Ben Bernanke's Fed Offers Investors False Reassurance

On Wednesday, the Federal Open Market Committee left monetary policy unchanged. As they have done for months, Chairman Ben Bernanke and other Fed policymakers announced that the risks to the U.S. economy were balanced. Once again, they indicated that they would reconsider their stance as additional data dictates.

Unfortunately, while investors seemed to applaud the policymakers' lack of action, the truth is that the central bank's seemingly measured approach since Ben Bernanke's tenure began has had numerous unintended -- and unwelcome -- consequences. In my view, the Fed has:

• Encouraged bad behavior. By reassuring everyone that the economy remains in a holding pattern, policymakers have inspired investors to carry on as before: piling on leverage, taking excessive risks, and failing to prepare for the inevitable negative turn in credit, economic, and risk cycles.
• Fostered misperceptions about risk. Policymakers' continuing assertions that economic and inflation threats have more or less equal weight has engendered the illusion, in some quarters at least, that these two risks somehow cancel each other out, when it is the growing overall risk exposure that should matter most.
• Pointed investors in the wrong direction. The balance of recent economic data, including today's report on April retail sales, suggests that recession, rather than inflation, is the greater near term threat, but policymakers' have nonetheless managed to keep markets focused on the latter. As a consequence, investors have taken inappropriate actions that will come back to haunt them once the Fed acknowledges reality.
• Undermined policymaking effectiveness. In adopting what appears to be a reactive rather than proactive stance, the Fed has relinquished its leadership role, essentially leaving hedge funds, politicians, and foreign nations in charge of U.S. monetary policy.
• Laid the groundwork for future instability. With monetary policy being increasingly data-dependent, the risk is that policymakers will find themselves behind the curve at the worst possible moment. That boosts the odds that they will either under or overreact to a change in circumstances, or they will be totally blindsided by unforeseen events.

Despite what appears to be an unusually good start, Mr. Bernanke's next year on the job may not be so fortuitous.

The Wall Street Journal's MarketBeat Blog earlier noted some of my views on the subject in "Laissez-Faire Fed?"

Comments

[k_denninger:]

I agree entirely.

I've been following this on my blog at market-ticker.denninge... for quite some time.

The same-store sales picture is not unexpected. All you had to do is read the credit card issuer's financials during earnings season, then the credit report.

Duh. The home ATM machine is closed, so now we're charging up the credit cards.

That ends badly - very badly - when the consumer bangs up against his credit limit and can't refi it into the house any more!

2007 May 10 07:02 PM

[Phil Anthropy:]

The Treasury Sec on CNBC was talking about Chinese investment in our treasuries. I was confused, because on the one hand he said that foreign direct investment was ok, including purchase of treasuries, but on the other hand he said in reply to questions on Chinese diversification of reserve currencies that the amount of Chinese investment in treasuries was not that great. Assuming I understood him correctly and am quoting him correctly, I don't know which to believe. It seems to me that several speakers over the past months have said that the Chinese purchase of treasuries wasn't a large enough proportion of treasuries to hurt us if they stopped buying. If that is true, then who is doing the buying of treasuries? My own theory, for what it's worth, is that the Fed itself has been doing the buying, using printed money. I don't know if that could actually happen, but it would explain how interest rates can remain so low when our deficit is increasing, and how the printing of money can be noninflationary (it never gets into the economy -- just recycles into treasuries and other federal debt). I would love to be wrong on this, so please correct me if you have information that shows it to be all foolish conjecture on my part. From what I see, we are locked in a financial deadly embrace. If the dollar plummets, it will destabilize financial systems. So everybody is walking on eggshells trying to avoid that while still protecting themselves if it actually happens. I would presume that the diversification of reserve currencies isn't a big deal now, because governments are probably hedged against a falling dollar through currency options. But those options don't last forever, so eventually the Euro will ascend as the world's dominant currency, in my view. The big risk is that more countries will start pricing oil in Euros, not dollars, so nobody will want our dollars. We do have a lot of overseas sales of manufactured goods, but it is only a matter of time until the Chinese and Indians undercut us in those markets. I give it another 20 years or so, and unless trends change, we'll be waiters and dishwashers to the world's tourists. I hope I am wrong.

2007 May 10 11:58 PM