Page 1 of 2 Bernanke's words strike false note
By Julian Delasantellis
In 1968, the Australian rock band The Bee Gees sang the song Words, a melancholy
ballad of a penurious lover, trying to win the
hand of his intended through verse and prose, the
only romantic tools at his disposal:
Talk in everlasting words, and dedicate them all to me.
And I will give you all my life, I'm here if you should call to me.
You think that I don't even mean a single word I say.
It's only words, and words
are all I have, to take your heart
away.
Now, 40 years later, US Federal Reserve chairman Ben Bernanke tells the world
that he has reached the point where "only words, and words are all I have" to
deal with the simultaneous problems
of inflation and unemployment now bedeviling the global economy.
For the first time since last August, a meeting of the Federal Reserve
Board�s Open Market Committee has come and gone without a cut in US
short-term interest rates. After cutting the Federal Funds Target rate 3%, or
300 basis points, from September 17 of last year to last April 30, rates have
finally been held steady. Following the last rate cut, I
compared the current Fed chief to a losing poker player raising the
stakes to play one more penultimate hand; here, at last, he has stood up from
the table to attempt to cash in what few chips he has left.
Of course, the entire Fed rate-cutting enterprise was designed to counteract
the deleterious effects of the subprime/credit crisis, especially the threats
to the solvency of the banking and financial system. Therefore, with the rate
cutting now apparently finished, could one conclude that the threats to the
financial system have now passed, that the banks have picked themselves up out
of the gutter that they have been flailing around in as recently as last March?
That was the time of the emergency bailout of Bear Stearns. Following upon
that, have these institutions dusted themselves off and are now ready to resume
their central role as the purveyors of the essential monetary liquidity to the
general economy?
That's a fine view to hold, as long as you don't mind being contradicted by the
data. All of the various indices measuring the prices of stocks in this sector
have fallen well underneath the panic lows set during the dark days of Bear
Stearns in March. Shares in Citigroup, America's largest financial institution,
have fallen to levels not seen since the Asian financial crisis in late 1998.
Bank of America, with more of a presence in the once-considered more stable US
consumer finance market, has fallen to levels not seen since just after
September 11, 2001.
Up until recently, it was hoped that America�s smaller, regional banks,
not known to have been so foolish as to make the same head-first dives from the
high platform into the credit sewer that the big banks did with their subprime
collateralized securities, might be spared the worst of the banking system's
travails. Most of this wishful thinking is now dashed; the stock of previously
fast-growing Cleveland, Ohio-based Keycorp is down over 70% just this year.
At the core of the current difficulties is, of course, US housing, the spot
where the pin finally burst the leverage balloon. Here, things are looking just
about as bleak as ever. The April measurements of the S&P/Case-Shiller
Housing Price Index indicate that US housing prices are falling at the fastest
pace since the index was created 20 years ago, with futures prices based on the
index not indicating a price bottom until 2010.
At the very least, it appears that US home prices will be rolling off a cliff
until the last of 2007 vintage subprime/option ARM mortgages get reset in 2009;
up to 50% of these loans are now going into default. Until the vicious circle
of foreclosure - forced sale - lower prices - more foreclosures abates, the
pressure being transmitted from falling home prices will continue to be the
core of the dark cloud of de-leveraging hanging over the US financial system.
The 2007 crop of subprime mortgages, which were being written right up to the
credit freeze-up in August, was particularly pungent, for by then the banks had
already gone through all the subprime borrowers with even a chance of someday
paying back the loans; what was being reached for last year was the bottom of
the barrel, those dregs who couldn�t pay their mortgages even if the US
Mint left a printing press in their five-car garage.
It all sounds pretty grim. But at Wednesday's Federal Reserve Board meeting,
the Open Market Committee managed to actually dig through, as Ronald Reagan
used to say, all the ordure to find the pretty pony underneath.
According to the statement that accompanied the no-decision decision,
Recent
information indicates that overall economic activity continues to expand,
partly reflecting some firming in household spending. ...
The substantial easing of monetary policy to date, combined with ongoing
measures to foster market liquidity, should help to promote moderate growth
over time. Although downside risks to growth remain, they appear to have
diminished somewhat, and the upside risks to inflation and inflation
expectations have increased.
Of course, the recent "firming in
household spending" referenced in the statement is directly resultant from the
US$160 billion of stimulus checks sent out by the government in May. Like a
quick line of consumer cocaine, this kept the consumer wired high through the
spring, but now, as the hit wears off, the inevitable crash is returning, with
consumer confidence measurements reaching some of their lowest readings since
the surveys began in 1967.
So what accounts for the Fed's sunny chirpiness? Should someone tell the
pharmacy to put a hold on Ben Bernanke's next Prozac refill?
The Fed is acting as the Funny Clown of commerce because it has no real choice.
If it actually presented a realistic picture of the bleakness of the economic
situation, the question would be why it was not following up on its mandate to
foster full employment in the US economy with another rate cut. And, these
days, another rate cut is the absolute last thing that the Fed wants, or is
even able, to do.
Like hunting an escaped murderer imprisoned for a killing spree 30 years ago,
the US and world economy is once again being forced to deal with a threat they
probably thought they would never have to face again, simultaneously rising
inflation and unemployment, sometimes called stagflation. Led by the galloping
price of crude oil, but also including food price rises (in part resultant from
US farmers diverting corn production into ethanol to feed America's gasoline
addiction) US consumer prices are up 4% year over year, up 0.6% just in May
alone.
These numbers are well above the Fed's comfort zone "target ranges" for
inflation of around 2.5%; on page one of the owner's manual of any modern
central bank must be the warning, painfully learned in the late 1970s and early
1980s, that it's a lot easier to combat inflation in its earliest, larval
stage, before it hatches into a swarm, eating and destroying all it encounters.
So, therefore, at the most recent meeting, convincing arguments could have been
made to both raise and lower rates. The Fed did neither - that is the crux of
the predicament it has placed itself in.
It's not as if the Fed ignored inflation in the statement. Indeed, it said that
"in light of the continued increases in the prices of energy and some other
commodities and the elevated state of some indicators of inflation
expectations, uncertainty about the inflation outlook remains high ... the
upside risks to inflation and inflation expectations have increased".
Undoubtedly as the Fed expected, observers considered this stronger
anti-inflation language than what appeared in the statement following the April
30 meeting, when it was said that "Although readings on core inflation have
improved somewhat,
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