Don't Let The Door...

Includes: DIA, QQQ, SPY
by: Alhambra Investment Partners

My fellow Americans, our long national nightmare is over. Ben Bernanke has joined the millions of Americans in the unemployment line that he worked so hard to lengthen. Over two terms as Chairman and almost three years as a Governor of the Federal Reserve - interrupted by a brief stint as head of President Bush's Council Of Economic Advisers (talk about the blind leading the blind) - Bernanke presided over a massive devaluation of the U.S. Dollar, blew a housing bubble and nearly allowed the U.S. to fall into a monetary deflation in its aftermath, bailed out Wall Street and blew a bubble in emerging markets - and probably U.S. stocks - with QE. In his final act he managed to create a little global chaos on his way out with tapering. Not only that, but somehow he managed to escape Washington with his reputation intact. I read numerous articles this last week praising his tenure, primarily due to his response to the Great Crisis of 2008. That's akin to lauding a quarterback for making the tackle on an interception return (this was written on Super Bowl Sunday).

When Ben Bernanke arrived at the Federal Reserve in August of 2002, the U.S. Dollar index stood at 107 already down from its high of almost 120. At its nadir in 2008 the index scraped 71.33, a fall of a third against the currencies of our major trading partners. At the beginning of his term as Governor, gold was at $305 and at its peak had risen over 6 fold. If a nation's currency is a measure of its economic success then the Bernanke era must be considered nothing short of a disaster. Some might excuse him for the period that covers the end of Greenspan's term but it seems obvious, to me anyway, that it was Bernanke's deflation fears that led Greenspan down the path of keeping rates too low for too long in the aftermath of the dot com bust and 9/11. I hold no admiration for Greenspan, but Bernanke's influence was obvious and pernicious from its beginning.

Ben Bernanke is not solely responsible for the underperformance of the U.S. economy over the last 12 years. He had lots of help from President Bush, a string of bad Treasury Secretaries, President Obama and a series of Congresses - controlled at various times by both parties - with no clue what is required to allow for the healthy growth of a mostly free market economy. In an ideal world, the Fed would be largely irrelevant and the retirement of one Chairman and the hiring of a new one would go without notice. The Fed's job should be nothing more than maintaining a stable value for the dollar and acting as a lender of last resort - and that only very rarely and when done, according to Bagehot's rules. Bernanke's study of economic history apparently began and ended with the Great Depression. Unfortunately, we don't live in that ideal world and we are all forced to consider the actions of our monetary central planners.

And that brings us to Bernanke's well timed exit and the current contretemps surrounding the emerging markets. The falling dollar that I mentioned above and QE lie at the root of the emerging emerging market problems. Initially, it was the falling dollar and U.S. debt fueled consumption that fed capital into emerging markets. Capital goes where it is treated best and a country intent on devaluing its money - as the U.S. was during the Bush administration - doesn't fit the bill. After the crisis, the Fed's inflationary policies continued with QE and with China continuing to invest in capacity for the sake of capacity - I've referred to the period after the crisis as China's pyramid building phase - capital continued to flow to countries with the best growth prospects, emerging markets drafting in China's wake. The credit bubble that developed in the emerging world is now being deflated by the tapering of QE put in place by Bernanke before his exit, stage left. The Fed may believe and want you to believe that tapering is not tightening, but as our own Jeff Snider has pointed out repeatedly, for the rest of the world, it most certainly is. In a world of free floating currencies and free movement of capital, there is no such thing as independent monetary policy kept within national boundaries. What happens at the Fed most definitely doesn't stay at the Fed.

The problems in emerging markets are probably not over and there is a definite feedback to the U.S. economy and markets. Despite a growth acceleration in the second half of last year, the U.S. economy still suffers from lagging consumer demand and weak investment primarily due to weak income growth and continued deleveraging. That is a part of the problem with emerging market economies such as Brazil - and developed economies like Australia and Canada - that relied on Chinese raw materials demand to feed U.S. consumption. During the housing boom and now in the aftermath of its collapse, U.S. and European multinationals relied on emerging market demand - and financial engineering such as stock buybacks - for continued earnings growth. If that is now coming to an end or at least slowing considerably, earnings growth, that has been anemic anyway, may be even harder to come by. It seems unlikely that the recent rash of negative earnings warnings is entirely unrelated to the problems outside the U.S.

Unfortunately, the first sentence of this essay is probably not true. Ben Bernanke may be writing his memoirs but Janet Yellen now occupies his old chair and is, if anything, even more enamored of the Fed's power than her predecessor. Bernanke chaired the last meeting and the FOMC, maybe out of some sense of respect or maybe because they felt they had to, continued the tapering of QE Bernanke set in motion. Whether Janet Yellen will have the spine to continue it in the face of a slowing global economy is something I suspect we'll find out rather soon. I shudder to think what she might do to try and counteract the reaction to the end of Bernanke's years of monetary mischief. But at least we won't have Ben Bernanke to kick around anymore. He got out while the getting was good and didn't let the door hit him in the….