Why We're In This Mess

by: Scott Sumner

Everything you need to know about our current economic mess is contained in the recent Bernanke testimony before Congress. Not his answers, which were mostly sensible, but the questions. From the WSJ blog:

Sen. Tom Coburn (R., Okla.) asks whether all the major central banks easing might diminish the benefits and lead to trade protectionism.

"We don't view monetary policy aimed at domestic goals a currency war," [Bernanke] says. Easing policy can be "mutually beneficial" to other countries such as China, which depends on domestic demand in the U.S.

It's a "positive-sum game, not a zero-sum game," Bernanke says.

Exactly. Not a zero-sum game.

What would be the effect on markets if the Fed were to liquidate a big part of its holdings?

Bernanke doesn't have to answer that question as directly as Toomey may have hoped. "We could exit without ever selling by letting it run off," he says. In any case, the Fed has said it would sell its balance-sheet holdings "slowly, with lots of notice."

Bernanke isn't letting these barbs go easily. Maybe this is what you do in what could be your final year as Fed chairman.

Bernanke takes control to make a broader point about the economy: "There's no risk-free approach to this situation. The risk of not doing anything is severe as well."

Exactly. Doing nothing is a highly risky policy.

Bernanke endorses the Bank of Japan's new easy money approach. "I think they should try to get rid of deflation. I support their attempts to get rid of deflation."

Thank God someone in the US government understands that Japan is being hurt by falling NGDP, and that the easier money required to end the deflation will likely lead to a lower nominal exchange rate. Recall that the Very Serious People in Europe are outraged by Japan's so-called "easy money" policy.

Bernanke gets hit with this question again: essentially, is the stock market getting bubbly?

"I don't see much evidence of an equity bubble," Bernanke says. Earnings are high and equity holders still are being somewhat risk-averse, he says.

Good, but I'd prefer he'd simply said that 1987 proved that massive stock market bubbles don't matter, not even a tiny, tiny, tiny, tiny bit.

Then things get even worse:

A testy exchange between Sen. Bob Corker (R-Tenn) and Bernanke. Corker says Bernanke has sparked a global currency war and created "faux" wealth. Bernanke says he's not engaged in a currency war or targeting the currency. Corker says Bernanke is the biggest monetary 'dove' since World War II, proud of it and degrading society. Bernanke shoots back that he's got the best inflation track record among Fed chairman since World War II. Corker says Bernanke is punishing savers with his low interest rate policies and throwing seniors under the bus.

I can forgive Corker for not having read Friedman; for not knowing that low interest rates usually mean money has been tight. Even for knowing absolutely nothing about what's happened to Japanese interest rates over the past 20 years, as they've followed the deflationary policy the GOP seems to prefer. But how can Corker not know that Bernanke has presided over the lowest inflation of any Chairman since WWII? That's a pretty basic piece of knowledge.

Now consider Bernanke's response. A policy of ultra-low inflation during a period of very high unemployment is shameful, and indeed violates the Fed's mandate to focus on both employment and price stability. The Fed is supposed to run below average inflation during booms and above average inflation during recessions. Indeed they are legally required to do so!

So we have Bernanke essentially bragging that he broke the law and helped create mass unemployment, because it's his only way of defending himself against those Senators who want him to break the law even more egregiously - to create even lower than post-war record low inflation in order to create even higher unemployment. Despite my sarcasm, I sympathize with Bernanke. Indeed I probably would have said the same thing.

As I keep repeating, future generations will shake their heads in disbelief when they survey this train wreck. I used to wonder how policymakers could have been so stupid in the early 1930s. I will never again ask that question.

PS. Did anyone demand more monetary stimulus? Did even one senator show any understanding of what's going on? (I didn't see the full transcript.)

PPS. I look forward to Bernanke's memoir, when we find out what he really thinks of our public servants. Let's just hope there's nothing on what he really thinks of our snarky bloggers.