TCS Daily


Is Bernanke Wise Enough to Exit?

By Larry Kudlow - July 22, 2009 12:00 AM

Fed head Ben Bernanke went before Congress this week with his midyear update on monetary policy and the economy. In so many words, the former Princeton economics professor is taking credit for averting the collapse of our financial system; is cautiously optimistic about economic recovery by year-end and 2 to 3 percent growth in 2010; and says he has the tools and wisdom for a carefully crafted liquidity-exit strategy that will prevent future inflation and more asset bubbles.

Do we believe him? Is he credible? Or is this a triumph of hope over experience?

Before, during, and after Bernanke's testimony a flood of corporate-earnings reports beat Wall Street expectations, sending stocks into an unexpected summer rally that has virtually beaten the bears into submission. A third-straight rise in the Index of Leading Economic Indicators points emphatically to recovery and an end to the recession. Strong profits at companies like Apple, Caterpillar, Merck, and Starbucks suggest that "someone, somewhere, somehow is spending money," in the words of Wall Street blogger Douglas McIntyre. Or maybe the Fed's liquidity mustard seeds are finally germinating.

Yes, nearly 10 percent of the workforce is unemployed. But the other 90 percent who are still working -- along with the companies that employ them -- are out there taking risks and going about their daily chores. Think of them as recovery canaries in the coal mines of the economy.

So I say amen to Mr. McIntyre, which means Mr. Bernanke should be getting ready to implement his exit strategy.

In ballpark terms, the Fed pumped $1 trillion of new cash into the economy to stop the financial crisis last fall. So far in 2009, the Fed's balance sheet has flat-lined; no new money has been created. That, by itself, could spell the beginning of an exit strategy.

In a much-ballyhooed editorial in the Wall Street Journal this week, Bernanke said that while a near-zero interest rate will be maintained for an extended period, the Fed is on guard to stop potential inflationary pressures. And he correctly noted that most of the Fed's newly created cash has been deposited by the banks as reserve balances at the Fed itself.

These "excess reserves" are way more than the banks need to keep at the Federal Reserve. And when banks re-employ these reserves with renewed lending, Bernanke says he'll have a signal to gradually take restraining actions. The Fed can drain the excess cash by selling Treasury securities, or it can pay higher interest on the reserve balances themselves.

I find it very interesting that these so-called excess reserves are already coming down. Last May they were running close to $850 billion, which is an astronomical number. But in the last few weeks they've dropped to $700 billion. This may suggest that the economy's animal spirits are awakening from their slumber.

My hope is that Bernanke & Co. actually uses the excess reserves as a policy variable, rather than as something to be manipulated by the interest charged for those reserves. But the bigger question for future Fed policy may be whether the government bank employs forward-looking market-price indicators to gauge future inflation and its own operations. These consist of the dollar, commodities (including gold and energy), and Treasury bond rates.

Mr. Bernanke has a poor track record here. As Alan Greenspan's copilot in the early 2000s, Bernanke deliberately dissed the dollar and commodities in Fed meetings as potential inflation influences. So from 2002 to 2005, an over-easy Fed bubbled up housing, energy, and commodities, allowed the dollar to sink, and wound up moving the consumer price inflation rate from 1 percent to 6 percent, all of which helped sink the economy into the Great Recession.

As chronicled in the Wall Street Journal editorial pages, these Bernanke-sponsored monetary errors weren't the result of stupidity, but of using the wrong targets -- such as the unemployment rate, resource-capacity underutilization, or the difference between actual and potential GDP. These statistical measures are highly suspect, whereas market prices are the real McCoy.

So right now, if the Fed targets the unemployment rate and the recessionary underutilization of economic resources -- as Bernanke suggested it might in his congressional hearing -- it is quite possible the central bank will repeat the very same mistakes it made in the early part of this decade.

Complicating matters, President Obama's massive spending-and-borrowing policies -- and the tax hikes to pay for them -- will significantly reduce the economy's ability to grow. This means that each dollar of Fed-created money becomes potentially more inflationary, just as it means unemployment will stay higher than usual.

I have no doubt that Mr. Bernanke and the Fed have the right tools to protect the consumer dollar. The question is: Do they have the wisdom?


This article first appeared on Kudlow's Money Politic$.
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14 Comments

Larry, you said ...
"President Obama's massive spending-and-borrowing policies...will significantly reduce the economy's ability to grow. This means that...unemployment will stay higher than usual."

Unemployment is higher than usual because we are in a recession and companies are laying people off. When the economy recovers to the point that we are no longer in a recession then companies will stop laying people off. When the economy starts growing faster than productivity gains can support then companies will start hiring again and the unemployment numbers will improve.

