Page 2 of 2 Bernanke wins a bit of time
By Julian Delasantellis
down on the farm derangement, is off by 33%. Overall, the broad based Rogers
Commodity Index is off 17% from its highs, the CRB Commodity Index is off 16%.
In the Daily Telegraph, Ambrose Evans-Pritchard is reporting that Deutsche
Bank, once the most hard-charging of the commodity bulls in expecting higher
raw materials prices, is now advising its clients to take profits and sell out
of their positions, feeling that the current world economic slowdown will
inevitably lead to sharply lower commodity prices.
But plunging commodity prices are not the only indicator of spreading global
economic weakness. On July 3, the European
Central Bank, displaying the European elite's hypersensitivity towards rising
prices dating back from the belief that the out-of-control inflation led to
rise of fascism and Nazism in the 1920s, raised their short-term benchmark rate
to 4.25%.
At the time, the bank seemed to be promising more rate rises to come; now, with
the spreading economic weakness in Europe, the bank is trying to get the
message out that further rate hikes will be a long time coming-if they occur at
all. The perception that no more rate hikes are soon forthcoming out of Europe
is the cause of the euro's recent fall against the US$, from just over 1.6 to
just over 1.544 dollars per euro.
As described by Olivia Chung in her August 5, Asia Times Online article,
China to ease economic brakes, Chinese economic policy is once again
shifting towards an emphasis on growth, as a slowdown in exports to the
subprime stricken US and the rest of the Western world threatens to boost
joblessness. In the US, despite some good news on economic growth fueled by
last spring's government rebate checks, news that the US mortgage finance
crisis was now spreading out of the subprime sector to the supposedly more
creditworthy "Alt-A" loans, along with reports that the credit contraction was
now resulting in banks pulling in the lines of credit to their corporate
borrowers once considered well qualified and creditworthy, means that most
sober economic observers (those not interested in selling you a stock, a house,
or John McCain) believe that America's economic difficulties will be lasting
until at least well into 2009.
Against this backdrop, it is not surprising that Bernanke seems to feel he has
the room and leeway to soften his rhetorical barrages against inflation a bit.
Most observers feel that the statement that accompanied Tuesday's announcement
of no rate change was less strident in its emphasis on the need to contain
inflation than the statement of June 25.
Gone from the current statement is any concern with inflationary expectations
reflected in long-term futures prices, as is an observation that the downside
risks to growth have diminished. Perhaps most important to Bernanke, even with
the lesser emphasis on inflation, he still held on to the vote of Philadelphia
Fed president Charles Plosser, who, wanting a stronger anti-inflation Fed
stance, dissented from Fed cuts in March and April. Fisher of Dallas, who
apparently sees himself as a sort of Will Kane (Gary Cooper) lonely inflation
fighter, a la 1952's High Noon, once again desired an immediate rate
hike, and so once again dissented from the Bernanke consensus.
The question then becomes, if Bernanke sees the renewed danger of another
economic leg down, can he do anything about it?
There have been no general Fed short-term rate cuts since late April, but that
does not mean that all has been going swimmingly. The continued liquidity
stresses caused by the credit contraction and deleveraging in the financial
system are causing massive utilization of the special borrowing facilities,
such as the Term Auction Facility (TAF) and Term Securities Lending Facility
(TSLF), set up by the Fed to aid those banks that are being shut out of the
private short-term capital markets due to concerns about their continued
viability.
However, the banks are learning that usage of the special facilities represents
a form of Scarlet Letter (after the 1850 Nathaniel Hawthorne novel about an
adulteress forced to publicly wear a red letter "A" in 17th century
Massachusetts) of fiscal debauchery and licentiousness, as that, once word gets
around the markets that a bank is using the special facilities, other banks,
fearing the prospect that they won't be repaid, pull back even further from
their lending to the threatened bank. This is the reason that, even with the
225 points of short-term interest rate cuts since September, mortgage rates are
still roughly unchanged since that period. As of yet, nothing that the Fed has
done, either with the rate cuts or the special facilities, is seeming to be
able to persuade lenders that US real estate, and US real estate borrowers, are
all that safe an investment.
Of course, the next step could be another general interest rate cut. However,
if the commodity selloff suddenly reverses and the rallies resume, Bernanke
will then have to raise rates even further and faster to regain his
credibility. Also, if he pushes the Federal Funds target rate down towards 1%,
he would be implicitly walking in the shoes of his predecessor Greenspan, whose
driving of rates down to 1% in 2003 and '04 is now widely credited with stoking
the subsequent real estate and credit insanity.
Even if it is clear what a problem is, it does not automatically follow that
the solution is equally pellucid.
Americans should not expect any more help from the actual government; with the
federal budget deficit expected to more than double this year, to almost $500
billion, US consumers have probably seen the last of the checks they can take
to Best Buy to get more stuff from China.
Plutarch quoted Themistocles that the ancient warrior said he could, "were a
small and obscure city put into his hands, make it great and glorious". Now
that the anti-inflation insurgency on the Fed's Open Market Committee has been
successfully put down, now that all Fed power has been put into his hands,
Bernanke has free rein to make the US and world economies once again "great and
glorious." He had better do it fast. Things are getting worse, and time is
running out.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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