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Generational Dynamics Web Log for 13-Dec-07
Ben Bernanke: The man with increasing agony.

Web Log - December, 2007

Ben Bernanke: The man with increasing agony.

In 2005, I described Bernanke as the "The Man without Agony," because he didn't express any concern about the global financial situation. At various times in the past, he's said that he doesn't believe in bubbles, that the Fed could easily have prevented the 1930s Great Depression, that deflation is easily prevented, and that Fed jawboning is all you need to prevent inflation. This is all blithering nonsense, so much so that I've pretty much ignored most of what Bernanke has said, even since he became Fed Chairman.

That's all pretty remarkable, but what's even more remarkable is that Bernanke apparently learned nothing from the experience of the Japanese in the 1990s. Japan had a huge stock market bubble that burst in 1990, leading to 15 years of deflation. Bernanke, as I understand it, simply shrugged off Japan's experience, and blamed it on policy errors by the Bank of Japan.

(From the point of view of Generational Dynamics, Japan's experience was right on time. In brief, Japan had a major generational stock market panic and crash in 1990, just like America in 1929. But Japan's previous major stock market crash was in 1919. So you have: Wall Street: Crash in 1929, new bubble in 1995, 66 years later; Tokyo Stock Exchange: Crash in 1919, new bubble in 1984, 65 years later.)

In my 2005 article, I contrasted Bernanke's attitude with that of then-Fed chairman, Alan Greenspan. On this web site, I've been tracing Greenspan's changes of moods: Congratulating himself in January 2004; mixed emotions in July 2004; total repudiation of his previous views by February 2005; and his schizophrenic swan song as Fed chairman in August 2005.

This last speech contained a memorable paragraph that's worth reading again:

"Thus, this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent. To some extent, those higher values may be reflecting the increased flexibility and resilience of our economy. But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums."

Now, this is EXACTLY what's happened since then, and it's what happening now. The reason it's so memorable is that no one can claim they weren't warned. Did Bernanke even read this? If so, did he think that Greenspan was an old fool who didn't know anything?

And what about hotshot journalists like Greg Ip at WSJ, or Steve Lieseman at CNBC. Did they pay any attention?

This is a very significant and predictive paragraph, and yet I've never seen it quoted anywhere except on this web site. Why is that?

Actually, there is ONE place. It's referenced in an op-ed article appearing in the Wall Street Journal on Wednesday. The author? Alan Greenspan:

"On Aug. 9, 2007, and the days immediately following, financial markets in much of the world seized up. Virtually overnight the seemingly insatiable desire for financial risk came to an abrupt halt as the price of risk unexpectedly surged. Interest rates on a wide range of asset classes, especially interbank lending, asset-backed commercial paper and junk bonds, rose sharply relative to riskless U.S. Treasury securities. Over the past five years, risk had become increasingly underpriced as market euphoria, fostered by an unprecedented global growth rate, gained cumulative traction.

The crisis was thus an accident waiting to happen. If it had not been triggered by the mispricing of securitized subprime mortgages, it would have been produced by eruptions in some other market. As I have noted elsewhere, history has not dealt kindly with protracted periods of low risk premiums." [My emphasis.]

Later in the article, Greenspan points out:

"After more than a half-century observing numerous price bubbles evolve and deflate, I have reluctantly concluded that bubbles cannot be safely defused by monetary policy or other policy initiatives before the speculative fever breaks on its own. There was clearly little the world's central banks could do to temper this most recent surge in human euphoria, in some ways reminiscent of the Dutch Tulip craze of the 17th century and South Sea Bubble of the 18th century."

However, in keeping with general policy of telling half-truths, Greenspan doesn't bother to reach the conclusion that he's obviously implying: That the current bubble is going to end with the same kind of disastrous financial crisis as did the Tulipominia and South Sea bubbles.

Greenspan is clearly expressing a great deal of agony. Born in 1926, he's lived through and survived this kind of disaster before, and he knows what's coming.

But that leads to the obvious question: Does Ben Bernanke yet feel any agony? Has he begun to realize that his conclusions about the easy avoidability of the Great Depression -- conclusions that he arrived at while sitting on his grandmother's knee as a child, as I drescribed in "Bernanke's historic experiment takes center stage," -- has he begun to realize that his entire view of world finance is 100% wrong? Or does he still believe that he can save the world by announcing exactly the right kind of interest cut, accompanied by exactly the right kind of jawboning?