It is possible that the Administration's borrowing is sucking up private capital that might otherwise be invested into corporations...but unless the banks increase lending then the incremental liquidity needed to leverage up such equity investments will not be there and those private funds will simply stay on the sidelines. For the moment everyone with cash seems to be holding onto it...including the bankers...so there is little evidence that Treasury debt instruments are confounding anything.

If that government spending does not turn out to be very stimulative then at least we can say the TARP kept the financial system from melting down around us...taking our economy with it.

The government is not big enough to make this economy do anything positive. The government can only cover short term losses that might lead to a collapse and the government can do some stupid things that might mess the economy up. The Soviets were great at that, for example. But the underlying utility for American financial capitalism...our Supply Side economy...to operate is leverage. Our multinational corporations, our largest banks and those immense non-banking financial institutions and markets that dominate the game require leverage to underwrite their balance sheets and to make their ROE numbers. If they are deleveraging...and they are...then they must reduce their asset bases, shrink their revenues, cut expenses to stay profitable, stop issuing equity (to keep their dividends up) and hold onto their cash. If they execute this drill carefully (and they seem to be) then their stock prices should stay up, specualtors will drive them higher and they will have earnings in spite of our recession.

They are all multinational players and the global economy is still growing in many places. It is entirely possible that they will find markets to exploit, continue beating up on US consumers and the DOW will look great while the American economy itself continues to decline and eventually recovers to 1% stasis. This will be a deflationary picture for the US dollar just like Japan yen has been enduring.

If our markets are not growing very fast then at least they are still very large and staying flat. So the Supply Side players...American corporations, Japanese, Germans, Koreans and Chinese can depend on us but they will sell their incremental units into consumer markets that are indeed expanding. The US is only 5% of the total global population anyway. And the opportunities here have already been saturated. We don't make money manufacturing our own stuff anymore. So if we are not buying so much then we will not make any money selling foreign made goods to ourselves either. Commercial real estate will sit empty (look around) and be less valuable. Also very deflationary.

The way this thing looks we have a choice between Japan's far right economic stasis and France's far left economic capitulation. Of course, we have President Obama to blame now...so we should feel good about ourselves that at least it's not our fault, we can die with a clear consciences and go straight to heaven!

All of us except Bernie, of course. There will surely be some hard time in purgatory for him. When he does show up in heaven, though Madoff will be smiling for all eternity because he really did grab this game by the horns, he was on top for a very long time and while he was he kicked all our butts. Greed is good...them's the rules...read 'em and weep. Bernie's problem is he lived past his prime and he never thought he would. Happens to Football players all the time. Go figure.

No Subject
FDR increase bank's reserve requirements by 55% in a year and then another 33% a year or so later causing banks to call in functioning loans from farms and businesses in order to have cash in the drawers to stay open. This also played a large part in putting 4 thousand or more banks out of business.
This time we are making sure there is money in the banks' tills to loan out.. as well as increasing reserve requirements. Milton Friedman talks about how government policies locked up the business environment in his Monitary Mischief. Others talk about the cartelization FDR fostered and the crazy inflation policies that directly harmed business recovery.
This time lots of people.. unfortunately most not part of this government.. seem to be on guard with some common sense economics and history to prevent a government triggered depression.

It doesn't matter what Bernanke does...
...because any Important Job in D.C. that 'opens up' is automatically slated for one of Obama's Cronies.

And the stupider and less educated the crony is, the better. Exhibit A: Sotomayor.

That's the very well established pattern both over the last few months as well as in the Thugocracy of Chicago.
The Fed chairman and board members will not be immune.

Quit? Just like that?
Appointees to high office serve at the pleasure of their president. Obama is assuming Bernanke is on the team. Should he just decide to quit?

That would be okay if you were Sarah Palin. You could just decide to walk off the job whenever it got to be too much for you. But I think Ben Bernanke has a much greater sense of responsibility than that.

"Governors may not be removed from office for their policy views. "
"Once appointed, Governors may not be removed from office for their policy views. The lengthy terms and staggered appointments are intended to contribute to the insulation of the Board--and the Federal Reserve System as a whole--from day-to-day political pressures to which it might otherwise be subject. If all Governors serve full terms, a President would be able to appoint only two Governors during a four-year presidential term. Moreover, even a President reelected for a second term would not have appointed a majority of the Governors until late in the second term. In reality, many Governors do not complete their fourteen-year terms, and recent Presidents have averaged more than one appointment to the Board every two years."

