Page 1 of 2 Bad times get worse for Ben
By Julian Delasantellis
The 1970 movie Love Story has recent Harvard graduate Oliver (Ryan
O'Neal) and Radcliffe graduate Jenny (Ali McGraw) living off campus as Jenny
works to put Oliver through law school. The two have a spat, and Jenny runs
tearfully out of their apartment. Oliver goes out to find her, even returning
to the Harvard campus and its environs to find his lost love. Last week, US
Federal Reserve chairman Ben Bernanke, Harvard class of 1975, returned to his
alma mater, giving a commencement speech that was, in effect, an attempt to
find his lost credibility as an inflation fighter. Oliver found and was
reunited with his Jenny; Bernanke's search is proving far more problematical.
"That's life" Frank Sinatra sang, "that's what all the people say. You're
riding high in April, Shot down in May." Last week,
Bernanke was riding high on Tuesday and Wednesday, and yes, he went down in
flames on Thursday and, especially, Friday. He now is faced with a number of
policy choices in order to return to the US Federal Reserve's traditional
position of command of the monetary skies. Some of those choices are bad; the
rest are even worse.
Last month, I noted the apparent change in the Federal Reserve's policy
emphasis from their last meeting on April 30 (Self-Inflicted
US Misery Asia Times Online, May 28, 2008). Finally, the Fed had become
cognizant of the growing world inflation threat, a threat seemingly exacerbated
and intensified by the Federal Reserve's rapid fire "shock therapy" policy of
cutting interest rates, which was initiated in response to the
subprime/structured finance crisis that hit the markets late last summer. From
September to April, the Federal Reserve's benchmark Federal Funds Target rate
was repeatedly and rapidly slashed, from 5.25% to 2%. Eschewing the slow and
steady policy of his predecessor Alan Greenspan, who cut 25 basis points at a
time, Bernanke cut fast and hard, twice, on January 22 and March 18, reducing
the rate a full 75 basis points at a time.
Did it work, did it save the US and the world economy from the howling chasm of
the subprime/structured finance crisis? For a while, or, at least until Friday,
the application by the Fed of electric defibrillation paddles to the markets
seemed to have had its proper effect, helped by the Fed's switch of role in
mid-March to be the preacher at the shotgun wedding of brokerage houses Bear
Stearns and JP Morgan (see
A Risk Free Revolution, Asia Times Online April 2, 2008). No major
banks and/or financial institutions have failed since mid March; indeed, the
shares of the companies in the S&P 500 BIX bank stock index, luxuriating in
the implicit bailout umbrella Bernanke threw over their interests, rose over
20% from mid-March to early May.
Many economic reports, most notably the first quarter US GDP growth numbers
reported on May 29, came in surprisingly strong. Here, the US economy's free
market/Bush mouthpiece shills cackled, was the subprime crisis; roaring like a
lion in January, but now mewing like a kitten, tamed by the inherent dynamism
of the US economy unleashed by the Bush administration's tax cuts.
So, like the pre-WW I German General Staff's Schlieffen plan, which called for
the German army to quickly defeat the French, then wheel East to do likewise
with the slower mobilizing Russians, now, it was thought that it was time for
Field Marshal Bernanke to battle inflation.
The threat here was seemingly obvious. The US Government's Bureau of Labor
Statistics (BLS) keeps many data sets of the changes of prices in the economy,
from the Personal Communications Expenditure (PCE) Index favored by the Fed, to
the base Consumer Price Index (CPI) metric that measures - sort of - what real
people in the economy actually use and buy. All the measurements are now
showing growing inflationary pressures outside the Federal Reserve's comfort
zone.
Although we are not at present seeing the variant of late 1970s inflation
called cost-push, wherein rising prices led workers to demand wage increases in
excess of productivity gains, thus setting prices up for another round of
raises, the current variant of inflation, demand pull, arising from out of
increased demand for basic commodities from the newly industrializing economies
such as India and China, is proving to be just as potentially troubling.
From the time the Fed commenced its rate cutting last year to early March, the
widely followed CRB commodity price index gained almost 40% before settling
back a bit since then; just in the first five months of 2008, the Exchange
Traded Fund based on the Rogers International Commodity Index was up 14% - then
it tacked on another 7% just in the first week in June.
