"I keep asking myself this question: What is the Federal Reserve seeing that I am not seeing?" This is how I started off my blogpost of March 4, 2013. This is an important question to me because I have always argued: Trust markets first.
I have led three banks in my career and I cannot tell you how many times I have heard bank chairmen, bank directors, and bank executives claim that the financial markets are wrong, that they just don't know what is going on with respect to the bank they were associated with. Generally, the belief was that the market was substantially under-valuing their bank.
Note that all of these banks were turnarounds (successful turnarounds I might add) and I was either the turnaround guy brought in to turn the bank around (twice) or the new chief financial officer of the management team brought in to turn the bank around.
The thing I found out in talking with investors and with analysts is that the financial markets knew very well the value of the banks and were more "spot on" than were the chairmen, directors, or executives that believed the market was not valuing them correctly.
Seeing this re-enforced my belief that one needed to trust markets -- in this case financial markets -- trust the markets first. The markets may be wrong, but see what they seem to be saying and work as hard as you can to interpret the market pricing before you start to look elsewhere. Only after trying very hard to find out what the markets are tying to tell you do you start to search for reasons why the market might, in this case, be wrong.
This is where I have gotten with respect to the Fed. I have looked long and hard at what the Fed is doing and have tried the best I can to understand why the Fed has been doing what it has been doing. My question has become, how has the Fed been interpreting the current environment?
For the longest time, I argued that one of the major reasons the Fed was doing what it was doing was the weakness of the banking system, particularly the weakness in a large numbers of banks that were smaller than the largest 25 commercial banks in the country. (These 25 banks hold more than 60 percent of the assets held by domestically chartered banks in the United States.)
My point was, and I still believe this to be the case, that the number of troubled banks in the United States was sufficiently large that the Federal Reserve felt it needed to keep plenty of liquidity in the banking system to allow the FDIC to close or arrange mergers for these banks in the least disruptive way possible.
For example, in the fourth quarter of 2012 the banking system lost 72 commercial banks. Only 8 commercial banks were closed during the quarter, yet the banking system shrunk by nine times the amount of banks that were closed. That is an annual rate of over 280 banks closing during a year! And, a large number of commercial banks still remain on the FDIC's list of problem banks.
To me, although they were not explicitly saying it, the Fed was being gentle on the banking system because the banking system was still extremely weak. The commercial banks needed "liquidity" in order to provide the "calm waters" to work in so that troubled banks could closed or be merged out of existence as smoothly as possible.
But in my mind, the Fed has gone beyond this. Mr. Bernanke and the Federal Reserve have just kept on pumping more and more "stuff" into the banking system. It seems as if this is all Bernanke knows! So, there must be more to the Fed's stance than just the solvency of banks.
This is why I suggested in my March 4 blogpost that "maybe Chairman Bernanke is afraid of some future Milton Friedman who is going to come along and say that the Federal Reserve and the chairman of the Federal Reserve, did not do enough to combat the Great Recession of the 2000s and did not provide enough stimulus in the 2010s to get the economy going again."
The point is Mr. Bernanke is focusing, like most economists of his generation, on the shorter-run -- on the immediate business cycle he is working within. He has lost sight of what might be going on in the longer-run.
I know, in the long run we are all dead. But, the long run becomes more important if there are dislocations in the economy that need to be worked out and that can't be overcome just by more and more short-term stimulus. The long run takes in a lot more than just putting people back to work in the jobs that they used to hold.
This is why I have focused on the fact that the period of the 1930s and 1940s was one of transition … the transition of the United States economy from an agriculture base to an industrial base. In the 1950s, the U.S. was structured differently than in these earlier times and the economic growth rate showed it. From 1950 through 1973 the U.S. economy grew at a compound rate of 3.9 percent. From 1973 though 2003 the economy grew at a compound rate of 2.9 percent. Recently, that compound rate has dropped to nearly 2.0 percent. Furthermore, the labor force makes up only about 63 percent of the working age population and capacity utilization is less than 80 percent. The former figure is around the 1960s figure while the latter is substantially below the capacity utilization figure during that decade.
I have come to believe that we are going through another transitional phase from an industrial society to an … information age? To an age of biological development? To an age of non-carbon-based energy? To an age of … well, I don't know what to call it because we are not there yet. But, short-term monetary policy solutions are not going to accomplish what Mr. Bernanke wants.
Can fiscal policy speed along the transition to a new age? Yes and no. I haven't got the space to discuss this at any length. I will just say that my view on this is: it depends -- and let it go at that.
So I posted my blogpost yesterday writing about the structural dislocations that exist in the United States economy and the fact that the United States is going through a transitional phase to get from the industrial society it was in the latter half of the twentieth century to wherever it is going to be in the future. I argued that monetary policy, especially quantitative easing, was not going to produce the economic growth that Mr. Bernanke and the Fed desired because these problems were structural and not cyclical in nature. I argued that the Fed was misinterpreting the situation.
Then I turned to the New York Times and found an op-ed piece written by Jeffrey Sachs, an economist at Columbia University. The article is entitled "On the Economy, Think Long-Term." The basic thrust of the article is "It's time to move beyond such transitory and piecemeal policies. Our underlying economic problems are chronic, not temporary; structural, not cyclical. To solve them, we need a systematic long-term approach."
I don't agree with all of Mr. Sachs' suggested solutions to the re-structuring. I do agree with him that short-run fiscal and monetary policies are not going to solve these longer-term problems.
Thus, I have moved on from the position that Mr. Bernanke and the Federal Reserve are not seeing something I am not seeing. I believe that they are just not reading the current situation correctly.