"As stipulated in the Banking Act of 1935, the Chairman and Vice Chairman of the Board are chosen by the President from among the sitting Governors and must be confirmed by the Senate. "
http://www.federalreserve.gov/generalinfo/faq/faqbog.htm

I don't think the president can fire anyone on the board. Just as he cannot fire the head of the FBI.

Not the way these things are done
Dis-appointments from high office are never so crude as that. A president would not humiliate anyone by firing him. He would have a word from the person in private, after which time that person would announce his retirement.

Writing a book, more time with his family, pursuing other opportunities or working on his golf game are all popular excuses.

He has no authority to do so.
Why wouldn't the Fed Chairman tell the president to **** off?

Who really has the juice?
The Fed chairman controls the economy, and the president's political future, and the head of the FBI has the secrets.
Who has the real control?

Dragged kicking and screaming
We've never had a situation where an appointed official had lost the public's confidence, to the point where the president hinted to him in casual conversation that he might want to pursue other opportunities.. and the guy dug his heels in and refused.

It's like in old Prussia, when the colonel screwed up. His aide would come to his chambers one night with a loaded pistol on a silk pillow. Then retire discreetly until he heard the shot.

If there really is mediocre performance, a great push should not be necessary. And I see no great popular tide now to the effect that Bernanke has been under performing.

Interesting thesis
"..any Important Job in D.C. that 'opens up' is automatically slated for one of Obama's Cronies."

Yup. Robert Gates, certified Republican and old pal of Bush the Elder.. our Secretary of Defense.

Ray LaHood, a Republican from Illinois, now our Transportation Secretary.

And very nearly Judd Gregg, the GOP's chief negotiator for the $700 billion bailout of the financial industry, as our Commerce Secretary. Until the Rs themselves shot him down.

Obama reached across the table.. and got his hand bit.

Still doesn't address the issue.
The President does not have the authority to replace the Fed Chairman until his term expires, by design, in the hopes that the economy is controlled apolitically.
You assert he does have such authority. (Standards and laws are damned annoying, no?)

I said 'important'
Defense is not considered 'important' to Obamacrats.

Or, their favor-grubbing constituents like ACORN or the pro-Baby Killer Lobby.

"Obama reached across the table.. and got his hand bit."

And so you blame the 'hand biters' don't you? Not the fool who stuck his hand out when anyone with any brains would know it would get bitten. That is what the Opposition does.

Roy's double standard
'Appointees to high office serve at the pleasure of their president'

Unless the president's name is George W. Bush and the appointees are deputy attorneys for the Justice Dept that he fired and had every right to w/o states cause.

Declare Victory--and Leave!
Why don't they ever know when to just quit? Personally, politically, and professionally--declare "Mission Accomplished," as did the latest Newsweek--and go on the lecture circuit, exit stage left.
But, no, the campaign continues.
Despite the latest "aw shucks, country boy" reincarnation of the cerebral Bernanke, he and his cohorts all say the same thing. Whether it be "we we we" oink of Orszag, juicy Sotto-voce Summers, "this is very important" Geithner, or ppp explosion Obama--these are lock-step lefty lieutanants. Their talking points are identical, "belt and suspenders," employment "lagging," and "green shoots." Remember the "jolt?" There is not a contrarian or originalist in the bunch.
You, dear precious Larry, have hit the nail on the head--do they have the "wisdom."
And, Bernanke, despite the Ivory Tower intellectualism, and the down-home charm, the Four-Point-Manifesto in the WSJ--what does he say at the end? "dual objectives of maximum employment and price stability." Now, wait a sec, dual mandate, yes, but..."price stability?" Let me check the charter.
The fact is, Bernanke is an indexer, not a prognosticator. He was WRONG about housing. He was WRONG about the recession. He was WRONG about the many "stimulus." If a trillion dollar stimulus was essential to end the recession--why is the recession "over" when only 8% has been spent? Check out his earlier Congressional testimony--he is WRONG WRONG WRONG>
Sure, with billions in bailout the banks are going through a relief rally, but the real economy is facing structural unemployment, rising deficit, impending inflation, commercial loan defaults, and distant rumblings on fiat currency. And, this, even before the newfound "regulations" take effect.
Which brings us to another point--Bernanke actually believes that he, and the Fed, are the best repository for this huge regulatory system, including a consumer protection agency? This guy has had his head too long in the rarified atmosphere of that Ivory Tower--oxygen deprivation, and/or pride, go before the Fall.
Much more to say, but enough for now, except LOVE YOU LARRY!

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