Page 1 of 2 Time for prayer
By Hossein Askari and Noureddine Krichene
In his testimony before the US Senate Committee on Banking, Housing and Urban
Affairs on February 24, Federal Reserve chairman Ben Bernanke depicted a
deepening economic recession with real output contracting at an annual 6.2% in
2008Q4 and unemployment rising to 7.6%.
This testimony was in sharp contrast with Bernanke's cheerful testimony of
February 2007:
I am pleased to present the Federal Reserve's Monetary
Policy Report to the Congress. Real activity in the United States expanded at a
solid pace in 2006, although the pattern of growth was
uneven. Real gross domestic product (GDP) is currently estimated to have
increased at an annual rate of about two-and-three-quarter percent in the
second half of the year. Consumer spending has continued to expand at a solid
rate, and the demand for labor has remained strong. On average, about 165,000
jobs per month have been added to nonfarm payrolls over the past six months,
and the unemployment rate, at 4.6% in January, remains low. The business sector
remains in excellent financial condition, with strong growth in profits, liquid
balance sheets, and corporate leverage near historical lows ... The central
tendency of those forecasts is for real GDP to increase about two-and-a-half to
3% in 2007 and about two-and-three-quarters to 3% in 2008. The civilian
unemployment rate is expected to finish both 2007 and 2008 around
four-and-a-half to four-and-three-quarters percent.
In 2007,
Bernanke was projecting solid economic growth and full employment in 2008. He
never foresaw financial chaos and economic collapse less than a year ahead,
with trillions of dollars in bailouts, disappearance of giant banks and
investment banks, effective government takeover of large banks, a stock market
crash that by some measures eclipses that of the Great Depression, and a global
recession with no end in sight.
Was this sudden collapse a surprise for economic and financial experts in the
US? It was not, but for Bernanke it certainly would appear to have been so. Yet
Bernanke had access to the most detailed and accurate economic and financial
information, the largest pool of economic model builders and macroeconomists in
the world and access to all major financial market participants in the US and
indeed around the world.
The rapid swing from solid growth to financial collapse and deep recession in
less than two years has not been brought about by natural causes and can be
largely explained by the Fed's failed aggressive monetary policy, through
reducing interest rates to zero bound, injecting unlimited liquidity, and
trying to reinflate the economy's way out of debt.
Such a powerful monetary shock precipitated the collapse of the dollar and
drove oil and food prices to limits that disrupted many vital sectors such as
transportation, agriculture, and manufacturing, contracted consumer spending,
and ultimately crippled the US as well as the world economy. The house of cards
- that is, an overleveraged inverted credit pyramid that was sensitive to even
small changes in interest rates - crumpled.
Following chairman Bernanke's latest monetary policy report presentation before
the US Congress Committee on Financial Services, on February 25, 2009, Ron Paul
(R, Texas) criticized the Fed's policy mistakes and fallacies in re-inflating
bubbles, in pushing unlimited negative real interest rate loans to over
indebted consumers, and in recapitalizing banks through unlimited creation of
money out of thin air. Paul attributed the economic and financial chaos to the
Fed's overly expansionary policy since 2000, noting that trillions of dollars
in bailouts and enormous fiscal stimuli had not yet spurred the economy.
Paul made a sharp distinction between capital and credit, a notion that the Fed
does not seem to understand. Credit can be created in unlimited fashion and
through printing money; capital, however, cannot be produced by the Fed's
liquidity creation. Capital is real consumer goods - corn, wheat, oil, and so
on - that are truly produced and saved to be transformed via investment into
machinery, cars, fixed capital, and the like.
Paul made the point that banks do want to lend; they had lost their real
capital in the form of bad loans and were now faced with negative real interest
rates; the government recapitalization through printing money was fictitious
and could not reconstitute real capital. He sharply criticized central banks
for continuing with failed policies and accelerating money printing, thus
undermining exchange rates and banking and economic stability. He stated that
current out-of-control money printing was only preparing for a collapse of
exchange rates and more devastating financial chaos.
The gap between Bernanke and Paul was wide. In spite of the ongoing severe
financial disorder and economic recession, and with much worse to come,
Bernanke was not convinced by Paul's strong appeal for restraining monetary
policy and allowing the market mechanism and private sector to work and help
restore economic growth. On February 25, Bernanke maintained that his
anti-market policies would work:
To break the
adverse feedback loop, it is essential that we continue to complement fiscal
stimulus with strong government action to stabilize financial institutions and
financial markets. If actions taken by the administration, the Congress, and
the Federal Reserve are successful in restoring some measure of financial
stability, there is a reasonable prospect that the current recession will end
in 2009 and that 2010 will be a year of recovery.
He projected
real GDP to recover at about 2-1/2% to 3-1/4% in 2010 and for inflation to
remain 1/4% to 1% in 2009-2010.
To achieve his high growth and low inflation objectives, Bernanke called for a
full-blast fiscal and monetary expansion, fiscal stimulus, unlimited bailouts
of banks, housing and borrowers of bad loans, with the same policies that led
to recession. He noted that:
Some borrowers presumably knew what they
were getting into, but from a public policy point of view, the large amount of
foreclosures are detrimental not just to the borrower and lender but to the
broader system. In many of these situations we have to trade off the moral
hazard issue against the greater good.
Why are large amount of
foreclosures detrimental not just to borrowers and lenders but also to the
broader system? If the large amount of foreclosures reflects an excessive
overvaluation and a large market imbalance between supply and demand, why not
let an orderly market adjustment take place to obtain equilibrium prices?
Was the sharp drop of oil prices from $147 per barrel to $35 per barrel
detrimental? Is it helpful to the financial system to bail out obvious Ponzi
finance and prevent speculative housing prices from adjusting? Is increasing
tax liabilities to subsidize overly inflated speculative prices good for the
system? Is subsidizing millions of people to live far above their means a sound
public policy? What is the greater good Bernanke wanted to achieve by
transferring free wealth to debtors by taxing wage earners, pensioners, and
future taxpayers? It is a zero-sum game.
After slashing the federal funds rate to zero, Bernanke vowed to use unorthodox
instruments for money creation by pushing the central bank into lending
programs to non-bank sectors, forced loans for triple-A subprime consumers and
mortgage credit, and revive the already defunct securitization. In spite of the
highest household indebtedness and highest rates of default, he put in place a
$600 billion facility for buying mortgage-backed securities and $1 trillion for
a Term Asset-Backed Securities Loan Facility for subprime borrowers. With banks
hit by unbearable losses and learning the hard lessons of unsafe banking,
Bernanke this time is now creating billions in toxic assets on the Fed's
balance sheet to loose at taxpayer's expense.
What is peculiar about Bernanke is that so far he seems to have remained
unaware of the extent of the damage he has caused by his cheap-money policy. He
has blamed the crisis on everything except on the Fed's destabilizing policies.
He blamed the current crisis on the housing market and does not acknowledge the
link between the housing crisis and imprudent monetary policy:
The
immediate trigger of the crisis was the end of housing booms in the United
States and other countries and the associated problems in mortgage markets,
notably the collapse of the US subprime mortgage market.
Such
an explanation, pointing to the effect instead of the cause, may mislead
laymen; it diverts attention from true causes, which were excessive fiscal
deficits, and unusually cheap money policy that pushed liquidity and lending
beyond all safety limits. Fiscal and money excesses caused the enduring
stagflation of the 1970s without any housing crisis.
Bernanke's simplistic view seems to be that if house prices
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