by Cullen Roche
Ben Bernanke spoke today at the International Monetary Conference in Atlanta. His speech was certainly market moving and as reports of the speech hit the wires the equity markets began to reverse on fears that QE3 is off the table. But there was a more interesting tone in his speech today than we’ve seen in the past. The Chairman was exceptionally defensive. In fact, the entire speech is basically an explanation as to why QE2 did not hurt the economy (of course it did). The most important section is attached:
“While supply and demand fundamentals surely account for most of the recent movements in commodity prices, some observers have attributed a significant portion of the run-up in prices to Federal Reserve policies, over and above the effects of those policies on U.S. economic growth. For example, some have argued that accommodative U.S. monetary policy has driven down the foreign exchange value of the dollar, thereby boosting the dollar price of commodities. Indeed, since February 2009, the trade-weighted dollar has fallen by about 15 percent. However, since February 2009, oil prices have risen 160 percent and nonfuel commodity prices are up by about 80 percent, implying that the dollar’s decline can explain, at most, only a small part of the rise in oil and other commodity prices; indeed, commodity prices have risen dramatically when measured in terms of any of the world’s major currencies, not just the dollar. But even this calculation overstates the role of monetary policy, as many factors other than monetary policy affect the value of the dollar. For example, the decline in the dollar since February 2009 that I just noted followed a comparable increase in the dollar, which largely reflected flight-to-safety flows triggered by the financial crisis in the latter half of 2008; the dollar’s decline since then in substantial part reflects the reversal of those flows as the crisis eased. Slow growth in the United States and a persistent trade deficit are additional, more fundamental sources of recent declines in the dollar’s value; in particular, as the United States is a major oil importer, any geopolitical or other shock that increases the global price of oil will worsen our trade balance and economic outlook, which tends to depress the dollar. In this case, the direction of causality runs from commodity prices to the dollar rather than the other way around. The best way for the Federal Reserve to support the fundamental value of the dollar in the medium term is to pursue our dual mandate of maximum employment and price stability, and we will certainly do that.
Another argument that has been made is that low interest rates have pushed up commodity prices by reducing the cost of holding inventories, thus boosting commodity demand, or by encouraging speculators to push commodity futures prices above their fundamental levels. In either case, if such forces were driving commodity prices materially and persistently higher, we should see corresponding increases in commodity inventories, as higher prices curtailed consumption and boosted production relative to their fundamental levels. In fact, inventories of most commodities have not shown sizable increases over the past year as prices rose; indeed, increases in prices have often been associated with lower rather than higher levels of inventories, likely reflecting strong demand or weak supply that tends to put pressure on available stocks.
Finally, some have suggested that very low interest rates in the United States and other advanced economies have created risks of economic overheating in emerging market economies and have thus indirectly put upward pressures on commodity prices. In fact, most of the recent rapid economic growth in emerging market economies appears to reflect a bounceback from the previous recession and continuing increases in productive capacity, as their technologies and capital stocks catch up with those in advanced economies, rather than being primarily the result of monetary conditions in those countries. More fundamentally, however, whatever the source of the recent growth in the emerging markets, the authorities in those economies clearly have a range of fiscal, monetary, exchange rate, and other tools that can be used to address any overheating that may occur. As in all countries, the primary objective of monetary policy in the United States should be to promote economic growth and price stability at home, which in turn supports a stable global economic and financial environment.”
He gets this partially correct, however, he is still in complete denial over the psychological effects of his policies and the speculative nature of market participants who believed the Fed was printing money and monetizing the debt. In fact, I don’t even think he’s in denial. I think he is being flat out disingenuous and completely unwilling to admit that he is now powerless. The reason I say this is because he discussed the psychological impacts of monetary policy in-depth in a speech in Japan in 2003. He said:
“A period of reflation would also likely provide a boost to profits and help to break the deflationary psychology among the public, which would be positive factors for asset prices as well. Reflation–that is, a period of inflation above the long-run preferred rate in order to restore the earlier price level–proved highly beneficial following the deflations of the 1930s in both Japan and the United States.”
This is exactly right. Beating deflation is largely a psychological battle, however, giving the public the impression that you are going to cause massive inflation through policies that neither you nor the public fully understands is no way to accomplish that effect. An economy battling deflation needs real economic growth and leaders who are not only willing to recognize the problems, but are willing to implement the right policy to combat this horrid economic disease.
The Fed Chairman is clearly being disingenuous with regards to his ability to influence the US economic recovery at this juncture. There’s no way you can be so cognizant of the psychological effects of monetary policy in 2003 and suddenly forget that impact in 2011. Then again, perhaps I am being a bit too hard on the Chairman. He is, after all, the ultimate academic. The banker of all bankers has zero actual banking and market experience so it would not be surprising to find out that the Chairman is oblivious with regards to the psychological impact of monetary policy on markets. Still, I find that hard to believe even though he has shown almost no ability to predict anything and has consistently been reactive to the economy and the markets when he should have been proactive. In other words, the Chairman has displayed a very poor understanding of the way markets react to the real economy and policy.
It’s time for the Wizard to step out from behind the curtain and inform Congress that he is not the omnipotent leader that everyone thinks he is. The Fed desperately needs the help of the US Congress in recognizing the plight that the US economy faces. The longer we wait and the longer Dr. Bernanke pretends to be the Wizard the longer this economic catastrophe will continue.
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