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Stop Thinking of Ben as Grandaddy of the Economy

October 28, 2011 Leave a comment

We can argue forever about how the Fed should do its job. And we can also argue forever about whether governments should control the money supply: If Not Ben, Who? If Not the Fed, What?

I find the latter most tedious because—debate it however much you like—that system ain’t changing anytime soon.

How about, instead, we stop thinking that the Fed has much or any ability to control the economy at all? Particularly in a globally interconnected system like now, why on earth do folks believe an institution like the Fed—ostensibly created to oversee and control commercial banking—would have the tools or ability to direct the larger economy? Because, if you do think that, then you have to ask yourself what kinds of tools the Fed actually has at its disposal to make the economy do what it wants. QE? Low short-term interest rates? Paying for deposits on reserve? These are great tools to control the fractional banking system, which admittedly plays a large role in the economy. But such things at best only obliquely address the wider economy.

We constantly read “is the Fed out of bullets?” It’s the wrong question—the Fed doesn’t even have the right kind of ammo in the first place and never has.

I’ve long argued in this space, on MarketMinder, and in my books, that markets and economies are CEAS (complex emergent adaptive systems). The recognition of this fact over and above the reductive mathematics of modern economics means also realizing the best way over time to create a stable, prosperous system is to allow it to form of its own volition. The Fed and its very small set of tools, and it’s very narrow mandate (stable prices and employment) are a poor place to look for savior or oracle. Certainly, metrics like the yield curve—its steepness and overall level—matter greatly to the economy. But I’ve always considered those things a function of whether the Fed was making a mistake in monetary policy rather than “making the economy grow”. The Fed can’t make the economy do anything, it can only set a few fairly narrow conditions (same is more or less true for the government). The rest is up to the economy itself (read: individuals acting of their own self interest).

But it’s also true that, though folks think of the Fed as an “institution”, and therefore generally unchanging and stodgy, it’s been one of the most dynamic and evolutionary financial entities of the last century. Particularly in the last 30 years, the Fed went from barely noted to holding press conferences on the economy and having its chairman show up on 60 Minutes (as noted here: Bernanke: Ready for His Close Up on 4/27.)

So, the public at large will keep looking to the Fed for messianic solutions, and the Fed will continue to evolve, particularly as a political entity. But don’t let that hype confuse you about what the Fed truly can and can’t do.

Fisher Investments Analyst’s Book Review: End the Fed by Ron Paul

January 28, 2011 Leave a comment

Congressman Ron Paul is now chair of the Monetary Policy subcommittee, which means he’s effectively chief antagonist to Ben Bernanke. Paul is a pure-form libertarian (read: pure-form tea partier), an ardent student of Austrian economics (read: laissez faire, free market capitalism), and has staunchly voiced his opposition to the very existence of the Federal Reserve every chance he gets.

With the new Congress fully installed, now seems the right time to have a look at Paul’s short but well-executed 2009 book, End the Fed. Of course, this is a political document, and on that basis it’s easy to see why Paul’s been around so long and did better than most expected in his 2008 presidential run—he’s a gifted communicator, able to exude down-to-earth everydayness, good humor, prudence, and practicality, but coupled with that eagle-eyed vision, intellect, and steadfastness that are the rhetorical hallmarks of most great public executives (be they CEO or president). Everything he writes sounds sensible, trustworthy, wonderful. You’d so like to have a drink with this gentleman.

This means, to really get value out of End the Fed, you have to work hard to be constantly vigilant of this layer of political rhetoric, especially when he relates stories about how he learned about money and saving as a kid from his father, as well as his encounters with economist Ludwig Von Mises and curmudgeonly philosopher Ayn Rand.

Past that, it turns out End the Fed is a great primer on how money, money creation, and central banking works. On some level, it’s refreshing to read a high-profile legislator write in such learned fashion on the issues he must, you know, legislate on.

Paul operates from the basic philosophical position that principles are more important than practicality. This is the crux of pure libertarianism. That is, panic of 2008 be darned, the Fed/Treasury/Congress had no business bailing out beleaguered banks—to a libertarian such intervention is morally wrong. In fact, in Paul’s view, liberty and freedom are antithetical to the way markets and banking are set up today. Because of moral hazard and the now-inextricable relationship between banks and the government, there really isn’t much true capitalism anymore. Instead, he describes today’s banking as a kind of public-private entity. Financial markets are really largely beholden to central planning of the government (he says), and the government has been manipulating the economy for many decades—from inflation to savings rates and basically all in between. He’d rather see the world do away with central banking altogether and return to the gold standard. (But he’s not really a “gold bug” per se. Paul says very clearly he doesn’t care if it’s gold or something else money is directly tied to—he just doesn’t want the government to control money supply.)

