there is still time. And of the things you can also do to prepare is take note that the next Chairman of the Federal Reserve has recognized that a burst housing bubble could do severe damage to the American economy.
In reply to Senator Bunning’s question, Dr. Bernanke wrote that the housing market posed certain risks to the economy. Specifically, he wrote:
“Developments in housing markets also bear close monitoring. Housing prices have risen rapidly in recent years, and concerns have been expressed in many quarters about whether the current high level of prices will be sustained. It is intrinsically very difficult to assess whether the value the market assigns to any asset is fundamentally justified, and housing is no exception to this rule.”
It is refreshing to hear a Fed official to tacitly admit that the market value of an asset may not be fundamentally justified. It would have been more refreshing for Bernanke to admit the Fed’s role in creating the disparity between market value and fundamental value. He continues:
“Certainly, some powerful fundamental forces have contributed to the run-up in housing prices, including growth in jobs and incomes, demographic trends, low mortgage rates, and limited supplies of buildable land in some areas. However, it is also true that exceptionally rapid price appreciation and what appears to be speculative buying have been observed in some local markets, suggesting that prices may exceed fundamental values in some areas.”
Fair enough. So there may be some tiny bubbles somewhere. Bernanke does go on to acknowledge that the tentacles of the bubble have found their way into consumer spending, the labor market, and the very financial system of the country:
“Whatever the sources, house price increases will surely moderate at some point, if they have not begun to do so already. If that moderation is not too sharp, then the slowing of consumption and residential investment that might result should be consistent with the modest cooling of growth that many forecasters expect over the next year or so. A sharper slowdown, less likely but possible, would have a larger effect on the growth of real output, particularly if it were to occur in the context of continued adverse developments in energy markets.”
So, a sharp slowdown in house prices, coupled with a sharp increase in energy price would have a “larger effect on the growth of real output” in America. You can say that again. And you can also say that both scenarios are far more likely than the future Fed chairman would care to admit.
This is why I continue to look for attractively priced long-term put options on TLT, IEF, and any other proxy of U.S. government bonds. In response to last week’s Whiskey & Gunpowder essay that the United States might just eventually default on its official obligations, a reader wrote in telling us to give up on the doom and gloom. He did not, however, offer to buy me a beer…
Sorry, folks. I’m not trying to be uncheerful. But I am trying to let you know that the thing which most economists, including Dr. Bernanke, consider improbable is lining up like the perfect proverbial storm: geopolitical energy conflict, energy inflation and the collapse of the dollar, and ultimately, the collapse of the Empire of Debt.
That doesn’t mean the collapse of America, although I see from Drudge that network television is hard at work on just those themes for the spring season. They must be reading The Daily Reckoning. Don’t look for “grand solutions” to these problems. Look for simple, safe ones. I believe the investments I’ve recommended and continue to pursue will help see you through the storm, and perhaps even with a smile.
But let’s not forget there’s a storm.
Which brings me to my last quote from Dr. Bernanke’s written testimony. Emphasis added is mine. Note that the Bernanke is loud and clear that the Fed does not want to be on the hook for a default on GSE bonds. Whether the Fed will take any of the unconventional measures Dr. Bernanke was famous for exploring in his “zero bound” policy paper is another matter. For now, the Fed is worried about the size of GSE balance sheets and wants the market to know it:
“Q.8. The Fed has been on the record with their fears of Fannie Mae and Freddie Mac being systemic risks to our financial system. Are you worried about other large financial institutions with portfolios similar to the GSEs being systemic risks?
“A.8. Market discipline is typically the governing mechanism that constrains leverage and ensures that firms do not undertake excessive risks. The market system generally relies on the vigilance of creditors and investors in financial transactions to assure themselves of their counterparties’ current condition and the soundness of their risk-management practices.
“Because of the availability of deposit insurance, market discipline is not by itself sufficient to control risk-taking in the banking system; for this reason, the Federal Reserve and the other banking agencies supervise and regulate banks. I believe that the tools available to the banking agencies, including the ability to require adequate capital and an effective bank receivership process, are sufficient to allow the agencies to minimize the systemic risks associated with large banks. Moreover, the agencies have made clear that no bank is too big to fail, so that bank management, shareholders, and uninsured debt holders understand that they will not escape the consequences of excessive risk-taking. In short, although vigilance is necessary, I believe the systemic risk inherent in the banking system is well managed and well controlled.
“In the case of the GSEs, market discipline is problematic. Market participants recognize that the GSEs are closely tied to the federal government and such ties create a view among market participants that the GSEs are implicitly backed by the federal government, thereby weakening market discipline. Consequently, strong regulatory authority and controls on GSE risk-taking are needed to ensure that they do not create systemic risks.”
Expect the Bernanke Fed to advocate larger regulatory control of the GSEs. Expect politicians who talk about the right of every American to a McMansion to resist. Expect the meltdown at Fannie Mae to continue in the back pages of The Wall Street Journal. Until one day next year, as interest rates rise, it burns its way to the front pages. And expect the chart below, which has lately shown a rally, to get much, much worse.
And on the other hand, it is never to late to buy some barbaric insurance. With gold cresting $500, can $1,000 be far behind? Not too far.
If the wait is short, markets have gone mad and something horrible has happened geopolitically, perhaps in Iran. If the wait is long, you’ll have time to read a new encyclopedia I’m compiling, with the help of friends and readers like you. The working title is: A Guide to Learning and Mastering the 42 Skills that Make Western Civilization Possible.
The global division of labor has meant that we don’t have to remember many of the important skills that led the comfortable standard of living we now enjoy. With the help of technology (the internet) I’m going to introduce you to those skills and show you how to perform them, or at least show you how people who really know how to do them do them. Coming soon…Until Then,
November 30, 2005