The events of the last 24 hours were apparently a great shock to Bernanke, if we're to believe the Wednesday morning chit-chat on CNBC. As we described in yesterday's article, commentators and economists were EXTREMELY CONTEMPTUOUS of the "miserly" Ľ% interest rate reduction announced by the Fed at 2:15, at which time the Dow Industrials fell 340 points.

If Bernanke really was shocked, then this is the first time we've known about it, and it may be a sign that Bernanke is finally beginning to question the nonsense he's believed since he sat on his grandmother's knee.

That contempt about the "miserly" rate cut continued through Wednesday, as defenders of Bernanke and the Fed were as scarce as hen's teeth.

Yesterday I discussed at length that investors are no longer interested in the market per se; all they care about is whether they anticipate a Fed "surprise" rate cut.

Along those lines, what happened on Wednesday was absolutely breaktaking.

Dow Industrials spiked 300 points, then started falling almost 400 points from the peak on December 12

Dow Industrials spiked 300 points, then started falling almost 400 points from the peak on December 12

Here's what appeared on the Wall Street Journal web site on Wednesday morning:

"Stocks Poised for a Rebound. Stocks are set to rally Wednesday on hopes the Federal Reserve, a day after a rate cut that disappointed the market, may step in to ease the credit crunch. Markets were mostly lower in Europe and Asia. 8:20 a.m."

And indeed they did rally, shooting up almost 300 points (Dow Industrials) within minutes after the market opened, by which time the Fed had announced its plan to inject liquidity into the economy.

(There were cynics who believed that the Fed's move was a reaction to the previous day's market plunge, but obviously the new policy was global and must have taken weeks to set up.)

Later in the day, the following appeared on the WSJ site:

"Fed Move Lights Fire Under Stocks. Stocks advanced after the Fed announced further steps to ease the credit crunch, though the major indexes were recently off their best gains of the day. Treasury yields surged. 1:02 p.m."

And by the end of the day it read:

"Stocks' Wild Ride Ends in Gains The Dow industrials climbed 41.13 to 13473.90, capping off a session of wild intraday swings with a modest gain as investors digested the Fed's plans to add liquidity to money markets and profit warnings from major banks. 6:26 p.m"

What's remarkable about all this, as I indicated yesterday, is nobody gives a damn about the stocks themselves, or the companies that they represent. Things are so bad in the credit markets that investors don't want to buy stocks, unless they believe that the Fed is going to "save the world."

As for Bernanke, he's in the midst of a major shock. Everything that he believed, everything that he taught as a Professor of Economics at Princeton is turning out to be completely wrong.

The conclusion that he reached on his grandmother's knee is that the Great Depression could have been avoided if the Fed had injected a little more money into the economy. Now he's beginning to realize the truth: That as the liquidity bubble recedes, there isn't enough money in the universe to end the credit crunch.

But it's more important than that. This represents the almost total collapse of the last few decades of macroeconomic theory. As I've said many times, mainstream economists have gotten everything wrong at least since the 1995 start of the bubble, including the bubble itself. Just before the Nasdaq crash of 2000 they were predicting that Nasdaq would increase forever. Many economists were saying that there's no housing bubble as late as a few months ago. Go back and look at their predictions about unemployment, inflation, and so forth, and you'll find that economists are far less reliable than weathermen are in predicting the weather.

And you can bet that nobody foresaw the current situation, or has any idea what to do about it. As I wrote last year in "System Dynamics and the Failure of Macroeconomics Theory," mainstream macroeconomic theory MUST include generational dynamics if it's going to work. But every time I mention this to one of these academics, they simply blow me off -- even though they get one thing wrong after another themselves.

As I've been saying for years, the entire world is in a huge bubble. That bubble is leaking, causing banks to hoard money. Bernanke and other central bankers are scrambling around, trying to keep the bubble from leaking, and of course they have no hope of stopping it. It's leaking because attitudes have changed massively among the entire Boomer and Generation-X generations. They're much less willing to take risks, and so they won't respond to Bernanke's schemes to stop the leaks.

It's worth repeating the paragraph from Greenspan's 2005 speech:

I wonder if Ben Bernanke is feeling any agony yet? Well, it doesn't really matter, because one way or the other, Bernanke is going to learn his lesson. (13-Dec-07) Permanent Link
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Generational Dynamics Web Log for 13-Dec-07 Ben Bernanke: The man with increasing agony.

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Generational Dynamics Web Log for 13-Dec-07
Ben Bernanke: The man with increasing agony.