Your Economy (No Politics)

[Bullwinkle]

It's Not About Bernanke
Comstock Partners, Inc.
Thursday, June 8, 2006


Poor Ben Bernanke. He inherited a mess that was probably beyond the capacity of any Fed chairman to solve and now the stock market seemingly plummets every time he opens his mouth. Although this should have been foreseen at the time of his announced appointment, the Street became so enamored of its “one and done” thesis that it overlooked the serious problems that should have been obvious at the time. In fact, the comment we wrote back in October bears repeating today, and we quote portions of it in the following paragraphs.

“It is indeed ironic that Ben Bernanke, upon his appointment as the next Fed Chief, found it necessary to promise a continuation of the Greenspan policies that are likely to cause him a great deal of grief during his coming tenure. While Wall Street is narrowly focusing on Bernanke’s qualifications for the job and whether he is an inflation hawk or dove, the important point is that the new Chairman will be inheriting a mess that is probably beyond the capacity of any Fed chairman to solve without a damaging recess and financial crisis.

Yes, Bernanke has an excellent resume, and, yes, the Greenspan era was marked by low inflation, decent economic growth and only two mild recessions. This economic record, however, was achieved by the creation of a record stock market bubble that ultimately burst, followed by a huge housing bubble that mitigated the damage, but led to a fragile, unbalanced economic recovery fueled by the cash raised from soaring home prices. The result is record household debt, negative consumer savings rates, a huge trade deficit and a dangerous federal budget deficit. All of this is being exacerbated by record energy prices…”

“Judging by Fed actions, statements and speeches, the FOMC’s main current concern is to prevent the huge rise in energy prices from creeping into the core inflation rate, although we also sense that they have been extremely concerned about the housing bubble as well. This is evident in their moves to clamp down on the more speculative aspects of mortgage lending and in the emphasis given to housing prices in Greenspan’s speeches and testimony in recent months. Given these concerns, it seems that the Fed is signaling that they will continue to raise interest rates at the so-called “measured pace” for at least the next two meetings…”

“Since the late 1990s the Fed has continually faced the dilemma of moving interest rates either too much or too little and, until now, has succeeded in avoiding great damage to the macro economy, although the stock market obviously suffered a major blow from which it still hasn’t recovered. At this point, however, they seem to have painted themselves into a corner with no place to go. That Greenspan, himself, seems to recognize this is obvious from his August speech at Jackson Hole, where he said, ‘Thus this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent…But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of debt that supported higher asset prices. THIS IS THE REASON THAT HISTORY HAS NOT DEALT KINDLY WITH THE AFTERMATH OF PROTRACTED PERIODS OF LOW RISK PREMIUMS.’ (Caps are ours).”

“It seems that after 18 years of cheerleading, the Chairman, in his last days in office, is now acknowledging the potential negative consequences of his policies. He leaves, however, with the knowledge that cleaning up the mess will fall to his hapless successor, and not to him. Whether Bernanke, despite his acknowledged brilliance, knows what’s awaiting him is not known, but he will find out soon enough.”

If Bernake did not really know what was awaiting him, he is certainly in the process of finding out now. He first tried a balanced approach by bringing up the possibility of a pause, but also said he would go with the incoming data. When Wall Street took this to mean that he was soft on inflation, he unwisely told Maria Bartiromo that he was misinterpreted. To prove his anti-inflation credentials he took a more anti-inflationary stance in his Congressional testimony and followed up with a hawkish-sounding speech a while later. As a result the Street now fears he may hike rates too much and cause a recession.

Investors wanted transparency, and now they have it, but they don’t like it. They wanted a chairman who would fight against inflation, but would not cause a recession. Although investors have an exalted view of what the central bank can accomplish, the fact is that the Fed’s power is severely limited, and they don’t have the tools to get the economy they desire. Having engineered a stock market bubble, followed by a housing boom, they are out of options, and there are no more obvious bubbles to create. They can pursue policies leading to inflation or recession or a combination of both with little or no room in between. In the end Greenspan finally got it right—“history has not dealt kindly with the aftermath of protracted periods of low risk premiums”. You can’t get much clearer than that.

http://www.comstockfunds.com/index.cfm/act/newsletter.cfm/CFID/3100225/CFTOKEN/15616716/category/Mar...