Ben Bernanke’s “Hail Mary”
Posted by Larry Doyle on August 29, 2010 11:12 AM |
Hail Mary passes are typically thrown late in a game in an attempt to clutch victory from the jaws of defeat. Ben Bernanke’s statement at the Fed’s Jackson Hole conference this past week is an indication that he is getting ready to throw his “Hail Mary.” The problem that I see, though, is that our ‘game’ is only somewhere in the second quarter.
Have you ever witnessed a football game where one team literally has to scrap its game plan because it finds itself in such a huge hole in the first quarter? That, my friends, is analogous to the state of the U.S. economy going into 2008. While we could debate whether the calls made by our coaching staff in Washington have helped or hurt our recovery, the fact is Ben and his fellow coaches have thrown everything and the kitchen sink at the economy and the results are anything but robust.
For a review of the game to date and the uncertain prognosis going forward, The New York Times’ Peter Goodman provides a wealth of ‘sense on cents’ in his fabulous and comprehensive commentary,
THE American economy is once again tilting toward danger. Despite an aggressive regimen of treatments from the conventional to the exotic — more than $800 billion in federal spending, and trillions of dollars worth of credit from the Federal Reserve — fears of a second recession are growing, along with worries that the country may face several more years of lean prospects.
On Friday, Ben Bernanke, chairman of the Fed, speaking in the measured tones of a man whose word choices can cause billions of dollars to move, acknowledged that the economy was weaker than hoped, while promising to consider new policies to invigorate it, should conditions worsen.
Yet even as vital signs weaken — plunging home sales, a bleak job market and, on Friday, confirmation that the quarterly rate of economic growth had slowed, to 1.6 percent — a sense has taken hold that government policy makers cannot deliver meaningful intervention. That is because nearly any proposed curative could risk adding to the national debt — a political nonstarter. The situation has left American fortunes pinned to an uncertain remedy: hoping that things somehow get better.
It increasingly seems as if the policy makers attending like physicians to the American economy are peering into their medical kits and coming up empty, their arsenal of pharmaceuticals largely exhausted and the few that remain deemed too experimental or laden with risky side effects. The patient — who started in critical care — was showing signs of improvement in the convalescent ward earlier this year, but has since deteriorated. The doctors cannot agree on a diagnosis, let alone administer an antidote with confidence.
This is where the Great Recession has taken the world’s largest economy, to a Great Ambiguity over what lies ahead, and what can be done now. Economists debate the benefits of previous policy prescriptions, but in the political realm a rare consensus has emerged: The future is now so colored in red ink that running up the debt seems politically risky in the months before the Congressional elections, even in the name of creating jobs and generating economic growth. The result is that Democrats and Republicans have foresworn virtually any course that involves spending serious money.
The growing impression of a weakening economy combined with a dearth of policy options has reinvigorated concerns that the United States risks sinking into the sort of economic stagnation that captured Japan during its so-called Lost Decade in the 1990s. Then, as now, trouble began when a speculative real estate frenzy ended, leaving banks awash in debts they preferred not to recognize and hoping that bad loans would turn good (or at least be forgotten). The crisis was deepened by indecisive policy, as the ruling party fruitlessly explored ways around a painful reckoning — boosting exports, tinkering with accounting standards.
“There are many ways in which you can see us almost surely being in a Japan-style malaise,” said the Nobel-laureate economist Joseph Stiglitz, who has accused the Obama administration of underestimating the dangers weighing on the economy. “It’s just really hard to see what will bring us out.”
Japan’s years of pain were made worse by deflation — falling prices — an affliction that assailed the United States during the Great Depression and may be gathering force again. While falling prices can be good news for people in need of cars, housing and other wares, a sustained, broad drop discourages businesses from investing and hiring. Less work and lower wages translates into less spending power, which reinforces a predilection against hiring and investing — a downward spiral.
Deflation is both symptom and cause of an economy whose basic functioning has stalled. It reflects too many goods and services in the marketplace with not enough people able to buy them.
For more than a decade, the global economy was fueled by monumental spending power underwritten by a pair of investment booms in America — the Internet explosion in the 1990s, then the exuberance over real estate. As housing prices soared, homeowners borrowed against rising values, distributing their dollars to furniture dealers in suburban malls, and furniture factories in coastal China.
But the collapse of American housing prices severed that artery of finance. Homeowners could not borrow, and they cut spending, shrinking sales for businesses and prompting layoffs.
Early this year, some economists declared that the cycle was finally righting itself. Businesses were restocking inventories, yielding modest job growth in factories. Hopes flowered that these new wages would be spent in ways that led to the hiring of more workers — a virtuous cycle.
But the hopes failed to account for how extensively spending power had dropped in the American economy, and how uneasy people were made by every snippet of data showing that houses were not selling, employers were not hiring, and stock prices were foundering.
Now, a new cause for concern is growing: the flat trajectory of prices, which might metastasize into a full-blown case of deflation.
The primary way to attack deflation is to inject credit into the economy, giving reluctant consumers the wherewithal to spend. The chief deflation fighter is the Federal Reserve, which traditionally adjusts a benchmark overnight rate for banks that influences rates on car loans, mortgages and other forms of credit. The Fed pulled this lever long ago, and has kept its target rate near zero since late 2008.
The Fed has also been more creative. During the worst of the financial crisis, the Fed relieved American banks of troubled investments, many linked to mortgages, to give the banks room to make new loans.
This engendered the sort of debate likely to fill doctoral dissertations for generations. Most economists praise the Fed for confronting the possibility of another depression. But the Fed added to the nation’s debts, provoking talk that it was testing global faith in the dollar.
