There Are None So Blind As Those Who Will Not See …

We already alluded to Ben Bernanke's admission that he once again suffers from advanced bubble blindness, but there were a few more pronouncements contained in his final speech as Fed chairman that are worth looking at. In an article in the Washington Post, the following was held to be worth highlighting:

“We hope that as the economy improves, and as we tell our story . . . people will appreciate and understand what we did was necessary and in the interest of the broader public,” Bernanke said. “It was a Main Street set of actions aimed at helping the average American.”

He may really believe that, but inflationary policy tends to redistribute wealth from relatively poorer strata of society to those who own the greatest amount of wealth and those who have first dibs on newly created money (there can be overlaps between the latter two). Initially, the policy was clearly intended to help with bailing out the big banks. Other than that, Bernanke makes the mistake of focusing on short run effects (monetary pumping always seems to 'improve the economy' in the short term – even Rudolf von Havenstein was able to make that claim) while completely ignoring the long run effects of yet another inflationary boomlet.

An article at Bloomberg reported a few more quotes from his speech and the subsequent Q&A. Let us review the 'bubble quote' in detail:

“Federal Reserve ChairmanBen S. Bernanke defended quantitative easing, saying it has helped the economy and shows no immediate sign of creating a bubble in asset prices.

“We don’t think that financial stability concerns should at this point detract from the need for monetary policy accommodation which we are continuing to provide,” he said today in Washington at a forum sponsored by the Brookings Institution.

Bernanke said of all the concerns raised about bond buying by the Fed, the risk it could prompt financial instability is “the only one I find personally credible.” Currently, asset prices are broadly in line with historical norms, he said.”

(emphasis added)

To the first sentence highlighted above, it should be pointed out that exactly the same argument was forwarded to justify the ultra-low interest rate policy implemented after the bursting of the Nasdaq bubble. 'Let's not worry about bubbles, we have an economic crisis to fix'. We all know how that turned out – what makes Bernanke think his echo bubble will turn out different?

As to the assertion about asset prices being 'in line with historical norms' – when it comes to stocks, the only 'historical norms' to which the current situation can still be compared are a small handful of moments in stock market history.  Cyniconomics recently had an interesting post on current valuations and where they actually stand in the historical context. John Hussman for his part pointed out that the current 'cocktail' of market syndromes (overvalued, overbought, overbullish, rising-yield conditions) could be observed only on the following occasions: August 1929 (sentiment imputed), December 1972, August 1987, July 1999 and June 2007. That's a who's who list of some of the worst times ever to believe that 'this time is different'. One suspects that Bernanke hasn't looked at a recent chart of margin debt either.

We may also wonder whether Bernanke has given any thought to the record issuance of junk bonds and especially 'covenant lite' and 'payment in kind' bonds observed over the past two years, or junk bond prices and yields themselves, since none of these yardsticks can any longer be said to align with 'historical norms'.

Junk bond yields – not even at the previous bubble peak was there comparable enthusiasm – click to enlarge.

We have of course an idea what Bernanke very likely bases his statement about 'historical norms' on – not on actual prices, P/E ratios or yields, but where they are relative to the interest rates manipulated by the institution he heads. In other words, he is not relying on history when he mentions these 'norms', he is relying on models that use his own manipulations of the money supply and interest rates as their major inputs.

However, the next remark really takes the cake in our opinion:

“Those who have been saying for the last five years that we’re just on the brink of hyperinflation, I think I would just point them to this morning’s CPI number and suggest that inflation is not really a significant risk of this policy,” Bernanke said, referring to a Labor Department report showing the consumer price index rose 1.5 percent in the past year. The Fed has set an inflation target of 2 percent.”

Let us leave aside for a moment that it is absurd to call a policy that targets a 2% annual decline in money's purchasing power a 'price stability' policy, or the fact that changes in relative prices represent a far more pernicious effect of the policy anyway. Let us also concede that hyperinflation is not an imminent risk and never was an imminent risk during Bernanke's tenure, although it is way too early to tell whether it won't become a risk in the future precisely because of the policy that has been pursued to date. There is after all no way to tell how the demand for money will hold up in the future, and how the central bank will react if/when a sharp decline in the demand for money should occur.

Rather, we have a major disagreement with his very definition of inflation and the assertion that 'inflation is not a risk of the policy'. It would be far more accurate to state that 'inflation IS the policy'.

Inflation of the money supply in the Bernanke era (denoted by the red rectangle). Inflation is not a 'risk' of his policy, it IS the policy – click to enlarge.

Bernanke further contends that the Fed is allegedly 'very worried' about the risks to financial stability its policies may create:

“Asked if the Fed’s efforts to fuel growth are creating asset-price bubbles, Bernanke said the Fed is “extraordinarily sensitive” to risks of financial market instability.

Referring to bond purchases by the Fed, he said, “it was at least somewhat effective, and given that we were at the limits of what conventional monetary policy could do, we felt that we needed to take additional steps.”

Fed officials saw diminishing economic benefits from their bond-buying program and voiced concern about future risks to financial stability during their December meeting, when they decided to cut the pace of purchases, minutes of the session showed.

At least one of his board colleagues (William Dudley) has admitted that they are really flying blind, and have not the foggiest idea whether or not 'QE' was/is 'effective', because they 'don't fully understand how it works'. So they have printed $4.65 trillion since 2008 without knowing what they are actually doing -  brilliant. The notion that they are 'worried about risks to financial stability' is belied by what asset prices have done as a result of the policy. While it is certainly not inappropriate per se to be worried here, it seems it is once again way too late (it strikes us as roughly comparable to the Fed getting worried about stock market speculation in the summer of 1929).

Lastly, here is Bernanke's interest rate non-forecast:

Referring to the FOMC decision to hold its main interest rate close to zero, Bernanke said today, “I’m not yet ready to conclude that very low interest rates are going to be a permanent condition.”

(emphasis added)

If Japan's post bubble experience is anything to go by, it will be 'ZIRP forever and ever', but that may admittedly not be an applicable comparison. It is quite conceivable that interest rates at the longer end of the curve will one day decide to 'get away' from the Fed's control – after all, it has happened before.

Conclusion

Like Greenspan before him, Bernanke is widely hailed as a savior upon retiring from his chairmanship, simply because he has presided over the kind of policy the central bank always implements on occasion of a bust: heavy monetary pumping, on an even grander scale than on the immediately preceding occasion (this is a result of the boom-bust amplitudes steadily increasing). The assessment of Greenspan's era has certainly become a lot more nuanced in the meantime. How history will ultimately judge Bernanke remains to be seen.

Charts by: St. Louis Federal Reserve Research