Mostly, Paul says the recent recession and most other banking crises are not the fault of capitalism but of the government—Fannie and Freddie, artificially low interest rates from Alan Greenspan, and so on. This all seems very compelling. But hidden in the sensible rhetoric is a classic mistake pure free marketers and socialists alike consistently make: Economic cycles can’t be “solved,” yet they prescribe and proselytize as if they can. We had depressions, bank runs and panics long before the Fed existed, and we’ve had them long after too—and will again. Fact is, we are in a more highly regulated world than ever before, but there’s still quite a lot of capitalism out there too. And as such, we’re not going to do away with economic cycles—ever. They’re part and parcel of markets. If you mitigate the downturns, you mitigate the economic growth. Efficient allocation of capital is of course beholden to short-term psychology, and corrections can be swift and devastating. But any good economist knows economic readjustment is usually better done with relative alacrity than drawn out for years, letting uncertainty fester. One can argue central banks exacerbated the recession/panic unduly; but maybe sometimes they helped avoid ruin too. But their existence won’t change the basic mechanics of capitalism, which is by nature destructive, cyclical, and ultimately wealth-creating for society. Cycles are here to stay.

This loops us back to Paul’s hard-line position that practicality must always be trumped by principles—his world is a kind of “no relativism zone.” That’s a fine and noble political view and an easy place from whence to evoke the Founding Fathers and other pious mantras. But investors steadfastly hold to principles at their peril. Bull and bear markets happen in both Elephant- and Donkey-led eras; in socially dominant and “deregulated” eras. William James’ Pragmatism is a much better worldview for an investor. (Of course, the communists didn’t do so well with their capital allocation.) In investing, it’s the pragmatic who evolve and see the world with clear enough eyes to navigate the many market situations encountered over a lifetime.

The bottom line, though, is this book is darn near essential reading if you want to understand an important contemporary undercurrent in US politics and central banking today. This is not a work of inflammatory flim-flam; it’s thought-provoking, well argued, and a fine contribution to the conversation.

Weekend Brief

December 6, 2010 Leave a comment
  • So far a recovery in employment hasn’t had anything to do with the bull market or the economic recovery. See this week’s (or this year’s) returns relative to the new higher unemployment number.
  • Few will see it this way, but history could very well show that the US —more or less—did things right once the crisis hit. At the outset, huge liquidity provisions to keep the system afloat, and once the recovery took hold a few years later it looks like we’ll get extended tax cuts and probably even some spending cuts. QE2 notwithstanding (granted, that’s a BIG notwithstanding), that’s actually a pretty good way to navigate a financial crisis on in to a recovery.
  • One of my favorite things is to read Fed commentary literature—it’s some of the best speculative writing since Ray Bradbury. Everyone thinks they “know” what Ben is “really” trying to say in his speeches. Ignore that stuff and act according to what is done, not said.
  • A worthwhile readWho Pays for Big Government?
  • Russia hosting the World Cup will be less a grand display of the country and its prospects and more like a last gasp on the global stage.
  • A thought-provoking and worthwhile opinion piece from Gerald O’Driscoll Jr. in today’s WSJ on whether we even need a central bank, and how the world might look without one.
  • EU business confidence recently hit an all-time high. The EU economy will grow nicely this year and projected next year too. It’s a bizarre dichotomy right now between European sovereign troubles and their recovering/thriving private economies.
  • The ECB extending unlimited lifelines to banks one quarter at a time doesn’t really help much at this point—knowing you’ve got a backstop for another 3 months doesn’t address the real issues. Although, it’s probably good that they didn’t sunset the program. That the ECB is buying Portuguese and Irish bonds right now is fine enough, but the scale of the purchases as of right now is way smaller than previous programs—it’s not a big initiative at this moment. Maybe it’ll grow…
  • …you can think about the debt crisis in poker terms: Ben Bernanke’s got a terrible bluff—usually telegraphing his moves well in advance. Trichet’s got a great poker face, sometimes even misdirecting the public before making a move. He says he doesn’t expect another big stimulus initiative by the ECB—I wouldn’t hold my breath on that, particularly with EU finance ministers meeting in a few days.
  • One of the main reasons for Europe ’s current fiscal problems is political. Have a look at Prime Minister Zapatero in Spain —he’s getting more unpopular by the day. Meanwhile, he’s got to figure out a way to make his budget work and support the smaller Spanish banks with dwindling political capital. Tough to get things done in that environment.
  • An interesting thing about Obama and his administration is that they’re nothing if not persistent. Initiatives like the Healthcare laws and parts of FinReg looked DOA and yet eventually got done. And now the South Korean trade pact—which looked all but dead a week ago after the tepid G20 summit—now looks like it could actually get done again. That’s a good thing…the US has woefully under-participated in new free trade pacts this year where the rest of the globe’s done tons.
  • Surprisingly profound quote of the Day: “It’s always here and now my friend, it ain’t once upon a time!” – David Lee Roth

 

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