Unforeseen Contingencies

I’m starting to be alarmed. Fed Chairman Ben Bernanke spoke to Congress on Wednesday (27 February). I’ve read Bernanke’s testimony. I’ve heard some of the questioning and his answers. Bernanke is a highly trained economist. Yet much of what he said is nonsense, not so much because it’s factually incorrect, but because his interpretation is out of touch with economics (i.e. reality).

Consider this: "And, as a whole, the nonfinancial business sector remains in good financial condition, with strong profits, liquid balance sheets, and corporate leverage near historical lows."

Commerce Department announced earlier the same day that its measures of durable goods orders declined 5.3%. And the Conference Board announced its measure of consumer confidence fell for the second straight month, and is at a 17 year low. Did these wonderfully "liquid balance sheets" take into account that demand is collapsing? Will "strong profits" continue, when consumers (who have $1.35 in debt for every $1.00 of income, on average) find they can’t make their minimum credit card payments?

Inflation? Bernanke: "Consumer price inflation has increased since our previous report, in substantial part because of the steep run-up in the price of oil. Last year, food prices also increased significantly, and the dollar depreciated."

But don’t worry, he continues, because "core inflation in the first half of 2007 was damped by a number of transitory factors -- notably, unusually soft prices for apparel and for financial services -- which subsequently reversed. For the year as a whole, however, core PCE prices increased 2.1 percent, down slightly from 2006."

In other words, a cooked-up figure "core personal consumption expenditures" indicates inflation really isn’t a problem. Someone who doesn’t eat or use energy, and only buys new clothes and services of mortgage bankers will find unusually low prices! Great news! (Point of clarification: "core inflation" excludes food and energy prices.)

In his questioning, Bernanke’s answers seemed crazy. He seems to think higher oil prices cause inflation. He doesn’t seem to think his expansionary monetary policy does. Go figure.

His main point: "The incoming information since our January meeting continues to suggest sluggish economic activity in the near term.

The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further."

Good grief. Let’s put this all together. Bernanke’s main worry is recession. But why shouldn’t the bad investments in housing, in commercial real estate, in credit card loans, etc., be liquidated? Shouldn’t banks, lenders, and borrowers who made bad financial decisions have to face the consequences of their decisions? Bernanke’s Principles textbook says so. But Bernanke himself apparently doesn’t, and my guess is that it’s simply because the magnitude of the problem is so large. The banking system must be on the verge of a real breakdown. Nouriel Roubini is now estimating that the costs to Americans of fixing this could go as high as nearly 1/5th of U.S. GDP... that's, (gulp) $2.7 trillion. Martin Feldstein outlines a scenario in which the financial system breaks down, and Fed monetary policy is powerless to stimulate it. Nightmare stuff.

Mr. Bernanke is willing expand the money supply to help try to avoid this nightmare. It won’t work, but it will generate inflation. It will cause further collapse of the dollar against other currencies. Pump out new money all you like, the problem is that Americans don’t save, and have been living on borrowed funds from abroad and easy credit from the Fed. Artificially low interest rates, speculative demand and artificially high housing prices aren’t cured by continued expansion of the money supply. I don’t believe recession is avoidable, and more stimulus isn’t the cure for what ails us. "Stimulus" is just Keynesian AD nonsense. The problem here isn’t insufficient aggregate demand, the problem is the Austrian story: bad investments and structural imbalance caused by central bankers.

I understand why Bernanke is fixated on averting a recession, since "liquidation of bad investments" in this case involves families losing their homes, and maybe jobs. (And even worse, from the policymakers’ perspective, think of the losses to financiers!) Well, the losses are already there, and this is all simply a game of figuring out how to distribute them among hapless consumers and taxpayers so as to minimize the dislocations. Inflation is just one of the tools for doing this: "privatize the profits, socialize the losses," as they say. I don’t count on a soft landing, though. The problem is too big.

Yes, it's alarming. We have recession ahead, and this "stimulus" Bernanke is promoting will not fix it, but will wreck the dollar, making things worse.

I also understand why Bernanke doesn't want to acknowledge the extent of the mess. But back to his speech to Congress: when Greenspan spoke, he at least would pay lip service to fiscal, monetary, and financial responsibility, things which are, in fact, the only real way out of this mess. Bernanke didn’t even mention these.

Say, that has me wondering, just what is Greenspan saying these days? Uh-oh... He’s telling the Gulf States to drop their dollar pegs. It’s probably good advice. Just wait until they really take it to heart and stop using the dollar for oil contracts. Imagine: oil at 66 euros per barrel (esentially its present price), and the dollar at 0.5 euros (instead of its current 0.66).

I wonder what Bernanke will say to Congress when that happens.

(Note: Pretty bleak, huh? To cheer yourself up, click on the $10 note at the top of this post.)