The dramatic expansion of the national debt — which began in the Bush administration, via hefty tax cuts and two wars — has ratcheted up fears that, one day, creditors like China and Japan might demand sharply higher interest rates to finance American spending. Those rates would spread through the economy and inflict the reverse of deflation: inflation, or rising prices, as merchants lose faith in the sanctity of the dollar and demand more dollars in exchange for oil, electronics and other items.
So far, the reverse has happened. As investors lose faith in real estate and stocks, they are flooding into government savings bonds, keeping interest rates exceedingly low. Still, inflation worries occupy the people who control money, not least the governors of the Fed. The Fed has been seeking a graceful exit from its interventions, aiming to unload its cache of mortgage-linked investments and — likely in the far future — lift interest rates.
But the recent disturbing economic news has delayed those plans. This month, the Fed said it would take the proceeds from its mortgage-linked investments and buy Treasury bills to keep longer-term interest rates down. The Wall Street Journal reported that this decision came amid substantial disagreement among the Fed’s governors, suggesting that future action will be constrained by fears of inflation.
Republicans in Congress have embraced further tax cuts and less spending as the answer to the weak economy, while accusing the administration of squandering stimulus spending on efforts that brought little gain. Some conservative analysts liken the government’s reliance on spending and credit to imbibing another cocktail to take the edge off a hangover. In this view, the weak economy should be welcomed for the discipline it imposes, forcing a paring back of unsustainable spending, while building up savings that can finance investment and later feed healthy economic growth.
“The recession is the cure for the disease that affects the economy, but the politicians don’t have the stomach for it,” says Peter Schiff, president of Euro Pacific Capital, a Connecticut-based brokerage house. “They’re going to keep stimulating the economy until they kill it with an overdose. The hyper-inflation that results is going to be far worse than the cure.”
Germany, which has long harbored particularly powerful fears of inflation, has done relatively well in the current downturn without large stimulus spending, and that experience is now cited by adherents of austerity. But it can be argued that the Germans had two advantages over Americans: A more extensive social safety net to give consumers more money and the confidence to spend it, and a vibrant manufacturing base to churn out more goods for export.
Most economists who are close to the policy making arena for both parties take the position that austerity is the wrong medicine for what ails the American economy, and they dismiss warnings about inflation as akin to focusing on the side effects of chemotherapy in the face of cancer. First, they argue, take the medicine and stave off the lethal threat; then deal with the collateral problems.
Regardless, inflation fears persist, constraining what limited prescriptions might otherwise be thrown at a weakening economy.
The impending elections in November — with control of Congress hanging in the balance — has further narrowed the contours of political possibility
Six months ago, Alan Blinder, a former vice chairman of the Federal Reserve, and now an economist at Princeton, dismissed the idea that America’s political system would ever allow the country to sink into a Japan-style quagmire. “Now I’m looking at the political system turning itself into a paralyzed beast,” he says, adding that a lost decade now looms as “a much bigger risk.” Congress and the Obama administration have ruled out further stimulus spending. The Fed appears to be running out of powder. “Its really powerful ammunition has been expended,” Mr. Blinder says.
Even after the November election, few expect a different dynamic. “We’re already in a gridlock situation, and nothing substantive is going to change,” says Bruce Bartlett, who was a Treasury economist in the first Bush administration. “Clearly, a weak economy in 2012 will be very good for whoever the Republican presidential candidate is. It’s hard to see how the Republicans lose by blocking stimulus.”
On the other hand, if deflation emerges as a verifiable menace, many economists expect Mr. Bernanke — an expert on the Great Depression — to again champion aggressive measures, perhaps expanding the Fed’s balance sheet to buy pools of auto loans or credit card debt.
“It’s very likely the Fed will bend in that direction if the economy stays soft, especially if they are starting to see deflation,” says Kenneth S. Rogoff, a former chief economist at the International Monetary Fund, and now a professor at Harvard. “That’s really starting to loom.”
On Friday, Mr. Bernanke, whose board can operate independent of politics and the government, offered assurance that he still had powerful therapies to use should conditions worsen. Yet he also expressed concern about the potential side effects, underscoring a reluctance for more action.
“The issue at this stage is not whether we have the tools to help support economic activity and guard against disinflation,” he said. “We do.” Then he added: “The issue is instead whether, at any given juncture, the benefits of each tool, in terms of additional stimulus, outweigh the associated costs or risks of using the tool.”
Right now, many homeowners owe the bank more than their homes are worth, prompting some to abandon properties, adding inventory to a market choked with vacant addresses. An Obama administration program aimed at slowing foreclosures has prolonged trouble, say some economists, by failing to relieve borrowers of unsustainable debt burdens or making transparent the extent of losses yet to be confronted by the financial system.
“The big question is, who’s going to swallow the losses,” says Mr. Stiglitz. “It should be the banks, but they don’t want to. We’re likely to be in paralysis for years if they prevail.”
The Treasury sits in the middle, concerned by the continued weakness of housing, yet unwilling to pressure banks to write down mortgage balances.
Like their Japanese counterparts a decade ago, Treasury officials worry that forcing the banks to take losses could weaken them and risk another crisis.
By default, muddling through has emerged as the prescription of the moment.
“Early in the second quarter, and back drops Ben Bernanke into a shotgun formation, split wide is Tim Geithner, and Bernanke calls an audible. He appears to be indicating Geithner should go deep, very deep, ….”
If only this were just a game….
I have no affiliation or business interest with any entity referenced in this commentary. As President of Greenwich Investment Management, an SEC regulated privately held registered investment adviser, I am merely a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.
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