It was almost as if a laboratory simulation of the core monetarist creed that
inflation is caused by too much money (in this case from all those rapid-fire
Fed rate cuts) chasing too few goods was being run; in this case you had the
rare social science phenomenon of all the theories in a ready agreement with
the facts.
Of course, it is the meteoric rise in oil prices that is the prima donna in the
commodity inflation symphony. Even before last week's fireworks, crude oil
prices were up almost 35% just in 2008, an astounding 98% since last August.
Simultaneous to, and in many minds causative of, the oil price jump has been a
particularly severe fall in the value of the US dollar, down almost 20% against
the Euro since August.
Obviously, with all this intense inflationary pressure developing, both in the
United States and stretching all the way to the Persian Gulf countries that had
pegged their own currencies' value to the falling US dollar, the rate cuts had
to stop. In a happy coincidence brought about by apparent proper US central
bank policymaking, no more rate cuts were required - the subprime crisis was
over!
No longer a problem
In an address via satellite on Tuesday to the International Monetary Conference
in Barcelona, Spain, Bernanke set out a change in policy in that no longer
would the US dollar be simultaneously America's national currency and the
world's problem.
"We are attentive to the implications of changes in the value of the dollar for
inflation and inflation expectations and will continue to formulate policy to
guard against risks to both parts of our dual mandate, including the risk of an
erosion in longer-term inflation expectations. Over time, the Federal Reserve's
commitment to both price stability and maximum sustainable employment and the
underlying strengths of the US economy, including flexible markets and robust
innovation and productivity, will be key factors ensuring that the dollar
remains a strong and stable currency."
The following day at Harvard, Bernanke took another victory lap. In a
3,300-word address that found time to include his own, extended, wistful
school-day recollections on what it was like to be a fan of the hapless Boston
Red Sox baseball club in the 1970s, (but just one indirect reference to the
subprime crisis), Bernanke reassured the young leaders of tomorrow that his Fed
continued to stand ever vigilant to the inflationary threat of rising commodity
prices.
Since [Federal Reserve chairman] Paul Volcker's time ['79-'87], the
Federal Reserve has been firmly committed to maintaining a low and stable rate
of inflation over the longer term. And we recognize that keeping longer-term
inflation expectations well anchored is essential to achieving the goal of low
and stable inflation. Maintaining confidence in the Fed's commitment to price
stability remains a top priority as the central bank navigates the current
complex situation.
For a few hours at least, the sudden
appearance of the new sheriff on the anti-inflation beat seemed to be scaring a
lot of the troublemakers off the streets, or, more accurately, out of the NYMEX
crude oil futures pits. Oil prices, which opened trading on Tuesday at over
US$127 a barrel, fell almost 4% by the time Bernanke finished talking on
Wednesday. Surely, the Federal Reserve's new inflation fighting resolve was
going to make life painful and pointless for all those nasty speculators
scaring the townsfolk and riling up the horses with their high energy prices.
But it was then that reality, the eternal, black-hatted enemy of every
government bureaucrat who ever dreamed of wearing the tin star of the
benevolent and effective policy maker, rode into town.
A bull market in any traded stock or commodity does not mean that its price
just always goes up and up and up. No, even in the strongest bull markets,
prices always slow down, take a breather, sell off for a while, be it for
months or weeks, before starting back up again. However, if the selloff is
extremely brief, like the two-day oil market selloff of last Tuesday and
Wednesday, you know you’ve got a very bullish market, indeed, a virtual buyers'
panic, going on before your eyes.
In many cases, the biggest, most successful financial markets traders, those
with billions and billions of dollars under their management, use a trading
strategy called trend following, or momentum. This involves identifying the
primary trend, be it up or down, that a traded instrument is in, and then
buying when the price takes a temporary break down from that trend, or,
conversely, selling into rallies in bear markets. Since 1998, oil's primary
trend has been up. The trend-following money managers, or, more accurately, the
trading software of the trend-following money managers, saw the two-day price
break, and so were thus buying like crazy on the open on Thursday. Oil finished
up just under $6 that day, but that was just the opening act for a truly gory
market psycho slasher flick that would be produced on Friday.
In the markets, 8:30 am on first Friday of every month is the time when the
most important US economic statistic of the month is released, the non-farm
payroll (NFP) data, commonly known as the jobs or the employment report. This
report informs on the state of the nation's jobs and joblessness for the
previous month.
After showing a contraction in employment for the first four months of 2008,
there were expectations that the report for May
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