Why Bernanke's attempts to fix the economy are only a façade
America has an economy that produces about $13 trillion of activity each year. America also has a Federal Reserve Chairman that produces about 13 trillion raised eyebrows each year.
Last week, in Jackson Hole, Wyoming, Bernanke raised a few more eyebrows by asserting that the Federal Reserve remains in control – more or less – of economic conditions here in the United States.
Like a guy who falls down a flight of stairs, then stands up and says, “I meant to do that,” Bernanke insisted the economy’s dismal trajectory is neither particularly surprising nor particularly worrisome. “The preconditions for a pickup in growth in 2011 appear to remain in place,” the Chairman declared. And even if economic growth continues to disappoint, the Chairman claims he’s still got lots more gadgets in his bag of tricks.
“Should further action prove necessary,” he remarked, “policy options are available.” The list of potential “further actions” include: 1) Further purchases of securities; 2) a change in the Fed’s policy statement and; 3) a reduction of the interest rate it pays on banks’ excess reserves.
In other words: 1) Printing money; 2) Issuing comforting words and; 3) Encouraging leveraged risk-taking.
“The FOMC will do all that it can to ensure continuation of the economic recovery,” Bernanke added. “The issue at this stage is not whether we have the tools to help support economic activity and guard against disinflation. We do.”
Here’s our question: Do the words or deeds of a Federal Reserve Chairman – even an intelligent, well-intentioned Federal Reserve Chairman like Ben Bernanke – possess any real power to counteract the natural forces of economic entropy? Or to rephrase the question, can one man really change the course of a $13 trillion economy?
Your editor is skeptical. Isn’t Ben Bernanke just building sand castles?
For a while the sandy walls will redirect the whitewater. But at the end of the day, the ocean will have its way and little Ben will have a sunburn.
Last Friday, investors seemed to believe that the Fed’s sandy walls could actually repel the forces of debt liquidation and creative destruction. They seemed to believe that an “FOMC statement” here or a “policy measure” there could actually prevent doomed businesses from failing, or underwater homeowners from defaulting.
And so for one day the stock market rallied, bond prices slumped…and investors entertained happy thoughts. But the truth of the matter is that the economy was just as feeble on Friday as it was on Thursday.
Stocks did not rally because Ben Bernanke is back in control. Stocks rallied because the time for a rally had arrived. Nothing more; nothing less. Numerous measures of investor sentiment had tumbled to extreme negative readings. And as every seasoned investor understands, whenever sentiment reaches an extreme, share prices usually head in the opposite direction…at least for a while.
“A good market bottom seems at hand,” options pro, Jay Shartsis, observed last Wednesday near the close of trading. “The ‘peak’ open interest in the S&P 500 Index ETF (NYSE:SPY) is in the Sept 100 puts with an open interest of 435,578. In contrast, the largest call open interest is only 145,869 in the SPY Sep 115 call. Way too many bears- this is a bullish indication for the broad market.”
In other words, for those readers who do not “speak option,” bearish trades outnumbered bullish trades by about three to one. Such lopsided bearish trading is very unusual, and usually indicates a short-term change in the market trend – from down to up.
But do not forget that such indicators tend to be very short-term. Longer-term, the song remains the same. Notwithstanding Chairman Bernanke’s optimism, the US economy continues to produce a dreary drumbeat of negative economic reports. Accordingly, the Commerce Department lowered its estimate for gross domestic product in the second quarter to an annual pace of 1.6 percent from an initially reported 2.4 percent.
The economy’s funk is no great surprise. Prosperity does not usually proceed from the interaction of government intervention and private sector chicanery. The US economy has endured way too much of both. Sustainable growth emerges from the interaction of investment, innovation and industry.
Unfortunately, Bernanke’s remarks in Jackson Hole remind us that delusions die slowly. Even after the crisis of 2008, a nation of investors still places its faith in the words and deeds of a Federal Reserve Chairman. At the same time, a nation of investors still places its faith in the words and misdeeds of the American credit rating agencies.